Edited version of private advice

Authorisation Number: 1051839397731

Date of advice: 18 May 2021

Ruling

Subject: Lump sum payment

Question 1

Is any part of the lump sum payment (the Benefit) you received from the insurer (the Insurer) assessable as an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the Benefit assessable as ordinary income under subsection 6-5(2) of the ITAA 1997?

Answer

No.

Question 3

Is the relevant capital gains tax asset in relation to the Benefit the Licence?

Answer

Yes.

Question 4

Did a capital gains tax event C2 occur when the Licence was cancelled?

Answer

Yes.

Question 5

Will you be able to disregard any capital gain arising in relation to the termination of the Licence?

Answer

Yes.

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were born in Australia and were employed by an overseas organisation (Company A) for which you required to have a specified qualification (the Licence) to be able to undertake your employment role.

You lived and resided in an overseas country (Country X) and were not a resident of Australia for taxation purposes.

During your employment with Company A you obtained an insurance policy (the Policy) through a fund (the Insurer) and made contributions to the Insurer for capital benefits.

The Product Disclosure Statement for the Policy includes the following information:

•         The Product provides financial support to its members who are unable to undertake their employment due to a suspension or failure of their Licence due to an illness or injury

•         Members are required to make annual contributions

•         If the member's Licence is suspended or cancelled by the relevant authority, and the eligibility criteria is met for the benefit/s is met, the member may be able receive benefits

•         The benefits (the Benefits) include capital benefits.

You suffered a medical issue and the relevant authority suspended your Licence.

You made a claim for a payment of benefits under the Policy.

You were diagnosed with a medical condition and in accordance with the Policy rules, you undertook a medical examination by the relevant authority to determine the likelihood that you would be deemed fit to resume your employment role with Company A.

After a period of time, your employment with Company A ceased.

You came to Australia for a short period to visit family and friends before returning to Country X to be with your partner who resided in Country X and was a resident of another overseas country.

You were notified by the relevant authority that it intended to refuse to renew your Licence.

You returned to Country X after a short visit in Australia to be with your partner who resided in Country X and is a citizen of another country.

The decision by the relevant authority to not issue your Licence became final after you had returned to Country X.

You returned to Australia with your partner accompanying you for a short period with both of you having return flights booked. However, the borders for Country X were closed to international flights due to COVID-19 during your stay.

At that time, you had considered returning to Australia to live here permanently but had not made the final decision, which you planned to make when your partner's employment in Country X ended in a few months.

You were notified by the Insurer that you had met the conditions to be eligible to receive the Benefit consisting of capital benefits totalling $XXX,XXX to be paid to you, which you received during the following month.

Following the closure of Country X's borders, you and your partner lived with your parents in Australia, with your partner continuing their employment virtually.

Country X's borders opened several months after they had been closed and your partner returned to Country X so that they could resume their employment.

You did not return to Country X with your partner due to the strict ban on Australian citizens and permanent residents leaving Australia, which had been in place since early 2020.

During the period you were in Australia due to Country X's border closure, all of your possessions, personal effects, furniture, household items, and shared property remained in Country X with your intention to return to Dubai.

Due to the effects of COVID-19 you decided that you may find it hard to obtain employment in Country X and you decided to remain in Australia, becoming a resident of Australia for taxation purposes several months after the Licence had been cancelled.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Subsection 82-130(1)

Income Tax Assessment Act 1997 Paragraph 82-130(1)(a)

Income Tax Assessment Act 1997 Paragraph 82-130(1)(b)

Income Tax Assessment Act 1997 Paragraph 82-130(1)(c)

Income Tax Assessment Act 1997 Section 855-10

Income Tax Assessment Act 1997 Section995-1

Reasons for decision

Question 1: Is any part of the lump sum payment (the Benefit) you received from the insurer (the Insurer) assessable as an employment termination payment in accordance with section 82-130 of the ITAA 1997?

Summary

The Benefit you received from Insurer is not considered to be an employment termination payment.

Detailed reasoning

Employment termination payment

Section 995-1 of the ITAA 1997 states that:

employment termination payment has the meaning given by section

82-130 of the ITAA 1997.

For the lump sum payment, you received from your employer to be considered an employment termination payment (ETP), the payment must satisfy the definition of an ETP set out in subsection 82-130(1) of the ITAA 1997.

Subsection 82-130(1) of the ITAA 1997 states that a payment is an employment termination payment if:

  (a)        it is received by you:

                          i.    in consequence of the termination of your employment; or

                         ii.    after another person's death, in consequence of the termination of the other person's employment; and

  (b)        it is received no later than 12 months after termination (except for situations mentioned in subsection (4)); and

   (c)        it is not a payment mentioned in section 82-135.

To determine if a payment constitutes an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 must be satisfied.

In consequence of the termination of your employment

The Commissioner's view on the meaning of the phrase 'in consequence of; in the context of termination of employment is set out in Taxation Ruling TR 2003/13 Income tax: employment termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of'.(TR 2003/13).

In paragraphs 5 and 6 of TR 2003/13, the Commissioner states:

5. ...payment is received by a taxpayer in consequence of the termination of the taxpayer's employment if the payment 'follows as an effect or result of' the termination. In other words, but for the termination of employment, the payment would not have been received by the taxpayer

6. ... The phrase requires a causal connection between the termination and the payment, although the termination need not be the dominant cause of the payment. The question of whether a payment is received in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

Application to your situation

Applying the Commissioner's view to your situation, it is clear that a connection did not exist between the payment of the lump sum and the termination of your employment for the following reasons:

a.    The Policy with the Insurer was taken out by you in the event of the loss of your Licence and not as a result of your employment with your employer.

b.    You received the Benefit from Policy as a result of meeting the relevant eligibility conditions and not as a result of your employment being terminated.

c.     The claim to the Insurer was approved and paid outside of the termination of your employment and based on medical grounds.

d.    The nature of the benefit is such that based on the information in the product disclosure statement it would have been paid out provided you met the conditions of the Policy even if you had continued your employment.

Therefore, the Benefit is not considered to be an employment termination payment and the first condition under subparagraph 82-130(1)(a)(i) of the ITAA 1997 is not satisfied.

Failure to satisfy any of the conditions under subsection 82-130(1) of the ITAA 1997 will result in the payment not being considered an employment termination payment. It is not therefore necessary to consider any of the other conditions of subparagraph 82-130(1) of the ITAA 1997.

Question 2: Is the Benefit assessable as ordinary income under subsection 6-5(2) of the ITAA 1997?

Summary

Based on the information provided the Benefit does not have the character of ordinary income and will therefore not be assessable under section 6-5 of the ITAA 1997.

Detailed reasoning

Ordinary income

Section 6-5 and section 6-10 of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary and statutory income (such as capital gains) derived directly and indirectly from all sources, whether in or out of Australia during the income year.

The ITAA 1997 does not provide specific guidance on the meaning of ordinary income. However, a substantial body of case law exists which identifies its likely characteristics. Amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income, as are amounts that are the product of any employment of, or services rendered by, the recipient. Further, amounts which compensate for lost income or serve as a substitute for other income are themselves income according to ordinary concepts.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Application to your situation

In your case, you received the Benefit as a result of being deemed by the relevant authority that your failure to meet the standards for the Licence was permanent due to your medical condition. As a result, you were paid the Benefits, which consisted of a lump sum amount made up of two capital benefit amounts.

Based on the information provided the amounts included in the Benefit do not have the nature of income as outlined above. The Benefit is viewed as being a single lump sum paid for cancellation of capital asset/s. Therefore, the Benefit will not be assessed as ordinary income under section 6-5 of the ITAA 1997.

Questions 3 and 4:

Question 3: Is the relevant capital gains tax asset in relation to the Benefit the Licence?

Question 4: Did a capital gains tax event C2 occur when the Licence was cancelled by the relevant authority?

Summary

The relevant capital gains tax asset was the Licence and capital gains tax event C2 occurred when the Licence was cancelled.

Detailed reasoning

Capital gains tax asset

Section 108-5 of the ITAA 1997 provides that a capital gains tax (CGT) asset is any kind of property, or a legal or equitable right that is not property.

For income tax purposes, a compensation amount generally bears the character of that which it is designed to replace. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts.

TR 95/35 discusses the various scenarios, including:

•         disposal of the underlying asset,

•         compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and

•         disposal of the right to seek compensation.

It is the character of the receipt in the hands of the recipient that must be determined: FCT v. Slaven (1984) 52 ALR 81; 15 ATR 242; 84 ATC 4077 (Slaven's case). Generally, the material factor in determining whether compensation is of an income or capital nature is not the measure of the compensation, but what it is truly paid for: Glenboig Union Fireclay Co Ltd v. IR Commrs (1921) 12 TC 427.

In determining, which is the most relevant asset, it is often appropriate to adopt a 'look-through' approach to the transaction or arrangement which generates the compensation receipt. We regard this concept as the most appropriate basis on which to determine whether any capital gain arises on the disposal of any asset of the taxpayer.

In cases where a dispute between the insurer and the insured is settled by way of the former making a lump sum payment to the latter; it would presumably be the case that the payment is intended to compensate the policy holder for the loss of entitlements under the policy, rather than to compensate the person for their injury or illness or wrong suffered as such.

Taxation Ruling IT 2230 Income tax: loss of licence insurance relates to a situation where the taxpayers had paid premiums in relation to the loss of licence insurance policies which provide for the payment of periodic benefits of income nature as well as benefits of a capital nature. It outlines that in situations where the benefits are a payment of a capital sum for the loss of the contributor's asset, the CGT asset was the licence to fly.

In Case 67 (1977) 21 CTR (NS), a pilot was not entitled to deduct any part of the premium paid under a "loss of licence" insurance policy, where the benefit payable was a lump sum for the permanent loss of the licence, being the capital asset.

CGT event C2

Under subsection 104-25(1) of the ITAA 1997, a CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends by the asset:

•         being redeemed or cancelled

•         being released, discharged or satisfied

•         expiring (see below)

•         being abandoned, surrendered or forfeited

•         if the asset is an option - being exercised

•         if the asset is a convertible interest - being converted.

Application to your situation

You were a member of the Policy through the Insurer and had made contributions to the Insurer which entitled you to receive capital benefits if the relevant conditions for the payment of the Benefit were met, which involved loss of the Licence.

You had a medical issue and made a claim to the Insurer for a payment of the Benefit under the Policy with your Licence being cancelled by the relevant authority.

Based on the information provided, and in accordance with the principles contained in IT 2230, your CGT asset was the Licence and a CGT event C2 occurred when the Licence was cancelled.

Question 5: Will you be able to disregard any capital gain arising in relation to the termination of the Licence?

Summary

As you were not a resident of Australian for taxation purposes when the CGT event C2 event occurred in relation to the Licence, you can disregard any capital gain arising in relation to the termination of the Licence.

Detailed reasoning

CGT rules for foreign residents

Under section subsection 855-10(1) of the ITAA 1997, foreign residents will only recognise a capital gain or loss where the CGT event happens in relation to certain specified assets known as taxable Australian property.

Taxable Australian property broadly includes direct or indirect interests in Australian real property and the business assets (other than Australian real property) of an Australian permanent establishment. Capital gains or losses made from other CGT assets will be disregarded.

Application to your situation

In this situation your CGT asset was the Licence. A CGT event CGT C2 occurred when the Licence was cancelled. You did not become a resident of Australia for taxation purposes until after the CGT event C2 had occurred in relation to the Licence.

Therefore, as the CGT event C2 occurred prior to you becoming an Australian resident, and you did not own the relevant CGT asset when you became a resident, there are no CGT implications for you in Australia in relation to the cancellation of the Licence.

Therefore, you are not assessable on any capital gain arising in relation to the termination of the Licence and can disregard any capital gain arising as a result of the CGT event C2 in this situation.

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