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Ruling

Subject: Lump sum compensation payment

Question

Is any part of your lump sum payment assessable as ordinary income or as a capital gain?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2012

The scheme commences on

1 July 2011

Relevant facts and circumstances

You applied for an Income Protection Policy (the policy). Your application was accepted and you were issued with a policy number.

You sustained an injury and made a claim under the policy. The insurer accepted your claim and you had been in receipt of monthly income protection (IP) payments.

A dispute arose and the insurer ceased your monthly payments.

Without an admission of liability the insurer made you an offer to resolve all matters relating to the policy.

You accepted the offer by signing the deed of release (the deed) and a lump sum amount was paid into your nominated bank account.

By signing the deed, you directed the insurer to cancel the policy from inception and to extinguish any past or future rights under the policy.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 6-15(1)

Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

In your case the lump sum payment you received is not income from rendering personal services, from property or from carrying on a business. The payment is also a one-off payment and does not have an element of recurrence or regularity. The settlement was a result of a dispute between the insurer and yourself where they questioned the information provided by you at the time you applied for the policy and therefore, your right to receive income under the policy. It is not a lump sum payment which only substitutes for an income stream but rather for entering into a deed of release with your insurer for the purpose of surrendering your rights under the policy. The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income. Capital gains are one form of statutory income.

Taxation Ruling TR 95/35 deals with the capital gains tax (CGT) treatment of compensation receipts. The ruling provides that an insured person's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation. The whole of the settlement amount is thus treated as capital proceeds from a capital CGT event happening to your right to seek compensation.

The disposal of an asset gives rise to a CGT event. However, paragraph 118-37(1)(b) of the ITAA 1997 disregards the payments or receipts where the amount relates to compensation or damages received for any wrong, injury or illness you suffered.

Applying paragraph 118-37(1)(b) of the ITAA 1997 to your circumstances, the lump sum payment would not be considered as an assessable capital gain. The insurer's purpose in making the lump sum payment was so that you would surrender your rights to make a claim under the policy for any event, injury or illness, no matter when the event, injury or illness arose or occurred. As the claim related to your illness, any capital gain or loss arising from the surrender of your rights under this policy will be disregarded.

Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income. Therefore no part of the settlement amount is required to be included in your assessable income.

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