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Ruling

Subject : Mortgage protection policy

Question 1

Are the monthly repayments made by your insurer directly to your financial institution under the disability terms of a mortgage protection insurance policy assessable as ordinary income?

Answer

Yes.

Question 2

Is the lump sum payment you received under the trauma terms of a mortgage protection policy assessable as either ordinary income or as a capital gain?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts

You hold a mortgage protection insurance policy in relation to your joint home loan.

The policy provides the following types of cover:

· death cover

· trauma cover

· disability cover

· involuntary unemployment cover

You were diagnosed with a disease.

In accordance with the terms of your insurance policy, a trauma benefit was payable on the diagnosis of this disease and the insurer paid you a lump sum payment. Only one claim can be made during the period of cover.

In accordance with the terms of your insurance policy, a disability benefit was payable on the diagnosis of this disease. A monthly disability benefit has been paid directly to your financial institution and applied against your home loan.

The disability payments are still ongoing. Each month you submit a claim form completed by your medical practitioner to certify that you are unable to return to work due to your condition.

You have provided a copy of your current mortgage protection insurance policy renewal schedule and product disclosure statement.

The product disclosure statement for the mortgage protection insurance provides that where the applicable conditions have been met payments will be made for any claim for death, disability or involuntary unemployment directly to the financial institution and for trauma any amount will be paid directly to you.

Your policy remains current.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)

Reasons for decision

Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes ordinary and statutory income derived directly and indirectly from all sources during the income year.

Ordinary income has generally 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 earned

· are expected

· are relied upon

· have an element of periodicity, recurrence or regularity

Characteristics of a capital receipt include:

· being paid a lump sum, that is , not received periodically

· being a one-off payment, that is a payment made once and for all

· being expected but not relied upon.

Mortgage protection insurance

In your case, you have taken out a mortgage protection insurance policy which consists of death cover, disability cover, involuntary unemployment cover and trauma cover. The policy provides for the disability and involuntary unemployment benefits to be paid direct to your financial institution in the event of you being unable to perform your usual occupation in certain defined circumstances. If you die the policy provides for the loan contract amount as stated in the policy schedule be paid direct to your financial institution. If you suffer a trauma as specified in your policy you will receive payments to the sum insured selected by you as shown in your policy.

Disability benefit

Since the diagnosis of suffering from a disease that is a specified event under your policy, your insurer has accepted and processed your monthly disability claims. These payments have been made directly to your financial institution and applied against your mortgage.

Mortgage protection insurance is similar to a contract of personal disability insurance considered by the Full High Court in FC of T v DP Smith (1981) 147 CLR 578; 11 ATR 538; 81 ATC 4114.

As the payments are paid monthly to your financial institution, they have the element of periodicity, recurrence or regularity. These payments can be said to be expected and relied upon as mortgage protection aims to cover your obligation to the financial institution. Thus, the amounts paid by the insurer to the financial institution have the income replacement character of the personal disability insurance which was considered in FC of T v DP Smith.

The disability benefits paid directly to your financial institution are assessable as ordinary income.

Trauma benefit

The lump sum trauma benefit you received is not income from rendering personal services, income from property or income from carrying on a business.

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

The lump sum payment is not considered to be ordinary income.

Capital gains tax

Receipt of a lump sum payment may give rise to a capital gain (statutory income). However paragraph 118-37(1)(b) of the ITAA 1997 disregards payment or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness. The lump sum you received is considered to be exempt from CGT under paragraph 118-37(1)(b).

Conclusion

The disability benefit payments made under your mortgage protection policy directly to your financial institution are assessable as ordinary income and as such need to be included in your income tax return.

However, the trauma benefit you received under your mortgage protection policy is not assessable and does not need to be included in your income tax return.