Edited version of your written advice

Authorisation Number: 1051237608524

Date of advice: 14 June 2017

Ruling

Subject: Assessability of a lump sum compensation payment

Question 1

Is the lump sum payment regarded as ordinary assessable income?

Answer

Yes

Question 2

Are you entitled to a reduced amount of taxation on the lump sum payment?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commences on:

1 July 2016

Relevant facts and circumstances

You signed up to a risk insurance policy.

You worked in a family business with a family member. The business is no longer operating.

You were involved in a motor vehicle accident. You suffered significant injuries that are still impacting you.

The insurance company initially did not pay any amounts to you as a result of the policy.

You relied on your savings before receiving a disability support pension.

The insurance company eventually commenced making payments on a monthly basis.

The insurance company then advised that the benefits being paid were taxable. As a result, you applied for bankruptcy and have been subsequently discharged.

You have provided statements from your insurance company in relation to your insurance policy that shows you receiving a monthly benefit.

You have provided a quarterly progress form for total disability income protection confirming you are still unable to work.

You have provided a treating doctor’s statement advising that you are completely unable to work, and you will be unlikely able to work in the future due to ongoing pain.

You provided a medical certificate certifying that you have been on disability due to pain and a chronic injury.

Your insurance provider has provided you with an offer of a lump sum payment.

If you accept the offer:

● The claim will be finalised and you will not be required to provide your insurer with ongoing claim forms, further medical or other supporting evidence in relation to your claim.

● The policy will be cancelled and you will have no further right to claim under this policy in the future.

If you do not accept the offer:

● Your monthly benefit payments will continue subject to Progress Claim forms, treating doctors reports and other supporting evidence in relation to the claim.

You believe that the lump sum amount is for physical injuries, however, the insurance company and your doctor cannot confirm a total permanent disability.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-30

Income Tax Assessment Act 1997 section 118-37

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (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 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:

● Are earned;

● Are expected;

● Are relied upon; and

● Have an element of periodicity, recurrence or regularity.

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 (FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income:

● if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or

● to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

It is well established that, in general, insurance moneys are received on revenue account where the purpose of the insurance was to fill the place of the revenue receipt which the event insured against has prevented from arising (Carapark Holdings Ltd v. Federal Commissioner of Taxation (1967) 115 CLR at 633).

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was considered by the Commissioner in Taxation Determination TD 93/3. As outlined in paragraph 4 of TD 93/3, such a commutation would result in the lump sum remaining assessable, as its effect is simply to pay in advance the future periodic payments.

This view has also been confirmed in Sommer v. FC of T 2002 ATC 4815; 51 ATR 102 (Sommer’s case). The case involved a medical practitioner who had taken out an income protection policy. Following the rejection of the taxpayer’s claim for income replacement payments of $4,000 per month, the matter was settled out of court with the taxpayer receiving a lump sum.

The taxpayer argued that the amount was a payment of capital as it was paid as consideration for the cancellation of the policy, and the surrender of their rights under it or that the payment was capital as it was an undissected aggregation of both income and capital.

In dismissing the taxpayer’s appeal it was held that the payment was in settlement of income claims of the taxpayer in circumstances where the purpose of the insurance policy was to fill the place of a revenue receipt. As a result, the payment was clearly on revenue account. The fact that the payment was received in one lump sum did not change its revenue character.

It is acknowledged that in accepting the lump sum you will give up your rights in relation to compensation. However, it is considered that your case is similar to Sommer’s case and the lump sum represents redemption of the right to receive income and is also regarded as income in nature. The insurance policy is for Total Disability Income Protection. As the payment to be received will be for income, then it will retain its character of ordinary income.

The fact that the income will be made in one lump sum does not change the revenue character of the receipt as it will essentially be designed to compensate you in respect of your income claims or as a payment in substitution of those claims.

Consequently, a lump sum payment which relieves the obligation to make future payments to you retains its character of ordinary income and is assessable under section 6-5 of the ITAA 1997 in the year that you receive it.

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