Edited version of your written advice

Authorisation Number: 1051204640225

Date of Advice: 21 March 2017

Ruling

Subject: Capital gains tax - trauma insurance proceeds

Question 1

Has a Capital Gains Tax (CGT) event occurred upon receipt of Trauma Insurance Proceeds by the company?

Answer

Yes.

Question 2

If a capital gain occurs, will the cost base include the value of all premiums paid under the Trauma Insurance Policy since inception?

Answer

No.

Question 3

Are you eligible for an exemption under section 118-300 of the Income Tax Assessment Act 1997 (ITAA 1997) on receipt of the proceeds?

Answer

No.

Question 4

If a capital gain occurs, will the cost base include the value of all premiums paid under the Trauma Insurance Policy since inception?

Answer

No.

This ruling applies for the following periods:

The year ended 30 June 2016.

The scheme commences on:

23 December 2015.

Relevant facts and circumstances

In 2000, a company (the company) took out a bundled key man insurance policy on its sole director and majority shareholder (the insured).

The insurance was provided by an insurer.

The purpose of the Trauma Cover component of the policy was to enable the company to restructure and continue operating if something were to happen to the insured.

The purpose of the insurance was not to replace income, but was for capital reasons.

The premiums were paid over for several years totalling a specified amount.

In 2015, the insured was diagnosed with an aggressive form of cancer.

In 2016, the insured underwent surgery and began ongoing treatment.

A claim was submitted to the insurer by the insured in relation to the Trauma Cover portion of the policy.

Later in 2016, proceeds of a specified amount were received from the insurer representing payment of the trauma benefit of the policy.

The amount received represented the full payout under the trauma definition of the policy due to the severity of the cancer and removal of all of the affected area.

You have not claimed deductions on the premiums for the duration of the insurance policy.

The company has been the owner of the policy for the full period of cover.

Proceeds were paid to the company, and not the insured.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 118-37

Income Tax Assessment Act 1997 Section 118-300

Income Tax Assessment Act 1997 Section 995-1(1)

Reasons for decision

Summary

When the right to seek compensation from the insurer was surrendered CGT event C2 occurred.

The premiums paid do not form part of the cost base as the right to seek compensation is deemed to be created immediately before the time of vesting. The premiums are not directly or substantially linked to the arising of the right to seek compensation.

You are not eligible for an exemption under sections 118-300 or 118-37 of the ITAA 1997.

Detailed reasoning

Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the capital gains and capital losses provisions, commonly referred to as CGT. You make a capital gain or capital loss if a CGT event happens. Many CGT events involve a CGT asset and some relate directly to capital receipts

There can be CGT consequences when you receive compensation. Taxation Ruling TR 95/35 gives the Commissioner's view on the treatment of compensation receipts.

If a compensation payment is not in relation to an underlying asset, it relates to the disposal of a right to seek compensation (paragraph 11 of TR 95/35). A CGT event occurs when your ownership of the right to seek compensation ends by being released, satisfied or surrendered. Any capital gain arising on a disposal of that right is calculated using the cost base of that right.

In your case, CGT event C2 occurred (section 104-25 of the ITAA 1997) when your interest in the right to seek compensation ended by being released, satisfied or surrendered. This occurred when the right to seek compensation from the insurer was surrendered following the insurance claim.

Cost base

Under section 110-25 of the ITAA 1997, the cost base of a CGT asset is made up of five elements:

1. Money or property given for the asset

2. Incidental costs of acquiring the CGT asset or that relate to the CGT event

3. Costs of owning the asset

4. Capital costs to increase or preserve the value of your asset or to install or move it

5. Capital costs of preserving or defending your ownership of or rights to the asset.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts provides in relation to compensation received under insurance policies, that the creator of the asset is deemed to acquire the asset and to have owned it immediately before the vesting time. At the vesting time, the taxpayer acquires the asset from the creator and is deemed to commence to own the asset. The vesting time is generally at the time of creation (i.e., for a right to seek compensation this is at the time of breach). Furthermore, the newly created asset is disposed of by the taxpayer on the release, discharge, satisfaction, or surrender of his or her right to seek compensation.

However, Taxation Ruling TR 95/35 also provides that the cost base of the asset of the taxpayer includes the sum of money and the market value of property given as consideration for the creation of the asset. The consideration on disposal of the newly created asset is the settled sum or the judgment debt.

In your case, you cannot include the value of premiums paid under the Insurance Policy in your cost base as the asset is deemed to be created immediately before the time of vesting.

Exemptions

There are exemptions for certain capital gains made from CGT events happening in relation to insurance policies set out in sections 118-300 and 118-37 of the ITAA 1997.

In Taxation Determination TD 2007/4 Income tax: capital gains tax: is a 'policy of insurance on the life of an individual' in section 118-300 of the Income Tax Assessment Act 1997 limited to a life insurance policy within the common law meaning of that expression? The Commissioner takes the view that the expression 'policy of insurance on the life of an individual' is not confined to the common law meaning of that term. The expression also includes a life insurance policy (as defined in subsection 995-1(1)) to the extent it provides for a payment to be made if an event happens that results in the death of an individual.

There is no policy reason why the exemption in section 118-300 of the ITAA 1997 should exclude situations where death of the insured happens because of a particular illness.

This means, for example, a payment under a trauma policy may be exempt under section 118-300 of the ITAA 1997 if it is paid in respect of the death (rather than illness) of the insured and the other conditions in the provision are satisfied. A payment under such a policy in respect of an illness will not be exempt under section 118-300 of the ITAA 1997, although it may be exempt under section 118-37 of the ITAA 1997.

Under subsection 118-37(1) of the ITAA 1997, a capital gain or capital loss you make from a CGT event is disregarded if it relates to:

(a). Compensation or damages you receive for any wrong or injury you suffer in your occupation [paragraph 118-37(1)(a)of the ITAA 1997];

(b). Compensation or damages you receive for any wrong, injury or illness you or your *relative suffers personally [paragraph 118-37(1)(b) of the ITAA 1997]

Under section 995-1 of the ITAA 1997

relative of a person means

(a) The person's spouse; or

(b) The parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendent or adopted child of that person or of that person's spouse; or

(c) The spouse of a person referred to in paragraph (b)

In this case, you are not eligible for an exemption. The exemption under section 118-300 of the ITAA 1997 will not apply as the payment was not made as the result of the insured's death. The exemption under section 118-37 will not apply as the company does not meet the definition of 'relative' under section 995-1 of the ITAA 1997 in relation to the insured.

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