Edited version of your private ruling

Authorisation Number: 1012441048160

Ruling

Subject: Lump sum compensation payment

Question

Is any part of your lump sum payment 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 income protection insurance (the policy). Your application was accepted and you were issued with a policy.

Due to illness you made a claim on the basis that you were totally disabled (as the phrase is defined in the policy).

You received monthly benefits under the policy.

The insurer ceased your the monthly payments.

You commenced legal proceedings against the insurer.

The insurer denied liability and the claims made against it in the proceedings.

Without any admission to liability the insurer made you an offer to settle the matter out of court and to cancel the policy and extinguish your rights under the policy.

You accepted the offer by signing the deed of release (the deed) and a lump sum payment was distributed as per the signed deed.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 6-10

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

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 102-5

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.

In your case the lump sum settlement you received 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 does not have an element of recurrence or regularity. The settlement is a result of legal action where entitlement to receive income from the income protection policy was in dispute. It is not a lump sum payment which only substitutes for an income stream but rather for entering into a Dead of Release with your insurer for the purpose of surrendering your rights under the policy. 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.

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.

Section 10-5 of the ITAA 1997 lists those provisions. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains.

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 of a right 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 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 will 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 no part of the settlement amount would need to be included in your assessable income.