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Ruling

Subject: Lump sum compensation payment

Question:

Is any part of your lump sum payment assessable as ordinary income or as a capital gain?

Answer:

No.

This ruling applies for the following periods

Year ending 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

You held an income protection policy.

You were diagnosed with a condition.

As a result of the condition, you made a claim upon the insurer for payment of total disability benefits. The insurer accepted your claim.

You returned to work and the insurer continued to pay you partial disability benefits.

The insurer advised you that they were no longer entitled to benefits under the policy and they closed the claim.

You commenced legal proceedings against the insurer for breach of the policy for failing to pay further benefits in respect to the claim.

You were made an offer to settle the court proceedings and your entitlement to the income protection, business expenses and trauma components of the policy, and to extinguish any further rights to the theses components.

The life component of the policy remains current.

You accepted the offer and the lump sum payment were distributed as per the release agreement.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 6-15(1)

Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)

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.

In your case the lump sum settlement you received is not income from rendering personal services, from property or from carrying on a business. The payment is also a one off payment and does not have an element of recurrence or regularity. The settlement is a result of legal action where entitlement to receive income from the income protection policy was in dispute. It is not a lump sum payment which only substitutes for an income stream but rather for entering into a Release Agreement with your insurer for the purpose of surrendering your rights under the policy. The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income. Capital gains are one form of statutory income.

Taxation Ruling TR 95/35 deals with the capital gains tax (CGT) treatment of compensation receipts. The ruling provides that an insured person's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation. The whole of the settlement amount is thus treated as capital proceeds from a capital CGT event happening to your right to seek compensation.

The disposal of an asset gives rise to a CGT event. However, paragraph 118-37(1)(b) of the ITAA 1997 disregards the payments or receipts where the amount relates to compensation or damages received for any wrong, injury or illness you suffered.

Applying paragraph 118-37(1)(b) of the ITAA 1997 to your circumstances, the lump sum payment would not be considered as an assessable capital gain. The insurer's purpose in making the lump sum payment is so you would surrender your rights, not only to recover any such benefits in the action, but also to claim any further benefits to which you might now or in the future have an entitlement under your policy. As the claim relates to your illness, any capital gain or loss arising from the surrender of your rights under this policy will be disregarded.

Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income. Therefore no part of the settlement amount is required to be included in your assessable income.