Edited version of your written advice

Authorisation Number: 1012782630911

Ruling

Subject: Fringe benefits tax

Question

Can the otherwise deductible rule in section 24 of the Fringe Benefits Tax Assessment Act 1986 be applied to reduce the taxable value of the expense payment fringe benefits that arise from the payment of contributions to a loss of license insurance policy by more than 10%?

Answer

Yes

This ruling applies for the following periods:

1 April 2014 to 31 March 2018

The scheme commences on:

1 April 2014

Relevant facts and circumstances

The employer either directly pays or reimburses its employees for the premiums and contribution payments made to the various insurance providers.

The facts relating specifically to one of the loss of licence policies is as follows:

a. The premiums paid for the policy are contributions which are paid annually

b. There are three types of benefits that can be claimed under the policy being:

• Accidental Death - a lump sum payment to the estate of the member.

• Temporary Total Disability - made monthly up to a designated percentage of the member's income but no more than the maximum benefit amount.

• Permanent Total Disability - a lump sum benefit payment based on a pre-determined amount (less any payments already made for Temporary Total Disability). The lump sum payments bear no reference to the actual insured income and are paid once and for all as a lump sum.

The provider of the loss of licence insurance policy engaged an independent actuarial consultant to assess the proportion of the contributions to the policy that are in relation to Temporary Total Disability benefits.

The actuarial consultant provided an initial assessment that greater than 10% of the contributions to the policy are in relation to Temporary Total Disability benefits.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 section 20

Fringe Benefits Tax Assessment Act 1986 section 24

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Reasons for decision

Can the otherwise deductible rule in section 24 of the Fringe Benefits Tax Assessment Act 1986 be applied to reduce the taxable value of the expense payment fringe benefits that arise from the payment of contributions to a loss of license insurance policy by more than 10%?

Under the arrangement that is the subject of this Ruling the employer either directly pays the provider of a loss of licence policy or reimburses employees for contributions to the loss of licence policy.

Does a fringe benefit arise in relation to the arrangement that is the subject of this Ruling?

In general terms, the definition of a 'fringe benefit' in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) provides that this arrangement will be a fringe benefit if the following conditions are satisfied:

(a) a benefit is provided

(b) the benefit is provided to an employee or an associate of an employee

(c) the benefit is provided by the employer, an associate or a third party under an arrangement

(d) the benefit is provided in respect of the employment of the employee, and

(e) the benefit does not come within any of paragraphs (f) to (s) of the definition of a 'fringe benefit' in subsection 136(1) of the FBTAA.

It is accepted that the above conditions are satisfied and, therefore, a fringe benefit arises in relation to the arrangement that is the subject of this Ruling.

What type of fringe benefit is being provided?

The FBTAA categorises fringe benefits into 13 different types and each type has its own specific rules of calculating the taxable value of the fringe benefit.

Therefore, in order to calculate the taxable value of the fringe benefit under the arrangement that is the subject of this Ruling it is necessary to determine the type of fringe benefit provided by the employer.

Relevantly, section 20 of the FBTAA provides that an expense payment fringe benefit may arise in either of two ways:

a. where an employer reimburses an employee for expenses they incur, or

b. where an employer pays a third party in satisfaction of expenses incurred by an employee.

As the employer either directly pays the provider of the loss of licence policy or reimburses employees for contributions to the policy, the Commissioner determines that the fringe benefit provided under the arrangement is an expense payment benefit fringe benefit.

Taxable value of an expense payment benefit fringe benefit

Section 23 of the FBTAA provides that, in general, the taxable value of an expense payment fringe benefit is the amount the employer reimburses or pays.

However, section 24 of the FBTAA provides that where the recipient of the expense payment fringe benefit is the employee, the taxable value of an expense payment fringe benefit can be reduced in certain circumstances in accordance with the 'otherwise deductible' rule.

Under the arrangement that is the subject of this Ruling it is the employee is the recipient of the expense payment fringe benefit.

Broadly, the 'otherwise deductible' rule means that the taxable value can be reduced by the amount the employee would have been entitled to claim as an income tax deduction if the employee rather than the employer had paid for the expense.

Therefore, the taxable value of the expense payment fringe benefits that arise in relation to the arrangement can be reduced by the amount the employees would have been entitled to claim as an income tax deduction if they had paid for the contributions to the policy.

What is the amount the employees would have been entitled to claim as an income tax deduction if they had paid for the contributions to the loss of licence policy?

The Income Tax Assessment Act 1997 (ITAA 1997) stipulates in what circumstances an individual can claim an income tax deduction for an expense incurred. The general rules about deductions are found in section 8-1 of the ITAA 1997:

SECTION 8-1 General deductions

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

…

8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

Taxation Ruling TR 95/19 Income tax: airline industry employees - allowances, reimbursements and work-related deductions (TR 95/19) discusses income tax deductions for work-related expenses generally claimed by airline employees. In regards to loss of licence insurance TR 95/19 states the following at paragraphs 106 to 108:

106. The deductibility of premiums for salary guarantee and loss of licence insurance depends on whether the potential benefits payable to the insured are assessable or are considered to be of a capital nature.

107. The extent to which a premium is an allowable deduction is discussed in Taxation Rulings IT 208, IT 2230 and IT 2370. Generally, if the potential benefit is a one-off payment, e.g., for the loss of a limb, the payment is considered to be capital in nature and therefore the premiums are not deductible under subsection 51(1) of the Act.

108. However, where the benefit is by way of regular payments which replace lost earnings, the premiums are an allowable deduction to the extent of the portion of the premium which is attributable to the potential assessable benefits payable under the policy.

[emphasis added]

The amount the employees would have been entitled to claim as an income tax deduction if they had paid for the contributions to the loss of licence policy is the portion of those contributions that are attributable to potential assessable benefits payable under the policy.

What is the portion of the contributions to the policy that are attributable to potential assessable benefits payable?

ATO Interpretative Decision ATO ID 2002/175 Income Tax Assessability of income protection policy payments to financially support the taxpayer (ATO ID 2002/175) confirms that compensation payments that substitute income are held to be income under ordinary concepts:

Monthly payments received by the taxpayer under an income protection policy are assessable income under subsection 6-5(2) of the ITAA 1997.

..

Reasons for Decision

Subsection 6-5(2) of the 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 3 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:

• Are earned;

• Are expected;

• Are relied upon; and

• Have an element of periodicity, recurrence or regularity.

Payments of salary and wages are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997.

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 under ordinary concepts …

The monthly payments the taxpayer receives are intended to provide financial support for themselves and their family. The income replacement payments replace the salary and wages normally earned, expected and relied upon by the taxpayer. These payments are considered to be ordinary income as they acquire the character of the salary and wages for which they are substituted. The payments are assessable under subsection 6-5(2) of the ITAA 1997.

In Federal Commissioner of Taxation v Darcy Peter Smith 81 ATC 4114 (Smith) the assessability of benefits paid under a personal disability insurance policy is discussed.

In Smith the taxpayer was a medical practitioner who had paid a premium for a personal disability insurance policy. The policy provided that the insurer would pay a monthly indemnity for any period of total disability sustained by injury of the taxpayer. The benefit was not payable in respect of the first thirty days of disability and was reduced by any amounts paid under Workers' Compensation legislation. The taxpayer was injured and made a claim under the insurance. The case considered the assessability of the benefits paid and the deductibility of the premiums. In finding that the payments were assessable income the majority of Gibbs, Stephen, Mason and Wilson JJ stated at 4116:

Mr. Rowland points to some features of the policy to support his contention that the moneys paid under the policy do not bear a revenue character. No indemnity is payable in respect of the first 30 days of disability. If the disability continues beyond two years, then the monthly indemnity continues notwithstanding that the insured is then earning an income of whatever proportions so long as it remains the case that he is disabled from performing "each and every gainful occupation for which he is reasonably suited by education, training or experience". It is true that these features of the policy make it unlikely that the moneys received under the policy will bear any direct correspondence to the loss of earnings suffered by the insured. But do they fix those receipts with a character other than income? The existence of a qualifying period of 30 days is in our opinion entirely neutral in this regard. The fact that after a period of two years' disablement during which the insured is unable to engage in any gainful occupation at all he may then engage in some occupation other than that for which he is suited without jeopardising the continued receipt of benefits under the policy does not give those receipts a character different from that which would have attached during a period without any earnings at all. Even after the period of two years has elapsed, the inference of loss still remains. The loss of "ability to earn" in one's own calling is most likely to be reflected in an actual loss of earnings.

It is also to be noted that payment of workers' compensation will reduce the benefits payable under the policy. The significance that attaches to the question in the proposal form, namely,

"What portion of your average earnings does the disability indemnity under all policies you have and are applying for represent?"

may not be readily apparent, but at least it does not suggest that capital gain consequent upon a disablement is in contemplation.

In our opinion the conclusion is inescapable that the purpose of the policy is to diminish the adverse economic consequences of injury by accident. It was to provide a monthly indemnity against the income loss arising from the inability to earn. The revenue character of the benefits is so clearly stamped upon them during the period of two years during which the insured is totally disabled from earning that the remote possibility of him enjoying some windfall thereafter by reason of his securing gainful employment of the kind prescribed is of no consequence.

Murphy J, agreeing with the majority stated at 4118:

The fact that the receipts were calculated on a monthly basis points significantly, in a taxation sense, to the receipts being of an income nature. The premiums paid to achieve that income (if the contingency occurred) should be treated as allowable expenditure. If the premiums were paid to achieve a lump sum payment, for example for the loss of an eye, or for total or even partial permanent incapacity, presumably this should be treated as a capital receipt and the premium paid should be treated as of a capital nature. In general, if receipts under such a policy would be treated as income, the premiums should be treated as allowable expenditure and if the receipts would be treated as capital the premiums should not be allowable expenditure. Of course, there are circumstances where the premiums could be regarded as paid to acquire, if the contingency occurred, a benefit in the nature of an annuity; although the periodical sums received would be income, the premium could be regarded as paid to obtain a capital asset, the annuity. The Commissioner's argument was, as I understand it, that this was the arrangement here. To regard the policy in this way would introduce undue technicality and over-concentration on the analysis of intermediate steps. A practical business approach is to treat these amounts as the taxpayer did in his original return, that is, the premium as allowable expenditure and the receipts under the policy as assessable income.

There are three types of benefits payable under the loss of licence policy being:

a. Accidental Death - a lump sum payment to the estate of the member.

b. Temporary Total Disability - made monthly up to a designated percentage of the member's income but no more than the maximum benefit amount.

c. Permanent Total Disability - a lump sum benefit payment based on a pre-determined amount (less any payments already made for Temporary Total Disability). The lump sum payments bear no reference to the actual insured income and are paid once and for all as a lump sum.

Amounts payable in relation to Accidental Death and Permanent Total Disability are in the form of a lump sum payment. Consistent with the factors set out in ATO ID 20012/175 and in Smith these amounts will be treated as a capital receipt in the hands of the recipient.

Amounts payable in relation to Temporary Total Disability are in the form of a monthly payment. Consistent with the factors set out in ATO ID 20012/175 and in Smith, these amounts will be treated as an income receipt in the hands of the recipient

Therefore, the portion of the contributions to the loss of licence policy that are attributable to potential assessable benefits payable is the portion of the contributions to the policy that are attributable to potential Temporary Total Disability benefits rather than potential Accidental Death and Permanent Total Disability benefits.

Apportioning the contributions to the loss of licence policy between those attributable to Total Disability and those attributable to Accidental Death and Permanent Total Disability

Guidance for apportioning insurance premiums where there is both income and capital benefits is found in Case R 100 84 ATC 659 (Case R 100) and Taxation Ruling No. IT 2230 Income Tax: Loss of licence insurance (IT 2230).

Case R 100 concerned a taxpayer who was an airline pilot and a member of a voluntary loss of licence insurance fund through which three types of potential benefits were payable; monthly payments, a lump sum death benefit and a lump sum payment on permanent or deemed permanent loss of licence. In his income tax return the taxpayer had claimed a deduction for the cost of the premiums paid during the relevant income tax year. The Court allowed the taxpayers claim for the deduction in part, finding that the lump sum payments under the policy would be capital payments, the monthly payments income and that the amount of the premiums paid by the taxpayer attributable to the potential income payments only was deductible.

The Court held significant discussion regarding how to apportion the total premium paid to potential income and capital benefits, ultimately finding that 10% was a reasonable amount to attribute to the income benefits.

McCarthy J, forming part of the majority stated at 668:

10. … The quantum of material necessary for apportionment and the manner in which the apportionment is made will depend upon the circumstances of the particular case and the item which is sought to be apportioned. But it is certainly correct to say that arithmetical or actuarial precision is not required in this type of case. On the other hand, the peculiarities of the instant case cannot be disregarded. These principles were laid down by the Full High Court in Ronpibon N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R 47 where the Court said at pp. 59-60:

…

It is perhaps desirable to remark that there are at least two kinds of expenditure that require apportionment. One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. Of this directors' fees may be an example. With the later kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income. It is an indiscriminate sum apportionable, but hardly capable of arithmetical or ratable division because it is common to both objects.

In such a case the result must depend in an even greater degree upon a finding by the tribunal of fact …

The Court must make an apportionment which the facts of the particular case may seem to make just, and the facts of the present case are rather special. In making the apportionment the peculiarities of the cases cannot be disregarded.

…

11. Thus the inability of the actuary to determine with actuarial precision the amount of the premium attributable to the potential income benefits does not necessarily preclude the deductibility of a proportion of the premium. It would only do so if actuarial precision were required and the Full High Court has clearly held that this kind of exactness is not required for the purposes of sec. 51(1). On the other hand, if a taxpayer comes before a Board of Review seeking a deduction of 80% of his motor vehicle expenses of which the Commissioner has only allowed 50%, and the taxpayer's recollection is vague and his records non-existent, to pluck a figure out of the air would merely be to make "a third guess" as distinct from making a fair and proper apportionment. In such as case the evidence would not provide sufficient material for apportionment.

12. In my opinion the evidence provides sufficient material to enable an allowable amount to be determined without doing injustice to one side or the other. In the circumstances I consider 10% of the premium is attributable to the potential income benefits and should be allowed as a deduction in accordance with sec. 51(1) …

IT 2230 Income Tax: Loss of Licence Insurance sets out the ATO's view on the application of the decision in Case R 100:

11. The decision should be applied in comparable fact situations where taxpayers have paid premiums in respect of loss of licence insurance policies which provide for payment of periodic benefits of an income nature as well as benefits of a capital nature.

12. While the amount to be allowed in a particular case will need to be determined having regard to the terms and conditions of the loss of licence insurance policy, it may generally be accepted that in situations where the benefits payable under the terms of the insurance policy are similar to those described in paragraphs 2, 3 and 4 above, and are essentially geared towards the payment of a capital sum for the loss of a contributor's capital asset - the licence to fly - a deduction of 10% of the premium paid would represent a proportion fairly and properly attributable to the potential income benefits payable under the policy.

13. In situations where a greater deduction is sought, the taxpayer will need to furnish additional information such as an actuarial certificate from the insurer outlining the basis upon which the calculation has been made.

[emphasis added]

The provider of the loss of licence policy engaged an independent actuarial consultant to assess the proportion of the contributions to the policy that are attributable to Temporary Total Disability benefits and to Accidental Death and Permanent Total Disability benefits.

The actuarial consultant provided an initial assessment that greater than 10% of the contributions to the policy are attributable to Temporary Total Disability benefits based on information provided by the provider of the policy.

The Commissioner considers that the assessment provided by the actuarial consultant is a fair and reasonable method of apportioning the contributions to the loss of licence policy attributable to Temporary Total Disability benefits.

Conclusion

The Commissioner accepts that a fair and reasonable assessment of the portion of the contributions to the loss of licence policy that are attributable to potential assessable benefits payable is greater than 10%.

Therefore, the otherwise deductible rule in section 24 of the FBTAA can be applied to reduce the taxable value of the expense payment fringe benefits that arise from the payment of the contributions to the loss of licence policy by more than 10%.

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