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Ruling

Subject: Assessable income

Question

Are the proceeds you received on surrender of your investment linked life assurance policy to be included in your assessable income?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You purchased an investment linked life assurance policy with a death benefit in 1990.

You were required to make bi-annual contributions to the policy which increased in-line with the Consumer Price Index (CPI). Fees and charges were taken out bi-annually and the balance was re-invested.

You did not receive any bonuses or income from the policy during the 20 years you held it.

The policy matured in 2010 and you withdrew the full amount. The payout figure included a capital component and an investment gain component.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 26AH.

Income Tax Assessment Act 1936 Subsection 26AH(6).

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 118-300.

Reasons for decision

Summary

The proceeds you received on the surrender of your investment linked life assurance policy are not included in your assessable income as:

§ they are capital in nature and therefore are not assessable as ordinary income;

§ they do not meet the criteria for assessability under section 26AH of the Income Tax Assessment Act 1936 (ITAA 1936); and

§ any capital gain is disregarded under section 118-300 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Assessability of proceeds as ordinary income

Section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia during the income year.

Lump sum proceeds received on life assurance or endowment policies are not income according to ordinary concepts as they do not have the characteristics of ordinary income. These lump sum proceeds are of a capital nature.

Accordingly, the lump sum proceeds received on life assurance or endowment policies are not assessable under section 6-5 of the ITAA 1997.

Assessability of proceeds as statutory income

Section 6-10 of the ITAA 1997 also includes in a taxpayer's assessable income amounts that are not ordinary income but are made assessable under another provision; these amounts are statutory income.

One such provision is section 26AH of the ITAA 1936 which provides that a taxpayer's assessable income shall include bonuses, and some other amounts in the nature of bonuses, received under a relevant life assurance policy (an 'eligible policy') during a specified period (the 'eligible period').

An 'eligible policy' is defined as a policy of life assurance with a commencement risk date after 27 August 1982. An 'eligible period' means the period of 10 years commencing on the date of commencement of risk of the policy (if the date of commencement of risk was after 7 December 1983).

Taxation Ruling IT 2346 discusses the circumstances under which bonuses paid on certain life assurance policies are assessable. IT 2346 at paragraph 5,  provides that section 26AH of the ITAA 1936 may apply to amounts received under any form of life assurance policies, including those known as 'unbundled policies' which are categorised as investment account or investment linked polices. IT 2346 describes an investment-linked policy as a contract providing a death benefit and an investment account, the value of which is directly linked to the performance of a specific investment portfolio.

In the case of the more traditional policies (i.e. endowment policies) paragraph 8 of the IT 2346 defines a bonus as a guaranteed addition to the sum insured which is payable when the sum insured is payable. Paragraph 9 of the ruling states that in the case of 'unbundled policies', the concept of bonuses representing the profit or gain element passed on to the policyholder is maintained for the purposes of section 26AH.

Under the provisions of subsection 26AH(6) of the ITAA 1936, if a taxpayer receives an amount as or by way of a bonus under an eligible policy which has an eligible period of ten years, the amount included in assessable income shall be:

§ if received during the first eight years of the eligible period - the amount received (paragraph 26AH(6)(a) of the ITAA 1936).

§ if received during the ninth year of the eligible period - two thirds of the amount received (paragraph 26AH(6)(b) of the ITAA 1936).

§ if received during the tenth year of the eligible period - one third of the amount received (paragraph 26AH(6)(c) of the ITAA 1936).

Importantly, IT 2346 explains that any amounts received as or by way of bonuses in the 11^th or subsequent years would not be subject to tax.

In your case, an investment linked policy, under your name, was taken out in 1990. You withdrew the full amount from the policy on maturity in 2010. You received a lump sum payment which included a capital component and an investment gain component.

The policy you held was an 'eligible policy' for the purposes of section 26AH of the ITAA 1936 as the policy was taken out after 27 August 1982. In addition, the policy has been held for more than 10 years before its surrender.  

In accordance with the principles established in IT 2346, any bonuses paid on the withdrawal of the policy are not assessable if the commencement risk date of the policy is after 7 December 1983 and the policy has been held for more than 10 years.

Therefore, the bonus you received on the surrender of the investment linked life assurance policy you held will not be included in your assessable income under section 26AH of the ITAA 1936.

Capital Gains Tax

Section 118-30 of the ITAA 1997 specifically deals with the capital gains tax consequences of life insurance policies. This section provides that any capital gains and losses made on the disposal of an interest in a life insurance policy can be disregarded where the taxpayer is the original beneficial owner of the policy.

In your case, you are the original beneficial owner of the investment linked life assurance policy. Consequently, the proceeds paid to you on the surrender of the policy will not be subject to capital gains tax.