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Ruling

Subject: Insurance payment

Question:

Is the insurance amount you received for loss of wages taxable?

Answer

Yes.

Relevant facts

You had a sporting accident and due to this you were not able to work for a considerable period of time.

During your time off work you received sick pay from your employer.

You also received a lump sum loss of income payment due to the accident from an insurance company. The payment was calculated based on the period you were unable to work. The loss of income insurance cover is provided as part of your annual sporting club membership fees.

You will not be receiving any more insurance payments as you have now returned to work.

You included the insurance payment in your tax return.

Reasons for decision

Summary

Compensation payments are considered to be ordinary income where they are designed to replace ordinary income, whether or not they are paid as a lump sum for a given period of time. The payment takes on the nature of ordinary income, and as such, is taxable. The payment is included in the tax return for the financial year in which it is received.

Detailed reasoning

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. 

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, and

· have an element of periodicity, recurrence or regularity.

Lump sum payments received under a personal accident, income protection or disability insurance policy will be assessable under section 6-5 of the ITAA 1997 if it is found to be ordinary income. This will depend on whether the amount is payable in respect of the loss of earnings or in respect of the loss of earning capacity.

Payments to replace income are considered to be income (Keily v. Federal Commissioner of Taxation (1983) 14 ATR 156: 83 ATC 4248). An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82).  Payments made during a period of disability under a personal accident, income protection or disability insurance policy taken out by the individual are assessable on the same principle as workers compensation, that is, they are assessable where they are paid to replace lost earnings.

In addition to this, it is well established that, in general, insurance moneys are received on revenue account where the purpose of the insurance was to fill the place of the revenue receipt which the event insured against has prevented from arising (Carapark Holdings Ltd v Federal Commissioner of Taxation (1967) 115 CLR at 633).

Although a lump sum payment under a personal accident, income protection or disability insurance policy is not a periodic payment; the above principle may also apply to a lump sum paid to settle all outstanding claims under the policy. To determine the character of such a lump sum, it is necessary to consider the terms of the particular policy and the reason for making the payment.

Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and stated that such a payment is assessable income:

· if the payment is compensation for loss of income only (event when the basis of the calculation of the lump sum cannot be determined), or

· to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

If an amount is exempt income, it is not assessable income.

An amount of ordinary income is exempt income if it is made exempt from income tax by a provision of the income tax legislation or another Commonwealth law.

There are no such provisions which exempt a lump sum payment under a personal accident, income protection or disability insurance policy from income tax in your situation.

In your case, your insurance cover provided for the replacement of income as a result of your injury.  The income replacement payment replaced income that you would normally derive, expect and rely upon. This payment is thus considered to be assessable income and not exempt income as it acquired the character of the income it substituted and therefore will be assessable under subsection 6-5(2) of the ITAA 1997.

A lump sum compensation amount received for loss of income over a period is assessable in the income year it is received even if the loss of income occurred in a previous income year (Taxation Ruling IT 2107).