Edited version of private advice

Authorisation Number: 1051847327609

Date of advice: 02 June 2021

Ruling

Subject: Income tax - assessable income - life insurance bonuses and policies

Question 1

Is the receipt of the sum insured by the Taxpayer under the Group Life Insurance Plan (the Plan) in respect of the death of an employee assessable as ordinary income of the Taxpayer for the year ending 30 June 20xx under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the receipt of the sum insured by the Taxpayer under the Plan in respect of the death of an employee assessable as a capital gain of the Taxpayer for the year ending 30 June 20xx under Part 3-1 of the ITAA 1997?

Answer

No.

Question 3

Will the gift of an amount equivalent to the sum insured by the Taxpayer to the parents of the deceased employee be subject to a pay as you go (PAYG) withholding obligation under Part 2-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA)?

Answer

No.

This ruling applies for the following periods

Income year ending 30 June 20xx

Income year ending 30 June 20xx

Relevant facts and circumstances

1.    The Taxpayer is a partnership which conducts a legal practice.

2.    The Taxpayer employed Ms Smith on xx 20xx, on a permanent basis. Ms Smith died on xx xx 20xx.

3.    At the time of Ms Smith's death, the Taxpayer held the Plan with AIA Australia Limited.

4.    The purposes for which the Taxpayer took out (and continues to hold) the Plan were to access a more competitive premium for partners for their life and total and permanent disability insurance and to make it easier for some partners to obtain insurance coverage. The Plan also provides cover for the death of all permanent employees of the Taxpayer.

5.    The sum insured in relation to the death of a permanent employee under the Plan was fixed at $xxx,000.

6.    It is not a condition of employment that the Taxpayer takes out a life insurance policy in respect of employees.

7.    In month 2 20xx, the Taxpayer made a death claim under the Plan in respect of Ms Smith's death.

8.    The claim was approved by AIA Australia Limited in month 1 20xx and the Taxpayer received a payment of $xxx,000.

9.    The Taxpayer is able to retain those proceeds or distribute them to the partners. The Taxpayer is not obliged to pay the proceeds to the employee's estate.

10.  However, the Taxpayer wishes to make a gift of an amount equal to the sum insured to Ms Smith's parents.

Assumption

A purpose of the Plan held by the Taxpayer is not to replace revenue that is expected to be lost by the Taxpayer due to the death or total and permanent disablement of any permanent employee insured under the Plan.

Relevant legislative provisions

Income tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 paragraph 104-25(1)(b)

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 section 118-300

Income Tax Assessment Act 1997 subsection 118-300(1)

Taxation Administration Act 1953 Part 2-5 of Schedule 1

Taxation Administration Act 1953 section 10-5 of Schedule 1

Taxation Administration Act 1953 Subdivision 16-B of Schedule 1

Reasons for decision

Question 1

Summary

The sum insured received by the Taxpayer during the 2021 income year under the Plan in respect of the death of an employee is not assessable as ordinary income of the Taxpayer under section 6-5 of the ITAA 1997.

Detailed reasoning

Section 6-5 of the ITAA 1997 includes income according to ordinary concepts (ordinary income) in assessable income. Income according to ordinary concepts refers to an accepted usage of the word 'income' and income that Courts have determined is ordinary income.

Ordinarily, the receipt of insurance proceeds would not come within the term of ordinary income where the payment has been made in the event of death or for deprivation or impairment of earning capacity: Federal Commissioner of Taxation v. Slaven (1984) 1 FCR 11; 84 ATC 4077; (1984) 15 ATR 242. The exception, however, is where the insurance proceeds have been received to replace lost earnings: Federal Commissioner of Taxation v. DP Smith (1981) 147 CLR 578; 81 ATC 4114; (1981) 11 ATR 538.

The characterisation of insurance proceeds paid under life insurance policies taken out by employers in respect of their employees is no different (see Taxation Rulings IT 155[1] and IT 2434[2] which confirm the non-assessability of proceeds paid under life insurance policies taken out by employers in respect of their employees).

The payment of the sum insured under the Plan to the Taxpayer was not to replace lost revenue of the Taxpayer. This proposition is supported by the fact that the amount of the payment has no relationship to the amount of revenue expected to be lost by the Taxpayer due to the death of its employee, as well as the Taxpayer's intended use of the proceeds received. Accordingly, the sum insured is a capital receipt, and not assessable under section 6-5 as ordinary income.

Question 2

Summary

Any capital gain made by the Taxpayer during the 2021 income year upon receipt of the sum insured under the Plan in respect of the death of an employee will be disregarded under section 118-300 of the ITAA 1997.

Detailed reasoning

A CGT asset as defined in subsection 108-5(1) of the ITAA 1997 is any kind of property or a legal or equitable right that is not property. Contractual rights under an insurance policy are legally enforceable rights and therefore a CGT asset according to the definition in subsection 108-5(1) of the ITAA 1997.

When AIA Australia Limited paid the sum insured in satisfaction of the Taxpayer's contractual rights under the Plan, the Taxpayer's ownership of those rights was discharged or satisfied. This discharge or satisfaction of the contractual rights gave rise to CGT event C2 pursuant to paragraph 104-25(1)(b) of the ITAA 1997.

The Taxpayer made a capital gain from this CGT event if its capital proceeds from the ending of the ownership of its asset are more than the asset's cost base or, alternatively, a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-25(3) of the ITAA 1997).

However, section 118-300 of the ITAA 1997 exempts certain capital gains or capital losses made in respect of a policy of insurance on the life of an individual. The meaning to be given to the expression 'policy of insurance on the life of an individual' includes, but is not limited to, life insurance policies within the common law meaning of that term.

Item 3 of the table in subsection 118-300(1) of the ITAA 1997 provides that a capital gain or loss made from a CGT event happening in relation to a CGT asset that is an interest in rights under a life insurance policy is disregarded where the CGT event happens to the original owner of the policy (other than the trustee of a complying superannuation entity).

As the entity to which the Plan was first issued, the Taxpayer is the original owner of a policy of insurance on the life of an individual. Therefore, the Taxpayer is entitled under item 3 in the table in subsection 118-300(1) of the ITAA 1997 to disregard any capital gain or loss it makes under section 104-25 of the ITAA 1997 from the receipt of a payment of the sum insured by AIA Australia Limited under the Plan.

Question 3

Summary

Any payment of an amount equivalent to the sum insured made by the Taxpayer as a gift to the parents of the deceased employee will not be subject to a PAYG withholding obligation under Part 2-5 of Schedule 1 to the TAA.

Detailed reasoning

Under PAYG withholding (governed by Part 2-5 of Schedule 1 to the TAA), amounts are collected in respect of particular kinds of payments or transactions. Usually, the entity making the payment is required to withhold an amount from the payment, and then (in accordance with Subdivision 16-B of Schedule 1 to the TAA) pay the amount withheld to the Commissioner.

A payment, by way of 'gift', of an amount equivalent to the sum insured by the Taxpayer to the parents of the deceased employee is not a payment of a kind covered by PAYG withholding (refer to section 10-5 for summary of all withholding payments). The Taxpayer will not, therefore, be obligated to withhold (and remit) an amount from that payment.

[1] Key man insurance - Assessability of proceeds and deductibility of premiums.

[2] Income tax: Split dollar insurance arrangements.

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