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Ruling

Subject: Lump sum payment in arrears of disability insurance benefits

Question

Can the lump sum arrears of disability benefits that you received in the relevant year of income and which accrued, in part, in prior income years be taxed in the income years in which it accrued, and a portion of the tax withheld from the arrears be allowed as a credit in each of those income years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2001

Year ended 30 June 2002

Year ended 30 June 2003

Year ended 30 June 2004

Year ended 30 June 2005

Year ended 30 June 2006

Year ended 30 June 2007

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

1 July 2000

Relevant facts and circumstances

Your superannuation fund provides disability insurance cover to its members.

The disability insurance cover provides a monthly payment of a percentage of the insured member's pre-disability earnings.

You suffered a disability in a prior income year, and made a claim for disability benefits under your superannuation fund's insurance cover.

In the relevant income year, the insurer of the disability cover provided by your superannuation fund, completed their assessment of your claim and accepted it.

Monthly disability benefits were payable to you from a certain date which, due to a waiting period, was several months from the date you suffered the disability.

During the relevant year of income you received a lump sum payment in arrears which accrued, in part, in earlier income years. The arrears was a back payment of the monthly disability benefits payable to you for the period which covered several income years.

PAYG tax was withheld from the arrears lump sum payment.

The insurer issued you with a PAYG payment summary for the relevant year of income, which includes the arrears lump sum payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 4-10

Income Tax Assessment Act 1997 Section 4-15

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Summary

Your lump sum payment of arrears of disability benefits was derived at the time it was received, that is, during the relevant year of income. Accordingly, it is assessable income in that year of income and forms part of your taxable income for that income year, even though part of the arrears accrued in prior income years.

Detailed reasoning

Taxable income

Under section 4-10 of the Income Tax Assessment Act 1997 (ITAA 1997), income tax is worked out by reference to your taxable income for the income year. Taxable income for an income year is calculated by subtracting the deductions from the assessable income for that income year (section 4-15 of the ITAA 1997).

Assessable income

Under section 6-5 of the ITAA 1997, assessable income includes income according to ordinary concepts (ordinary income) that is derived during the income year.

Payments for rendering personal services (such as earnings and salary and wages) are ordinary income 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. Periodic workers compensation payments have been held by the courts to be ordinary income because they are received as compensation for loss of income or salary (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516).

Periodic payments paid to a taxpayer during a period of disability under a personal accident, income protection or disability insurance policy are assessable on the same principle as workers compensation, that is, they are assessable where they are paid to replace lost earnings (FC of T v. D.P. Smith 81 ATC 4114; (1981)11 ATR 538).

In your case, the disability benefits were calculated by reference to pre-disablement earnings. The disability benefits were paid to replace the earnings that were lost as a result of your disablement. These payments are assessable as ordinary income under section 6-5 of the ITAA 1997 as they were in substitution for the income you would have earned if it were not for your incapacity.

You have asked if it is possible that your lump sum arrears of disability benefits be taxed over the period in which the benefits accrued, rather than being taxed when the arrears was received in the relevant year of income.

Under section 6-5 of the ITAA 1997, ordinary income is included in the assessable income of a taxpayer in the income year in which it is derived.

When is a lump sum arrears of disability benefits included in assessable income?

Taxation Ruling IT 2107 deals with social security sickness benefits and workers' compensation benefits. It states that social security sickness benefits constitute assessable income of recipients in the year paid, and that so too are periodic receipts of workers' compensation, including lump sum arrears of compensation (paid in respect of the period between the date of the event giving rise to the compensation and the date of payment of those arrears).

The issue of when a lump sum payment in arrears of periodic compensation is included in assessable income has been considered in a number of cases.

In Case G8 75 ATC 27, 19 CTBR (NS) Case 102, the taxpayer suffered an injury at work as a result of which she became entitled to compensation. During the 1971 income year she received payments under Employees' Compensation legislation, covering various periods from 12 December 1968. The taxpayer claimed that so much of the compensation paid to her as related to prior income years should be excluded from her assessable income for the 1971 income year. It was held that the payments were derived at the time they were received, and accordingly were assessable income in the 1971 income year.

In Vargiemezis v. FC of T [2008] AATA 1152, the taxpayer had been incapacitated in the course of his employment and subsequently obtained a court order for a lump sum representing arrears of weekly compensation from his employer. The taxpayer requested a prior year amendment to apportion the lump sum over the year in which it accrued. It was held that the lump sum arrears was assessable in the income year it was received, notwithstanding that part of the amount was referable to a prior year.

Your lump sum payment of arrears of disability benefits was derived at the time it was received, that is, during the relevant year of income. Accordingly, it is assessable income in that year of income (under section 6-5 of the ITAA 1997), and therefore forms part of your taxable income for that income year.