Edited version of your private ruling

Authorisation Number: 1012437955301

Ruling

Subject: Lump sum compensation payment

Question

Will any part of the lump sum payment you have been offered be assessable as ordinary income or as a capital gain?

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 applied for an income protection policy .Your application was accepted and you were issued with a policy.

The assets and business of the insurer was transferred to a new insurer and you were issued with a new policy number.

The policy provided for the payment of benefits in the event of a person insured as defined under the policy was totally disabled or partially disabled as defined under the policy.

You have suffered from a series of injuries over a period of time.

As a result of the injuries you have made several claims upon the insurer for total disability benefits and partial disability benefits. The insurer accepted the claims and paid you benefits under the policy.

A dispute arose between you and the insurer. The insurer advised you by letter that they had finalised your claim and ceased paying your benefits under the policy.

You commenced legal proceeding against the insurer in the District Court.

You have been made, without admission of liability, an offer by the insurer to settle the court proceedings, and to extinguish all future liabilities under the policy.

You intend to enter into the Release Agreement which provides that in return for the insurer paying you a lump sum amount 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 the policy, but for those terms. The terms will provide that the policy is now void, although you would be able to retain any benefit payments that you have already received under the policy.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5

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

Section 6-5 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

· have an element of periodicity, recurrence or regularity.

In your case the lump sum payment will not be income from rendering personal services, income from property or income from carrying on a business. The payment is also a one-off payment and does not have an element of recurrence or regularity.

The offer from the insurer is a result of a legal action where entitlement to receive income from the income protection policy was in dispute. It is not a lump sum payment which 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 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 would 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, you would no be required to include the settlement amount in your assessable income.