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Ruling

Subject: Lump Sum Arrears Payment

Questions and answers:

1. Are you assessable on the lump sum payment in arrears paid to you by your employer in the year you received it?

No.

2. Are you eligible for a lump sum payment in arrears tax offset?

No.

3. When you repay your insurance provider for the amount you received in duplicate from insurance and your employer, can you amend your assessments to remove thus previously declared this income?

No.

This ruling applies for the following periods:

Year ended 30 June 20XX,

Year ended 30 June 20YY,

Year ended 30 June 20ZZ,

Year ended 30 June 20WW.

The scheme commenced on:

1 July 20XX.

Relevant facts:

In the relevant financial year you suffered a workplace injury.

For a period after you received worker compensation from your employer.

After a period your employer rejected your claim and ceased payment of your compensation.

You took legal actions against your employer.

It was held your employer erred in stopping your weekly compensation.

Whilst your employer ceased paying compensation you enacted your income protection policy.

During relevant year and subsequent year you received amounts from your income protection policy which was declared through your Australian tax returns.

During 20XX you received further amounts from your insurer. (You have not actually received all of these amounts).

Recently in line with the court decisions, your employer has paid you a lump sum amount, the amount that you should have received for fortnightly compensation.

Thus you have received duplicate income from insurance and your employer.

The lump sum received from your employer was calculated using the wage rate at the various times over the past years and they also assured you that they taxed you at the prevailing tax rates for the relevant individual years. Tax was paid at source.

The payment received from the employer was less than the total received from the insurer.

Your income protection company is now entitled to repayment of the gross arrears amount paid to you by your employer. Your insurance policy documents gives your insurer the right to recover money overpaid.

Your insurance company requires repayment of the amount overpaid less amounts you incurred for legal expenses.

Your insurer is still liable to make regular payments for loss of income to you as the amount you are receiving from your employer is less than the amount you are entitled to under your policy.

You are not actually receiving this payment for wages from the insurance company while the amount overpaid remains outstanding, as they are offsetting the amount you owe to them for the overpayment against the amount owed to you under your policy.

You are still receiving income from your employer in Australia.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-5(4).

Reasons for decision

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).

Based on case law, it can be said that ordinary income generally includes receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Payments of salary and wages for example are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997.

Compensation Payments

The High Court of Australia has established, in several cases, that for income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted, and that compensation payments which substitute income are income under ordinary concepts. (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82; Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; and Case Y47 (1991) 22 ATR 3422; 91 ATC 433.)

These principles have been confirmed as the ATO view by the Commissioner in Taxation Ruling TR 95/35.

Several ATO Interpretative Decisions have also discussed this issue, including:

· ATO ID 2002/175 - a taxpayer with a terminal illness was assessable on monthly payments received under an income protection policy.

· ATO ID 2004/662 - the Tax Office treated as ordinary income disability benefits paid under a mortgage protection policy because the taxpayer could not work due to sickness.

In regards to the assessability of disability benefits paid under an income protection policy, ATO ID 2004/662 explains:

The monthly disability benefit is intended to provide financial support and assistance for the taxpayer and their family. While not earned, the disability benefit is expected and relied upon by the taxpayer, and being paid monthly, has an element of recurrence and regularity. In certain defined events the disability benefit will effectively replace the taxpayer's income from salary and wages.

Accordingly, the disability benefit can be characterised as income according to ordinary concepts and is therefore included as assessable income within the terms of section 6-5 of the ITAA 1997 when derived.

Repayment of Income Protection Policy Amounts

Section 59-30 of the Income Tax Assessment Act 1997 (ITAA 1997) covers where an amount you receive is not assessable income where you must repay it and you repay it in later income year and you cannot deduct the repayment for any income year.

Section 59-30(1) of the ITAA 1997 says that an amount you receive is not assessable income and is not exempt income for an income year if:

(a) you must repay it; and

(b) you repay it in a later income year; and

(c) you cannot deduct the repayment for any income year.

However section 59-30(3) of the ITAA 1997 states that this exemption does not apply to an amount you must repay because you received a lump sum as compensation or damages for a wrong or injury you suffered in your occupation.

In your case, you suffered a work related injury. You received income protection payments which you are now required to repay as you have since received a lump sum payment for compensation from your employer.

The lump sum has been identified in court proceedings as payment for compensation due to loss of wages.

As per section 59-30(3) of the ITAA 1997 you are not entitled to amend your assessments for the amount previously declared as income and now required to be repaid.

Lump Sum Arrears Received From Employer

The lump sum you have subsequently received from your employer, is not assessable income under section 6-5 ITAA 1997. As per your insurance policy you are not entitled to this amount paid for loss of wages as it resulted in an overpayment by the insurer.

Because you are not entitled to receive this income, it is not assessable income to you.

Lump Sum Payment in Arrears Tax Offset

Individual taxpayers who receive assessable lump sum payments containing an amount that accrued in earlier income years may be entitled to a tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936). 

As the lump sum payment you have received is not assessable, you are not eligible for the lump sum payment in arrears tax offset.

Summary

You stopped receiving your regular salary and wages from your Australian employer.

You enacted your income protection policy.

In the years that followed you received payments from your insurer.

You have since received an amount to compensate you for weekly compensation payments owed to you by your employer.

As you had already been compensated for loss of wages by your insurer, they are entitled to recover the entire arrears payment made by your employer.

The amount that you are required to repay is less than the full amount you received from your employer. This is because your insurer recognises that you have incurred legal fees in order to recover the amount now owed to them. The fact that they have accepted that the legal fees were paid 'on their behalf' does not make the amount they are not recovering your income.

In addition to the lump sum received from your employer, they have also recommenced your normal entitlements. However this amount is not the same as what you would be receiving under your insurance policy and therefore your insurance policy has been paying the "gap".

This "gap" amount has not been paid to you as you still owe money to your insurance company. Although you have not physically received this gap amount you are still assessable on it and thus taxable on these amounts as per section 6-5(4) of the ITAA 1997: In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

In conclusion the tax effect of from 20XX to 20YY is as follows:

20XX to 20ZZ:

You are assessable on the income insurance policy amounts paid to you in previous years - tax already paid.

20YY:

You are assessable on the income insurance policy amounts offset against your debt for the current financial year - the "gap" amounts.

You are not assessable on the lump sum arrears payment received from your employer as it is not your income, it belongs to your insurance company.

Any payments received from your employer that do not relate in arrears amounts owed are also taxable in the relevant financial years as per normal receipt of salary and wages.