| Disclaimer This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law. You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4. |
Edited version of your written advice
Authorisation Number: 1012721123200
Ruling
Subject: Undissected compensation payment to end disability insurance policy
Questions and Answers:
1. Is the compensation payment you received not taxable?
No.
2. Is the compensation payment you received taxable as a discount capital gain?
Yes.
This ruling applies for the following period
Year ended 30 June 2014
The scheme commenced on
1 July 2013
Relevant facts and circumstances
You took out a disability income insurance policy. At a later time, you submitted a claim for benefits and received monthly benefits under the policy. However, at a later time, the insurance company advised you that you did not meet the terms and conditions for an entitlement to a benefit under the policy and declined you claim.
You commenced proceedings against the insurance company, where you sought relief for: (i) the reinstatement of your monthly benefits under the policy; (ii) a declaration that you remained disabled in accordance with the policy definition; (iii) damages; (iv) interest; (v) costs; and (vi) any further order the court deems appropriate.
The particulars of injury, loss and damage in your statement of claim were listed as: (a) psychological injury; (b) financial loss; (c) liability for additional interest on loans; (d) cost of re-training; (e) loss of capital investments; (f) loss of monthly benefits; and (g) liability for legal costs.
Around two years after commencing your legal action, without admission of liability, you and the insurer agreed to resolve and wholly extinguish their respective rights and entitlements and purported rights and entitlements under the policy. A settlement sum was paid to you. The settlement sum was inclusive of interest and costs less any applicable tax required to be deducted by law (if any).
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 108-5
Income Tax Assessment Act 1997 Section 104-25
Income Tax Assessment Act 1997 Section 115-25
Income Tax Assessment Act 1997 Section 115-100
Income Tax Assessment Act 1997 Section 118-37
Income Tax Assessment Act 1997 Section 118-300
Reasons for decision
Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) explains a CGT asset is any kind of property or a legal or equitable right that is not property, such as a right to enforce a contractual obligation.
Paragraph 104-25(1)(b) of the ITAA 1997 states CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied.
For certain CGT events, including CGT event C2, section 115-25 of the ITAA 1997 provides for a discount capital gain where the capital gain results from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event.
The discount percentage for an amount of a discount capital gain is 50% if the gain is made by an individual who is an Australian resident (section 115-100 of the ITAA 1997).
Section 118-37 of the ITAA 1997 exempts compensation or damages (from CGT a capital gain you make from a CGT event) you directly receive for any wrong or injury you suffer in your occupation or for compensation or damages you receive for any wrong, injury or illness you suffer personally.
Section 118-300 of the ITAA 1997 also exempts a capital gain you make from a CGT event happening in relation to a CGT asset that is your interest in rights under certain insurance policies but not a disability income insurance policy.
Taxation Ruling TR 95/35 is about capital gains and the treatment of compensation receipts. In having regard to section 104-25 and 118-37 of the ITAA 1997, paragraphs 3, 18, 19, 20 and 21 of TR 95/35 state:
An undissected lump sum compensation receipt is any amount of compensation received by the taxpayer where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated.
If the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.
Compensation received by an individual for any wrong or injury suffered to his or her person or in his or her profession or vocation is exempt from CGT…
Exemption…is available if the taxpayer receives compensation in an undissected lump sum which relates wholly to the personal wrong or injury suffered by the taxpayer.
However, if compensation is received by a taxpayer in a lump sum paid in settlement of a number of claims, including a personal injury claim, and its individual components cannot be determined or reasonably estimated, no part of the compensation can be quantified as relating to the personal injury of the taxpayer. Accordingly, the exemption…does not apply to any part of the compensation.
In the case of Purvis v. FC of T [2013] AATA 58 (Purvis' case), the Administrative Appeal Tribunal considered the tax consequences of a pilot receiving a lump sum insurance payment for the loss of licence. Although the loss of licence came about as a result of illness or injury, the Tribunal found that the payment did not relate directly to compensation or damages within paragraph 118-37(1)(b). The amount was calculated without regard to the nature of the personal injury suffered, save that the personal injury had to result in the loss of licence.
In your case, similar to Purvis' case, your claim against the insurer was not related to personal injury. Instead, your claim was related to your contractual rights under the relevant policy. In addition, you also made claims for financial loss, the cost of re-training and loss of capital investments, which were unrelated to both personal injury and entitlements under your policy.
It follows your compensation (settlement) payment was an undissected lump sum that does not qualify for the tax exemptions under section 118-37 or section 118-300 of the ITAA 1997. Instead, your compensation payment was simply your ending of your right to seek compensation (CGT event C2).
As your right to seek compensation (a CGT asset) was acquired over twelve months prior to your settlement, your capital gain qualifies for the 50% capital gains discount.
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).
