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Subject: capital gains tax - income - income protection plan - lump sum payment

Question: Will the lump sum payment received from an income protection policy be included in your assessable income in the income year in which the payment is made?

Answer: Yes.

This ruling applies for the following period

Income year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You have an income protection plan with Company A, which you commenced after 20 September 1985.

You currently receive monthly disability payments, which os offset due to you receiving a pension.

Company A have indicated that they are willing to investigate a possible lump-sum payout to finalise the ongoing income protection payments.

For the purpose of this private ruling, you will receive a lump sum payment from Company A during the 2011-12 income year.

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

Summary

The lump sum payment will be paid to you to replace the monthly income benefits under the income protection policy, and is therefore considered to be ordinary assessable income.

Detailed reasoning

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 (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; and

§ 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

As the lump sum amount you will receive from Company A is viewed as ordinary income, you will be assessable on the receipt of the lump sum amount in the income year in which the payment is made to you.