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Edited version of your written advice

Authorisation Number: 1012937109156

Date of advice: 15 January 2016

Ruling

Subject: Assessable income - lump sum payment

Question 1

Is your payout of a claim against a Total Permanent Disability Insurance (TPD) policy included in your taxable income?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were forced into early retirement due to major health issues.

You took out a TPD insurance policy against such an event.

This policy is outside of your superannuation and independent from your employment.

You made a claim against the policy and received a lump sum

The premiums are paid on an annual basis; for which you never claimed a deduction.

Your policy insures life and provides a lump sum that is not tied to your income.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5,

Income Tax Assessment Act 1997 section 6-10,

Income Tax Assessment Act 1997 section 102-5,

Income Tax Assessment Act 1997 section 118-37 and

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

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts. 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:

A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. 

Application to your circumstances

In your case the lump sum you received was not earned by you as it does not relate to services performed. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the insurance policy, rather than from a relationship to personal services performed.

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. Amounts received in respect of personal illness which is not direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax provisions of the ITAA 1997.

Accordingly, the lump sum payment is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997 in the relevant, financial year.

Capital gains tax arising from the compensation payment

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Section 15-30 of the ITAA 1997 lists those provisions. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains.

However, paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made where the amount relates to compensation or damages you receive for any wrong, injury or illness you suffer personally. 

Application to your circumstances

The capital gain is disregarded under section 118-37 of the ITAA 1997 in the relevant financial year.

The TPD payment you received is not assessable under either section 6-5 of the ITAA 1997 or section 6-10 of the ITAA 1997.

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