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Ruling

Subject: assessable income of lump sum payment from insurance policies

Question 1

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 were a member of a superannuation fund of which an insurance company is the trustee

You obtained an income protection insurance policy (IPIP) from the insurance company. The terms of the policy provided for monthly payments until you reach the age of 65 in the event of you suffering total disability or partial disability.

You became ill and were unable to continue your employment.

As a result of your illness, you submitted a claim to the insurer under the IPIP.

You were paid benefits under the policy for a period. Your insurer then disputed your claim and ceased to pay any further benefits. The insurer still disputes your claim.

You commenced legal proceedings in the District Court claiming damages representing benefits not paid under the policy.

Without admission of liability by any party, you and your insurer have now agreed to settle the income protection claim.

You obtained a total and permanent disability insurance (TPD) benefit under a policy of life insurance with the insurance company. The benefits included the following cover:

· Life cover

· TPD

Under the terms of the policy the insurer is to pay a lump sum payment in the event of you suffering TPD.

You submitted a claim to the insurer under the TPD policy in respect of your alleged TPD.

No assessment of your claim under the TPD policy has been completed by either the insurer or the Trustee.

You have now reached an agreement in principle under a Deed of Release with your insurer to settle the TPD claim.

It is proposed your insurer will pay the following:

· An amount under the IPIP which includes interest.

· An amount under the TPDIP.

· An amount for your legal costs.

Under the agreement you will release your insurer and the Trustee from all present or future causes of actions claims or demands arising out of or in connection with the IPIP and TPD and you will no longer be an insured person under the policies.

You have provided a copy of the proposed Deed of Release and copies of both policies.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

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.

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

The payments are also one-off payments and thus do 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.

Income Protection Insurance Policy

You were receiving monthly benefits under your IPIP as you were unable to work and suffering total disability. Your insurer disputed (and still disputes) your claim to the monthly benefit and ceased these payments.

You commenced legal proceedings in the courts claiming your entitlements under the policy, interest and costs.

You and the insurer are considering settling the claim without any admission of liability if you agree to surrender your rights under the insurance policy.

In your situation the lump sum payment you will receive for entering the deed of release with your insurer is for surrendering your rights under the policy. Consequently the lump sum payment would be a capital receipt and would not be ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Total and Permanent Disability Policy

You are insured for total and permanent disability. You became ill and were diagnosed as being totally disabled as defined within the policy. You submitted a claim to your insurer in respect of your alleged TPD. Your insurer has not completed an assessment of your claim under the policy but have without admission of liability and upon you agreeing to surrender your rights under the policy agreed to settle your claim as set out in a deed of release.

The lump sum payment is considered to be a capital payment and not a replacement of an income stream.

Consequently, the proposed 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

Legal expenses

You are to receive a payment for legal expenses that you incurred in bringing actions against your insurer to obtain benefits under your insurance policies. Where the benefits received are capital, the costs incurred in obtaining those benefits are also considered capital.

Therefore, the proposed payment for legal costs is considered a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Capital gains

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 proposed lump sum payments are 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 to 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.

Subsection 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.