Edited version of private advice

Authorisation Number: 1051997610206

Date of advice: 23 June 2022

Ruling

Subject: Lump sum payment - income protection insurance

Question

Can you amend your prior tax returns to include amounts paid to you in arrears under an income protection insurance policy?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You have a medical history.

You were diagnosed with an illness in 20XX.

Due to your illness, you were unable to work from 20XX until 20XX.

You had an income protection insurance policy approved by your insurer in 20XX which covered the period from 20XX until 20XX.

Your income protection insurance lump sum payment included amounts paid monthly in arrears for prior income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Subsection 6-5(4)

Reasons for decision

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.

An amount paid to compensate for loss generally acquires the same nature of what it is substituting (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433).Ordinary income has been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that:

•         are received as a product of any employment, services rendered, or any business;

•         are earned;

•         are received regularly or periodically;

•         are expected; and

•         are relied upon.

It is not necessary for all of these characteristics to be present for an amount to be considered ordinary income. A lump sum payment is generally classified as ordinary income if it is simply a lump sum made up of periodic income payments but paid in arrears to cover a certain period.

Income protection policies provide for periodic payments in the event of loss of income caused by the insured becoming disabled through sickness or injury. 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.

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings (TR 98/1) gives the Commissioner's view as to when income is received.

Paragraph 2 states, where income is earned in one year of tax but received in another, the adoption of an appropriate method of determining when income is derived under subsections 6-5(2) and (3) in a relevant year of income is an issue of practical concern to taxpayers and their advisers. Two commonly used methods of determining when income is derived in a relevant year of income are the receipts method and the earnings method.

Paragraph 8 states, the 'receipts' method is sometimes called the 'cash received' basis or the 'cash' basis. Under the receipts method, income is derived when it is received, either actually or constructively, under subsection 6-5(4) of the ITAA 1997. The effect of that subsection is that income is taken to have been derived by a person although it is not actually paid over, but is dealt with on his/her behalf or as he/she directs.

Paragraph 9 states, the 'earnings' method is often referred to as the 'accruals' method or the 'cash and credit' method. Under the earnings method, income is derived when it is earned. The point of derivation occurs when a 'recoverable debt' is created.

According to paragraph 18, the receipts method is likely to be appropriate to determine:

•         income derived by an employee; and

•         paragraph 41 states that generally, for non-trading income, it is when amounts are received that they have, applying the words of Dixon J, 'come home to the taxpayer in a realized or immediately realizable form'.

Further, paragraph 42 states that income from employment would normally be assessable on a receipts basis. Salary, wages or other employment remuneration are assessable on receipt even though they relate to a past or future income period.

In your circumstance, when the lump sum payment was first dealt with on your behalf by your insurer as outlined in the letter dated on XX/XX/XXXX, and the payment was credited and made available for you to do as you wish.

The lump sum payment that you received from the insurer in arrears of your previous monthly payments is to replace employment income. The lump sum payment received will need to be included as part of your assessable income under section 6-5 of the ITAA 1997 as ordinary income in the income year in which it was received, being the income year ended 30 June 20XX.

We acknowledge your circumstances and associated tax liabilities. However, the Commissioner has no discretion to assess the payment in any other income year as you have requested, other than when it was received by you.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).