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Ruling

Subject: Assessable income of lump sum payment from insurance policy

Question 1:

Is a lump sum paid as a full commutation of your Group Salary Continuance policy assessable income?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2009

The scheme commences on

1 July 2008

Relevant facts and circumstances

You are an Australian resident.

You commenced employment and as part of your remuneration package you were covered by the Employer's Group Salary Continuance Policy (Policy).

You were diagnosed with a number of illnesses and deemed unfit to work.

You made a claim under the Policy and you received monthly benefits for past years which have been included in your assessable income.

You were required to undergo regular medical assessments and as your medical condition had not been resolved you had not returned to work.

You participated in a number of medical and remedial treatments that were organised and funded by your insurer.

Your insurer advised of their intentions of finalising its obligations to you under the Policy rather than continue with monthly payments.

The policy allows for cover of total disablement with monthly benefits of 75% of the monthly salary for a maximum period of up to your 65^th birthday.

You signed a deed of release and agreed that the payment of the finalisation payment constitutes a full discharge of the insurer of its obligation to pay you 100% of the amount that your insurer would have been obliged to pay you in respect of your claim under the group salary continuance policy, and that you are not entitled to receive further amounts under the Policy in respect of the claim.

Your lump sum finalisation payment had been calculated allowing for withholding tax and investments earnings under the policy net of tax payable to you under the policy until you turn 65.

You have been issued with a Pay As You Go payment summary listing the gross payment and tax withheld.

You have provided a copy of the Policy and an executed Deed of Release.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Reasons for decision

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 you took 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, you had been receiving monthly payments after tax from your insurer under the policy. Your insurer has under the Deed of Release made a lump sum payment after tax in full for final settlement of your claim.

The character of the lump sum payment offered to you and accepted by you under the Deed of Release is to replace income for the loss of earnings 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.

It has been concluded from all the documentation provided that the lump sum payment was calculated to place you in the same position as you would be in had payments continued to be made monthly for the duration of the policy. This calculation took into account tax that would have been paid on monthly payments, any tax difference caused by receiving the monies as a lump sum, and likely investment earnings.

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

Although the insurer has paid for some treatments in the past, this does not appear to be as a consequence of any entitlement you had under the policy. The treatment was initiated by the insurer and not yourself, and you could not rely on any future treatments being offered.

The fact that your insurer organised and funded some medical treatments does not alter the fact that the amount you received was for the commutation of the periodic payments of income you were receiving.