Edited version of your written advice

Authorisation Number: 1051258994532

Date of advice: 4 October 2017

Ruling

Subject: Income in Arrears Rebate

Question

Is Your Client entitled to claim lump sum payments in arrears tax offset for the payment from the Fund?

Advice/Answers

Yes

This ruling applies for the following period

Year ended 30 June 20YZ

Year ending 30 June 20ZZ

The scheme commenced on

1 July 20YY

Relevant facts and circumstances

Your Client is unable to work due to permanent incapacity.

Your Client’s career ended prematurely a number of years ago after they suffered a severe illness due to a workplace incident.

In the 20XX-XY income year Your Client lodged a claim against their income protection insurance with their fund (the Fund).

As a result of an internal error, the Fund advised Your Client they were unable to make a claim under their policy.

Recently, Your Client discovered that they are in fact entitled to claim on the Fund insurance and the claim should have been allowed back in mid 20XY.

The Fund have now accepted Your Client’s claim and agreed to pay their income protection claim retrospectively from the relevant period 20XY to 20YY.

Your Client received a payment in the 20YY-YZ income year and the remaining balance will be paid in the 20YZ-ZZ income year.

Relevant legislative provisions

Income Tax Assessment Act1997 Section 6-5

Income Tax Assessment Act1997 Subsection 6-5(2)

Income Tax Assessment Act 1936 Section 159ZRA

Income Tax Assessment Act 1936 Subsection 159ZR(1)

Reasons for decision

Lump sum payments included in assessable income

Subsection 6-5(2) of the Income Tax Assessment Act (ITAA 1997) provides that, as an Australian resident for tax purposes, your assessable income includes ordinary income derived directly or indirectly from all sources during the income year.

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.

Generally the character of a compensation payment received by an employee, and its taxation outcome, depend on the nature of the payment.

There are two types of compensation payments, which have different taxation outcomes. The two types are as follows:

● A compensation payment to make up for loss of earnings or in substitution for income which would otherwise have been earned, is in the nature of income, and is liable to income tax in the hands of the employee.

● A payment to compensate for personal injury is not liable to income tax in the hands of the employee.

Taxation Ruling TR 98/1 considers the appropriate method of determining when income is derived under subsection 6-5(2) of the ITAA 1997 where income is earned in one tax year but received in another.

The receipts method is likely to be appropriate to determine:

● income derived by an employee;

● non-business income derived from the provision of knowledge or the exercise of skill possessed by the taxpayer; and

● business income where the income is derived from the provision of knowledge or the exercise of skill possessed by the taxpayer in the provision of services,

Paragraph 42 of TR 98/1 states that salary and wages or other employment remuneration is assessable on a receipts basis. This is irrespective of whether that income relates to a past or future income period.

Lump sum payments in arrears are payments that relate to an earlier income year or years. Therefore, a lump sum amount of assessable income in arrears will be included in a taxpayer’s taxable income in the year in which it is received even when it relates to an earlier year of income.

Lump sum payment in arrears tax offset

Individual taxpayers who receive certain assessable lump sum payments containing an amount that accrued in earlier income years may be entitled to a lump sum in arrears tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936).

The tax offset is intended to overcome the problem of the lump sum attracting more tax in the year of receipt than would have been payable if the payment had been taxed in each of the years in which it accrued. The tax offset is broadly calculated as the difference between the extra amount of tax payable in the year of receipt because of the lump sum and the amount of tax that would have been payable if the lump sum had been taxed as it accrued.

Section 159ZRA of the 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. The definition includes compensation, sickness or accident payments.

To be eligible for the tax offset, the amount of the eligible lump sum that accrued before the year of receipt must not be less than 10% of normal taxable income in the year of receipt less the arrears amount (paragraph 159ZRA(1)(b) of the ITAA 1936).

Normal taxable income is Your Client’s taxable income less certain amounts as defined in subsection 159ZR(1) of the ITAA 1936.

In this case, the lump sum payment in arrears tax offset would apply to Your Client’s payment from the Fund.

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