Edited version of your private ruling

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Ruling

Subject: Assessability of lump sum payment from income protection insurance

Question

Is a lump sum payment received from your income protection insurance policy assessable income?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

§ the application for private ruling ,

§ copy of offer of acceptance to the insurance company

You have an income protection insurance policy.

You have been receiving monthly benefits that have been included as assessable income.

Payments ceased for no reason and you took legal action to recommence payments.

After mediation your monthly payments recommenced and the insurance company agreed to pay you a lump sum payment less costs.

You offered to accept payment in full and final settlement of your claim under the income protection insurance policy for the period the payments ceased.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

Reasons for decision

Summary

The character of the lump sum payment was to replace income for the loss of earnings as a result of suffering an illness under the terms of your income protection insurance 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 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.

The lump sum payment made to you 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 also 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; ATD 82).

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).

Thus, amounts payable under a policy that provides a monthly indemnity against income loss arising from inability to earn are of a revenue character. Therefore, periodic payments received during a period of total or partial disability under a personal accident or disability insurance policy are assessable on the same principle as worker's compensation payments. Weekly or periodic worker's compensation payments (or periodic payments under other legislation) for loss of salary, either whole or in part, are assessable as ordinary income.

The character of a lump sum compensation payment or insurance benefit is derived from the terms of the particular policy or legislation and the reason for making the payment.

In your case, the character of the lump sum payment made to you was a final settlement under the income protection insurance policy to replace income for the loss of earnings during the period your payments ceased and is therefore considered to be ordinary income.

The Commissioner's view outlined in Taxation Determination TD 93/3 considers periodic payments paid as compensation for loss of income or salary as assessable income and that a lump sum payment, which is a commutation of such payments, retains its character as income. The issue of whether the commutation of an entitlement to periodic payments to a lump sum affects assessability was considered in Coward v. Federal Commissioner of Taxation 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 commutation of those future weekly payments was also income.

In view of the above, the lump sum payment made to you is considered to be ordinary income as it retains the character of the insurers' income protection insurance policy from which it was derived.