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Edited version of your written advice

Authorisation Number: 1012745127944

Ruling

Subject: Lump sum payments

Question 1

Are the lump sum payments received under the income protection policy assessable as ordinary income in the year of receipt?

Answer

Yes.

Question 2

Are you entitled to a lump sum payment in arrears tax offset?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commenced on

1 July 2012

Relevant facts

You received income protection insurance payments in the 2013-14 financial year.

The lump sum payments related to arrears from previous years.

You are the owner of the income protection insurance policy.

Relevant legislative provisions

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

Income Tax Assessment Act 1936 section 159ZRA

Detailed reasoning

Lump sum payment

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443;10 ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

Therefore periodic payments received during a period of total or partial disability under an income protection policy are assessable on the same principle as salary and wages. This is because the benefits are a replacement of employment income during the period of total or partial disability (FC of T v. D.P. Smith 81 ATC 4114; (1981)11 ATR 538).

The fact that payments are received as lump sums in arrears do not change their revenue character. The lump sum in arrears payments also retain the character of being ordinary income.

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings sets out the Commissioner's policy on the derivation of income. Paragraph 42 of TR 98/1 states that income from employment would normally be assessable on a receipts basis. Salary, wages or other employment remuneration are assessable on receipt even though they relate to a past or future income period.

As your income protection payments replace salary, it is considered that the receipts basis is the correct method in your case. That is, the insurance payments are assessable when received.

This view is supported by Taxation Ruling IT 2107 which states that a lump sum payment of arrears of periodic workers' compensation payments is assessable income in the income year it is received. Like workers' compensation payments, income protection payments replace salary and similarly we consider that the receipts basis is the correct method of determining when a lump sum of arrears of income protection payments is assessable.

Lump sum payment in arrears offset

Section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936) allows a lump sum payment in arrears tax offset where the taxpayer's assessable income in a year of income includes one or more 'eligible lump sums'.

An 'eligible lump sum' is defined as a lump sum payment of 'eligible income' received on or after 1 July 1986 that is included in the assessable income of the taxpayer and accrued, in whole or in part, in an earlier year or years of income (subsection 159ZR(1) of the ITAA 1936).

'Eligible income' is defined in subsection 159ZR(1) of the ITAA 1936 to mean certain specified types of income. Paragraph 159ZR(1)(c) of the ITAA 1936 includes in this definition payments covered by section 12-80 or section 12-120 in Schedule 1 to the Taxation Administration Act 1953 (TAA 1953). Section 12-120 in Schedule 1 to the TAA 1953 refers to a payment that is;

The lump sum was made under a policy of insurance which you are the owner of. Therefore this lump sum is excluded from the definition of 'eligible income' and consequently is not an 'eligible lump sum'. Accordingly you not entitled to a lump sum in arrears tax offset under section 159ZRA of the ITAA 1936.

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