Edited version of private advice

Authorisation Number: 1051585865795

Date of advice: 4 October 2019

Ruling

Subject: Lump sum payment - trauma compensation - assessable income

Question 1

Is the amount of $XXX,XXX that the Company received from the Insurance Company assessable income?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

In 201X, the Company took out a Life cover with trauma and TPD cover insurance policy (Insurance Policy) on one of its directors (Director).

The Insurance Policy was provided by an insurance company (Insurance Company).

The Insurance Policy cover amount was calculated based on a consideration of equivalent to x years of the Directors salary.

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, to provide funds to replace the Director and provide for his leave if needed.

The premiums were paid each year by the Company, and the full amount was included as a tax deduction in the Company's tax return.

In 201X, the Director was diagnosed with an illness.

The illness was one of the specified diseases covered by the Insurance Policy.

A claim was submitted to the Insurance Company by the Company in relation to the Trauma Cover portion of the policy.

In 201X, the Company received an amount of $XXX,XXX from the Insurance Company representing payment of the trauma benefit of the policy.

The funds will be used for

·        A claims management fee

·        The Directors medical expenses

·        Pay another employee

·        Pay arrears/compensation to the Director for the time off that he didn't take during the time between his diagnosis and receiving his claim.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

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

Trauma insurance policies generally provide for the payment of a set amount to the insured if the insured suffers a condition specified in the policy such as a heart attack, cancer, or stroke.

Taxation Determination TD 95/42 Income tax: can a premium paid by an employer on a trauma insurance policy in respect of an employee be an allowable deduction to the employer?, says that where a trauma policy is

a) owned by an employer;

b) the employer is the beneficiary of the policy;

c) the premium is paid for a revenue purpose; and

d) the purpose of the policy is to advance the business ends of the taxpayer;

then the premium is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997). Where compensation is received in these circumstances, the lump sum would constitute assessable income to the employer under section 6-5 of the 1997 Act.

Further Taxation Ruling IT155 Key man insurance - assessability of proceeds and deductibility of premiums says at paragraph 7 that

In deciding whether the proceeds of an accident or term policy are assessable income under section 25 of the Act it would be appropriate to work on the broad proposition, as the High Court did in the Carapark Holdings case, that -

"... in general, insurance moneys are to be considered as received on revenue account where the purpose of the insurance was to fill the place of a revenue receipt which the event insured against has prevented from arising or of any outgoing which has been incurred on revenue account in consequence of the event insured against, whether as a legal liability or as a gratuitous payment actuated only by consideration of morality or expediency."

IT 155 paragraph 10 states that the minutes or book entries may assist in establishing the purpose of the policy. The purpose for which the proceeds are used is also relevant.

TD 95/42 goes on to explain that where any benefit expected or obtained by the employer from the insurance policy was to cover the loss of profit, either due to a reflection of reduced income or increased expenditure, resulting from the loss of the employee, a revenue purpose may exists.

A revenue purpose exists where there is a nexus between the amount of the insurance benefit and the expected quantum of lost profits.

Section 6-5 of the ITAA 1997 provides that the assessable income of Australian residents includes the ordinary income derived directly or indirectly from all sources.

Ordinary income includes income from rendering personal services, income from property and income from carrying on a business.

Where the proceeds from an insurance policy relate to the carrying on of a business, the proceeds are considered to be income according to ordinary concepts under section 6-5 of the ITAA 1997.

In your situation the Company is the owner of the insurance policy and is the beneficiary of the policy.

The amount of cover was calculated based on a consideration of equivalent to x year of the Directors salary. The Company has included the cost of the insurance cover as a deduction in it's tax returns.

The intent of the Insurance Policy was that funds were to be used within the business.

Further you have stated that the funds will be used to pay the claims management fee, the Directors medical expenses, and remainder to pay another employee, or to pay the Director in arrears or compensation.

Salary and wage expenses are operating expenses or revenue expenses.

There is a clear nexus between the Insurance Policy and the expectation of increased costs as the cover amount is based on the Directors salary and you are planning on using the funds to pay another employee.

The purpose of the policy is to advance the taxpayers' business.

Therefore the funds received via the insurance policy are considered revenue under section 6-5 of the ITAA 1997.

Please note, the funds will be used to pay various expenses, these may be claimable deduction. Please refer to section 8-1 of the ITAA 1997 for further information.

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