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Ruling

Subject: Compensation payment

Question

Is a lump sum payment that you will receive under a group salary continuance policy included in your assessable income?

Answer: Yes

This ruling applies for the following period:

Year ending 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You had an accident whilst working.

On medical advice, you ceased being active in your employment as a result of the injuries you sustained.

You were advised by your employer that no other employment was available.

Your employer had insurance under a Group Salary Continuance Policy (the Policy). The extent of the cover of the Policy was for total and partial disability, disability by accident and proportionate benefits.

The Policy provided that a monthly benefit would be paid in the event of total or partial disability.

You applied for a total disability benefit. Your insurer accepted liability under the Policy and commenced making monthly disability payments.

Your insurer has elected to make a commercially based lump sum payment as you can never work again due to your disability. In exchange, you would release and discharge the insurer and the employer from any further liability in relation to the claim.

There is no specific calculation of the benefits. However, the proposed commutation is for the benefit entitlement up to the age of 65 years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Section 6-5 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.

Based on case law, it can be said that ordinary income generally includes receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Payments of salary and wages are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (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 according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

In FTC v. Slaven 84 ATC 4077 (Slaven's case), a taxpayer who was injured in a car accident received compensation under the Motor Accidents Act 1973 (Victoria). As a result of amendments made to the Act in 1979 specifically to exclude the payments from tax, the compensation was expressed to be for deprivation or impairment of earning capacity. The compensation was paid to the taxpayer in five irregular instalments which fairly closely approximated her net pre-accident earnings. The essential character of the payments was held to be compensation for the loss or impairment of earning capacity and therefore not taxable.

Salary continuance benefits are benefits payable in the event of partial or total disability. The benefits are designed to be paid during absences from employment to replace the salary of an employee. As the benefits are a replacement of employment income, they are generally treated like salary and wage for income tax purposes. Therefore periodic payments received during a period of total or partial disability under a group salary continuance policy are assessable income.

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was considered in Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138. In that case 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. Mathews J 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 of those future weekly payments was also income.

This is consistent with the approach taken by the Commissioner in Taxation Determination TD 93/3 which deals with the partial commutation of periodic payments to a lump sum. As outlined in paragraph 4 of TD 93/3, such a commutation would result in the lump sum remaining assessable, as its effect was simply to pay in advance the future weekly payments.

This view has also been confirmed in Sommer v FC of T 2002 ATC 4815; 51 ATR 102 (Sommer's case). The case involved a medical practitioner who had taken out an income protection policy. Following the rejection of the taxpayers claim for income replacement payments of $4,000 per month, the matter was settled out of court with the taxpayer receiving a lump sum. The taxpayer argued that the amount was a payment of capital as it was paid in the consideration of the cancellation of the policy, and the surrender of his rights under it or that the payment was capital as it was an undissected aggregation of both income and capital.

In dismissing the taxpayer's appeal it was held that the payment was in settlement of income claims of the taxpayer in circumstances where the purpose of the insurance policy was to fill the place of a revenue receipt. As a result, the payment was clearly on a revenue account. The fact that the payment was received in one lump sum did not change its revenue character.

In your case, you suffered an injury and received monthly benefits under the group salary continuance policy. This policy was to protect and provide income in the event of illness or disability. The regular payments payable under the policy are income according to ordinary concepts.

You are considering an offer of a lump sum payment in full settlement of the policy. That is your future payments would be commuted to a lump sum. The lump sum would be paid to substitute you for your loss of income which you otherwise would have earned. As your periodic income replacement payments are ordinary income, a lump sum payment also retains the character of being ordinary income.

The payment you receive would be as a consequence of your injury. However, it would not be paid to compensate for the loss or impairment of earning capacity as in Slaven's case. It would be paid to substitute for loss of income.

It is acknowledged that in accepting the lump sum you have given up your rights for future claims in relation to the policy. However, as the policy provides you with an income replacement, it is considered that your case is similar to Sommer's case and the lump sum represents a redemption of the right to receive income and is also regarded as income in nature.

Accordingly, the lump sum payment payable under the group salary continuance policy is assessable under section 6-5 of the ITAA 1997 in the income year in which you received the payment. As the income is considered to be assessable under section 6-5 of the ITAA 1997, we do not need to consider whether it is statutory income or a capital gain.