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Ruling

Subject: taxation treatment of money paid from an insurance policy

This ruling is about the taxation treatment of money paid from an insurance policy that was owned by a spouse's employer and interest on that payment

Question 1

Are you required to include an amount in your assessable income in relation to any money you received in relation to an insurance policy from the employer or in satisfaction of your interest in any rights under the policy?

Answer

No

Question 2

Are you required to include an amount in your assessable income in relation to any money you received which represents accrued interest on insurance proceeds owed to you in relation to the policy?

Answer

No

This ruling applies for the following periods:

The financial years ended 30 June 2011 and 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Your spouse died in an accident at work.

The employer made a claim on their insurance policy. The money was paid into a trust account which was maintained by a law firm. The interest bearing trust account was held on behalf of the employer and was held for the purpose of payment to the estate of the deceased.

You agreed to release, discharge and indemnify the employer from any claims against them in a deed of release, in your own capacity and that as executor of your spouse's estate. The employer instructed the law firm to transfer from the trust accounts and pay to your bank account the following:

· the insurance payment

· the interest payment.

You understand that the interest payment represents the accrued interest which arose in relation to the insurance payment while that amount was deposited in the trust account.

Relevant legislative provisions

section 6-5 of the ITAA 1997

section 6-10 of the ITAA 1997

section 103-25.of the ITAA 1997

section 104-25 of the ITAA 1997

section 110-25 of the ITAA 1997

subsection 110-25(2) of the ITAA 1997

section 118-37 of the ITAA 1997

paragraph 118-37(1)(b) of the ITAA 1997

section 118-300 of the ITAA 1997

Reasons for decision

Capital gains tax event

Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the capital gains and capital losses provisions, commonly referred to as CGT. You make a capital gain or capital loss if a CGT event happens. Many CGT events involve a CGT asset and some relate directly to capital receipts

There can be CGT consequences when you receive compensation. Taxation Ruling TR 95/35 gives the Commissioner's view on the treatment of compensation receipts.

If a compensation payment is not in relation to an underlying asset, it relates to the disposal of a right to seek compensation (paragraph 11 of TR 95/35). A CGT event happens (CGT event C2 under section 104-25 of the ITAA 1997) when your ownership of the right to seek compensation ends by being released, satisfied or surrendered. Any capital gain arising on a disposal of that right is calculated using the cost base of that right.

If an undissected lump sum is received as compensation then the whole amount is treated as an amount received for giving up the right to seek compensation (paragraph 18 of TR 95/35).

The cost base of the right to seek compensation is determined in accordance with the provisions of section 110-25 of the ITAA 1997. The consideration in respect of the acquisition of the right to seek compensation includes the total acquisition costs incurred as a result of which the right to seek compensation arose.

The cost base of a CGT asset consists of five elements. The first element of the cost base is the total of the money you paid and the market value of any other property you gave in respect of acquiring it (subsection 110-25(2) of the ITAA 1997).

The Commissioner believes that a wide view should be taken of what is included in the cost base of an asset (paragraph 98 of TR 95/35). If the right to seek compensation arises in respect of a monetary loss of the taxpayer, the amount of that loss is included in the cost base of the right to seek compensation for that loss (paragraph 104 of TR 95/35). If there was a capital gain or capital loss it would be the difference between the incidental costs and the compensation received.

A CGT event happened (CGT event C2 under section 104-25 of the ITAA 1997) when your ownership of the right to seek compensation ended by being released, satisfied or surrendered. This occurred when the right to seek compensation from your spouse's employer was surrendered under the deed of release.

On signing of the deed of release and receipt of the payment from the employer, CGT event C2 in section 104-25 of the ITAA 1997 happened because your rights in respect of the employer ended. You made a capital gain if the capital proceeds from the ending are more than the asset's cost base. You will make a capital loss if those capital proceeds are less than the assets reduced cost base.

There are exemptions and rollovers that may allow you to reduce, defer or disregard your capital gain or capital loss. The exemption in section 118-37 of the ITAA 1997 could be relevant in your case.

Exemptions in Division 118 of the ITAA 1997

Paragraph 210 - 217 of TR 95/35 talks about certain payments that can be disregarded for capital gains purposes under section 160ZB of the ITAA 1936. This provision has now been replaced by section 118-37 of the ITAA 1997. Paragraph 118-37(1)(b) of the ITAA 1997 provides that a capital gain or a capital loss you make from a CGT event which relates directly to compensation or damages received by you for any wrong, injury or illness you or your relative suffers personally is disregarded.

Section 118-37 of the ITAA 1997 disregards a capital gain you make from a CGT event relating directly to compensation you receive for any illness you or a relative suffer personally. Paragraph 118-37(1)(b) of the ITAA 1997 provides that a capital gain or a capital loss you make from a CGT event which relates directly to compensation or damages received by you for any wrong, injury or illness you or your relative suffers personally is disregarded.

In this case, the payment was made to you, due to the passing of your spouse in an accident at work. Any capital gain or capital loss as a result of the payment can be disregarded under paragraph 118-37(1)(b) of the ITAA 1997. However it may be regarded as ordinary income.

Ordinary income

Section 6-5 of the ITAA 1997 provides that the assessable income of Australian residents includes the ordinary income derived directly or indirectly from all sources. Under section 6-10 of the ITAA 1997 amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income.

Ordinary income includes 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.

Employment income is ordinary income and as such assessable income, unless specifically exempt from tax. Workers' compensation, which is a periodical receipt received in lieu of employment income where a worker sustains an injury which entitles them to compensation, is also ordinary income and as such assessable income, unless specifically exempt from tax.

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), and the method of payment does not alter the character of the payment (Brackenreg v. FC of T 2003 ATC 2196; Case X21 90 ATC 239; Case K34 10 TBRD 187).

Lump sum payments in partial commutation of rights to weekly payments can be distinguished from payments received as a redemption of all the injured worker's rights under the Compensation Act. Such payments are of a capital nature and so are not included in assessable income. Nor are these payments assessable under the capital gains provisions of the ITAA (subsection 160ZB(1).of the ITAA 1936)

The payment to you was from your spouse's employer company as a result of an accident while he was on work. The payment was made out of a trust set aside by the company to pay to the deceased. It was not earned by you and was not a payment for any personal services provided. It was paid to go towards compensating you for the suffering as a result of your spouse's passing. As a one-off payment it had no element of periodicity, recurrence or regularity. The payment is not assessable under section 6-5 of the ITAA 1997.

Interest income

Receipts in the nature of a return on capital invested, such as interest, dividends and rents are income according to ordinary concepts and will be assessable unless expressly excluded or exempted. Therefore interest received is assessable as ordinary income.

If you received, or were credited with, interest from any source within Australia, for example:

· interest earned from financial institution accounts and term deposits unless you were a non-resident and have paid, or should have paid, non-resident withholding tax on that interest

· interest the Tax Office gave you or credited you with

· if you opened or operated an account for a child and the funds in that account belonged to you, or you spent or used the funds in the account as if they belonged to you, you must include any interest from the account then you must declare this in your tax return.

Interest earned on investment accounts is assessable to the person or persons who are beneficially entitled to the income (Taxation Determination TD 92/106). TD 92/106 paragraph 1 says that entitlement depends on the beneficial ownership of the moneys in the account and that in the absence of any evidence to the contrary it is generally presumed that the account holder is the person who has beneficial ownership of the moneys held in the account.

Dwight v. FC of T 92 ATC 4192 dealt with a solicitor holding money in trust for his client United States Surgical as security for court costs. Hill J stated in his judgement:

In my opinion, the present is a case where United States Surgical had, in the relevant years of income, a vested and indefeasible interest in the income from the security account. For the reasons given in Harmer, the defendants had no such interest and indeed were not beneficiaries. But here, United States Surgical was a beneficiary, indeed the only beneficiary, and the moneys in the fund and the income to be generated from it belonged to that company, subject only to a charge or lien upon it in favour of the defendants to secure future cost orders. In the result, United States Surgical was presently entitled to the whole of the income of the security fund and, accordingly, s. 99A could have no application to assess for tax Mr Dwight. …

The issue of interest on compensation before it was paid was considered in FC of T v. Northumberland Development Co Pty Ltd (Northumberland Case) 95 ATC 4483; 31 ATR 161. In the Northumberland Case the company received an amount of compensation and interest. The Full Federal Court found that the interest component was part of the lump sum. The company did not have an entitlement to the compensation or the interest on it until it was paid to it. The interest amount was not an amount for the loss of use of the money. It was a payment made to bring the calculation of the compensation up to the figure it should be at the time it was paid.

In your case the money was held in an account in trust by the solicitor. You were not the beneficial owner of that money, you did not have a vested and indefeasible interest in the income from the money and you were not a beneficiary of the trust. The interest that accrued on that money while it was in the trust account waiting to be dispersed to you is not assessable to you. It was held in a trust account and you did not have any right to the money or the income on it until the deed of release was signed.

Conclusion

The money you received in relation to the policy is disregarded for CGT as it is compensation for an accident resulting in death suffered by your spouse and is not assessable income received by you.

Any interest that was earned by the money prior to you signing the deed of release is also not assessable as income to you.