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Edited version of your written advice
Authorisation Number: 1051362593538
Date of advice: 23 April 2018
Ruling
Subject: Assessable income - Income protection lump sum payment
Question
Is the lump sum payment that you have been offered to finalise your income protection policy claim be included in your assessable income as ordinary income?
Answer
Yes
This ruling applies for the following periods:
1 July 2017 to 30 June 2019
The scheme commences on:
1 July 2017
Relevant facts and circumstances
You are the policy owner of an income protection insurance policy.
The policy entitles you solely to income replacement payments should you meet its conditions for a claim.
You have been paid income protection benefits under the policy for the past x of years due to suffering a serious chronic illness.
You receive these payments on a periodic basis.
The insurer reviewed your claim and the unlikely change in your symptoms for the foreseeable future and made an offer to fully settle your claim under your income protection insurance policy.
The offer letter notes that these type of lump sum settlement payments are generally treated as assessable income.
The insurer sent you a proposed Deed of Release. In consideration of them paying you a lump sum amount you agree to:
(a) surrender all your remaining rights and entitlements to benefits including all income and other benefits under the Policy in respect of the Claim; and
(b) the Policy being cancelled with effect from the date you execute the Deed of Release.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Subsection 6-5(2)
Reasons for decision
Summary
The periodic payments you were entitled to receive under the policy was to substitute for the income you would have otherwise earned if not for your incapacity to earn as a result of the illness. The lump sum you will receive takes on the nature of the periodic payments that it was paid to replace and is therefore assessable as ordinary income.
Detailed Reasoning
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. Salary and wages are considered ordinary income.
Income protection insurance replaces an individual’s regular salary or earnings if they are unable to work for a period of time due to sickness or injury, by providing a regular income stream for an agreed period of time. These payments are assessable as income under section 6-5 of the ITAA 1997, as they are paid to take the place of lost earnings.
This view has been confirmed in Sommer v. FC of T 2002 ATC 4815; (2002) 51 ATR 102 (Sommer’s case) where a lump sum paid to a doctor in settlement of his claim under an income protection policy was assessable as ordinary income on the basis that it was in substitution for his original claim under the policy for lost income. The taxpayer argued that the amount comprised an undissected aggregation of both income and capital and, therefore should be treated as capital.The Sommer’s case was dismissed in the Federal Court where it was held that the commercial reality of the payment was that it was a full and final settlement of all the taxpayer’s income claims. The fact that it was a lump sum did not change its revenue nature.
The Sommer decision was followed in Gorton v. FC of T 2008 ATC 10-018, where a lump sum payment received by a former medical practitioner from his insurer in settlement of his professional income replacement claims was held to be assessable income.
Application to your circumstances
In your case, the income protection policy provides you with a regular income stream which is considered as ordinary income and included as assessable income under section 6-5 of the ITAA 1997.
The lump sum you will receive will be a payout of your remaining benefit and finalisation of your claim. Therefore, the lump sum payment is an advance of your future monthly payments and is assessable under section 6-5 of the ITAA 1997 as ordinary income in the year it is received.
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