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Ruling

Subject: Compensation payment

Question

Will the whole or any part of your settlement amount constitute assessable income in the year it is received?

Answer

No

This ruling applies for the following period

Year ending 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

You entered into a group salary continuance insurance policy with total and permanent disablement insurance cover.

You became totally disabled as defined in the policy due to an injury and have not returned to work since that date.

You submitted a claim to the insurer for payment of total disability benefits under the policy.

Your insurer disputed, and still disputes, your claim because they maintain that your cover had ceased under the policy when you commenced a particular type of leave.

You commenced legal proceedings in the Supreme Court seeking benefits under the policy and other relief included in an amended statement of claim filed which your insurer has denied entitlement sought in the claim

You have entered into a Deed of Release with your insurer agreeing to pay a lump sum payment inclusive of damages, costs and interest. In return you would discharge your insurer from all causes of action, claims or demands which you have against the insurer that arise out of or in connection with the policy, the claim, the proceedings, or in connection with any other matter already recited in the deed or in respect of any matter in anyway related to any of those matters and the policy becomes void from the date of settlement.

You have provided a copy of the Deed of Release.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

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

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.

The lump sum payment you will receive is not income from rendering personal services, income from property or income from carrying on a business.

The payment is also a one off payment and thus it does not have an element of recurrence or regularity.

A payment of the nature described in the scheme generally bears the character of that which it is designed to replace. If the lump sum payment is paid for the loss of a capital asset or amount then it will regarded as a capital receipt and not ordinary income.

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

The lump sum payment you will receive is for entering into a Deed of Release with your insurer for the purpose of surrendering your rights under the insurance policy.

Consequently, 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.

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

Applying paragraph 118-37(1)(b) to your circumstances, 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 insurance policy. As all of these claims relate to your personal injury or illness, any capital gain or loss arising from the surrender of your rights under this policy will be disregarded. As such, this amount is not statutory income.

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