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Ruling

Subject: lump sum and monthly payments received under an insurance claim.

Question 1

Do the lump sum and monthly payments received under an insurance policy form part of your assessable income if you are unable to return to work?

Answer

Yes.

Question 2

Are the lump sum and monthly payments received under an insurance policy considered to be exempt from income tax?

Answer

No.

Question 3

Are legal fees incurred in securing settlement of a claim under an insurance policy a deductible expense?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts and circumstances

Your employment ceased due to disabilities that you suffered. You have not been employed since.

You had contributed to an insurance policy. In the event of you being unable to work due to a disability the policy provided you with a monthly payment until you reached the age of 55 years. You made a claim under the policy due to your inability to continue your employment. The claim was disputed by the insurer.

After you had taken legal action to obtain payment under the policy you received a number of lump sum payments followed by monthly payments from the insurer. The monthly payments will cease on your 55^th birthday.

You have incurred legal fees in obtaining the above lump sum payments as well as the subsequent monthly payments.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 6-15(2),

Income Tax Assessment Act 1997 Section 6-20(1),

Income Tax Assessment Act 1997 Section 8-1 and

Income Tax Assessment Act 1997 Section 15-30

Reasons for decision

Question 1

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

The courts have identified a number of factors which indicate whether an amount has the character of income according to ordinary concepts.

A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity (FCT v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82).

One or more of the following characteristics will combine with periodicity to give an amount an income nature:

· it is made in substitution of income;

· it is made to provide financial support, for example, as an income supplement; or 

· it is received in circumstances where the recipient has an expectation of receiving the payment on a regular basis so that the recipient is able to depend upon the payment for his or her regular expenditure.

Payments for rendering personal services, such as salary or wages, are ordinary income and are included in assessable income under section 6-5 of the ITAA 1997.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments, such as workers compensation, which substitute income have been held by the courts to be income under ordinary concepts (FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142).

Periodic payments received by a taxpayer during a period of disability under a personal accident, income protection or disability insurance policy taken out by the taxpayer are assessable on the same principle as workers compensation, that is, they are assessable where they are paid to replace lost earnings.

Whether accident and disability insurance benefits are taxable came before the High Court in FC of T v Smith 81 ATC 4114. In this case Justices Gibbs, Stephen, Mason, and Wilson considered the purpose of the policy was to diminish the adverse economic consequences of injury by accident. Also they said the payment was to provide a monthly indemnity against the income loss arising from the inability to earn income. They were of the opinion that a revenue character was clearly stamped upon the payments. In addition to their findings that the amount was assessable under section 25(1) of the Income Tax Assessment Act 1936 (ITAA 1936) they said it was also assessable income under paragraph 26(j) of the same act.

Although section 25(1) and paragraph 26j of the ITAA 1936 have been repealed, it is considered that the judges' comments would be equally applicable to those sections' successors, namely sections 6-5 and 15-30 of the ITAA 1997.

Accordingly, the monthly payments you received and/or combinations of monthly payments you received in lump sum payments are considered to be assessable income, as they:

· replaced your salary;

· were expected; and

· were received periodically.

As a consequence, the back payment of monthly payments made in arrears as well as the subsequent monthly payments made to you under the policy must be included as part of your assessable income under section 6-5 of the ITAA 1997.

The lump sum payments as well as the monthly benefits paid during the relevant year are to be included in your income tax assessment for that year in accordance with section 6-5 of the ITAA 1997. Each monthly payment received after 30 June 20XX is considered to be assessable income in the respective income year in which each payment is actually received.

Question 2

If an amount is exempt income, it is not assessable income (subsection 6-15(2) of the ITAA 1997).

Subsection 6-20(1) of the ITAA 1997 states that an amount of ordinary income is exempt income if it is made exempt from income tax by a provision of the income tax legislation or another Commonwealth law.

However, there are no provisions which exempt a payment under a personal accident, income protection or disability insurance policy from income tax where the payment replaces income that would have been derived if the event that triggered the claim under the policy had not occurred. The payments you have received are therefore not exempt income.

The monthly payments, including those paid in lump sums, that you have been receiving under the policy are to replace lost earnings. They are therefore ordinary income and are included in assessable income under section 6-5 of the ITAA 1997. The payments are not exempt income.

Question 3

Section 8-1 of the ITAA 1997 states that you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing assessable income and is not:

· capital, private or domestic in nature

· incurred in gaining or producing exempt income

· prohibited by a section of the ITAA 1997 or the ITAA 1936

The legal expenses were incurred in order to obtain the benefits prescribed in the disability insurance policy and resulted in assessable income being received. Thus, there is a clear connection between the assessable income and expense.

The legal expenses do not meet the criteria for any of the three exceptions to deductibility listed above. Thus, the legal expenses have the essential character of an outgoing incurred in gaining assessable income and therefore are deductible under section 8-1 of the ITAA 1997.