Edited version of private ruling

Authorisation Number: 1011737639949

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Ruling

Subject: Compensation - income protection insurance

Question

Is the lump sum payment you will receive to buy out the risk for potential further claims assessable?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

In December 1996, you entered into a contract of insurance for income protection and life cover.

Under the life cover, you would be paid if you die or had a terminal illness.

Under the terms of the income protection policy, certain benefits would be payable if you were disabled as defined in the policy and the terms and conditions of the policy were otherwise met.

You decided to stop your claim for benefits following a factual interview.

An offer was made to you to buy out the risk for potential further claims.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-15(1)

Income Tax Assessment Act 1997 paragraph118-37(1)(b)

Reasons for decision

Section 6-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include 3 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 includes receipts that:

· are earned;

· are expected;

· are relied upon; and

· have an element of periodicity, recurrence or regularity.

The lump sum payment you will receive is not income from rendering personal services, income from property or income from carrying on a business.

The payment is also a one off payment and thus it does not have an element of recurrence or regularity.

A payment of the nature described in the scheme generally bears the character of that which it is designed to replace. If the lump sum payment is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling provides that an insured person's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation. The whole of the settlement amount is thus treated as capital proceeds from a capital gains tax (CGT) event happening to your right to seek compensation.

The lump sum payment you will receive is for entering into a Settlement agreement with your insurer for the purpose of buying out the risk for potential further claims. Consequently, the lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

The disposal of an asset gives rise to a CGT event. However, paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any 'wrong, injury or illness you suffer personally'.

Applying paragraph 118-37(1)(b) to your circumstances, the lump sum would not be considered as an assessable capital gain. The insurer' s purpose in making the lump sum payment is so you would surrender your rights, not only to recover any such benefits in the action, but also to claim any further benefits to which you might now or in the future have an entitlement under your income protection policy. As all of these claims relate to your personal injury or illness, any capital gain or loss arising from the surrender of your rights under this policy will be disregarded. As such, this amount is not statutory income.

Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income. Consequently no part of the amount received is included in your assessable income.