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Ruling

Subject: Income - lump sum payment

Question

Is the lump sum payment from your income protection policy included in your assessable income in the 2011-12 year of income?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You had an income protection insurance policy.

You made a claim on the policy and had been receiving a monthly benefit from that time.

You accepted a lump sum payment in lieu of the monthly payments.

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 an Australian resident includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources, whether in or out of Australia, 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.

Payments of salary and wages are examples of ordinary income.

Receipts that are not salary or wages, but are paid as a substitute for salary or wages that would normally have been earned, expected and relied upon by a taxpayer, are also assessable as ordinary income. The general principle is that such payments take on the character of the salary or wages they replace. That is, if the substituted amount was an amount of ordinary income, the amount paid to compensate for the loss of that amount will also be ordinary income.

This general principle was affirmed by the courts in Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82; (1952) 5 AITR 443; (1952) 10 ATD 82 where it was found that when a taxpayer is paid an amount to compensate for a loss, the payment will generally acquire the character of that for which it is substituted.

Income protection benefits paid under an income protection policy are a substitute for salary or wages and are therefore assessable income.

Assessability of lump sum payments that are a substitute for income

Taxation Determination TD 93/3 deals with the partial commutation of weekly compensation payments for loss of income or salary. TD 93/3 specifies that any lump sum that results from a commutation of such weekly payments will continue to be assessable as ordinary income because the character of the lump sum does not change from that of the weekly payments it replaces.

The issue of whether or not the redemption or conversion of an entitlement to assessable periodic payments to a lump sum affects the assessability of the lump sum has also been considered by the courts.

In Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138 Mathews J:

· found that payments made to replace income take on the character of the payment they replace and that the method of payment does not alter the character of the payment

· held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing a redemption (less a discounted factor) of those future weekly payments was also income.

Conclusion

The lump sum amount you received is assessable as ordinary income in the income year the payment was made to you.