Edited version of your written advice

Authorisation Number: 1012696156717

Ruling

Subject: Assessable income

Question 1

Are the benefits payment, no claim bonus and escalating claim benefit payments assessable as ordinary income?

Answer

Yes.

Question 2

Are the double benefits for specified sicknesses and the death benefit paid from an income protection policy assessable as either ordinary income or as a capital gain?

Answer

No.

Question 3

Is the refund of the insurance premium assessable as ordinary income?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

The deceased passed away in 20XX.

The deceased had an income protection policy (the policy).

The policy commenced in late 199X.

The deceased's estate (the trust) received the following benefit payment in mid 20YY:

Benefits $xxx

Double benefits for specified sickness $xxx

No Claim bonus $xxx

Escalating claim benefit (CPI) $xxx

Premium refund $xxx

Death benefit $xxx

Total payment $xxx

Details received from the insurer in relation to the payments are:

• Benefits - Although the deceased was receiving income from their employer, as the deceased was totally disabled and not working, the deceased was entitled to benefits after the three month waiting period.

• Double benefits - the policy provides for payment of double the normal monthly benefit for up to six months when the deceased was disabled by specified sicknesses.

• No claim bonus - As the deceased had not made a claim for six years, the monthly benefit is increased for up to the first year of claim by 25%.

• Death benefit - the insurance also provides for payment of six months benefits, up to a maximum of $60,000 in the event of death.

• Escalating claim benefit - if the life insured has optional indexed claim benefits, benefits will be increased annually after benefits have been paid for a full year. The increase to the monthly benefit will be either the increase in the CPI or 7.5%, whichever is lower.

Details received from your tax agent in relation to the payments are:

• Premium refund - the insurance premium had not previously been claimed as a tax deduction.

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 Subsection 20-20(2).

Income Tax Assessment Act 1997 Section 102-1.

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.

Benefits payment, no claim bonus and escalating claim benefit payments

Payments of salary or wages, including payments made under an insurance policy that replaces salary or wages are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997.

Whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability as ordinary income was considered in Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138. In that case Mathews J found that payments made to replace income take on the character of the payment they replace and that the method of payment does not alter the character of the payment. Mathews J held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing a redemption of those future weekly payments was also income.

This view was subsequently confirmed in Sommer v FC of T 2002 ATC 4815; 51 ATR 102 (Sommer's case). The case involved a medical practitioner who had taken out an income protection policy. Following the rejection of the taxpayer's claim for income replacement payments of $4,000 per month, the matter was settled out of court with the taxpayer receiving a lump sum. The taxpayer argued that the amount was a payment of capital as it was paid in the consideration of the cancellation of the policy, and the surrender of his rights under it or that the payment was capital as it was an undissected aggregation of both income and capital.

In dismissing the taxpayer's appeal it was held that the payment was in settlement of income claims of the taxpayer in circumstances where the purpose of the insurance policy was to fill the place of a revenue receipt. As a result, the payment was clearly on a revenue account. The fact that the payment was received in one lump sum did not change its revenue character.

The question of whether amounts paid under an insurance policy in lieu of income are assessable was considered by the High Court in F C of T v Smith, 81 ATC 4114 (Smith's case). In that case, the taxpayer was a medical practitioner employed by a hospital. He was injured in a traffic accident on 19 October 1977 and was disabled until 16 February 1978. For that period he received $2,112 under the terms of a personal disability insurance policy which he had taken out some years earlier.

It was held by the Full High Court that the amount of $2,112 was assessable. In their joint judgement Gibbs, Stephen, Mason and Wilson JJ said that, in their opinion, the conclusion was inescapable that the purpose of the policy was to diminish the adverse economic consequences of injury by accident. It was to provide a monthly indemnity against the income loss arising from the inability to earn. The revenue nature of the benefits was clearly stamped upon them during the period of four months during which the insured was totally disabled from earning.

The decision in Smith's case confirms the Commissioner's practice of including periodic benefits payable under a disability insurance policy as assessable income. It is considered that had an income protection insurance policy been the relevant policy in Smith's case the decision would have been the same.

In this case, the monthly benefit was received (as a lump sum) even though the deceased was receiving their normal salary from the employer. The intention of the income protection policy is to provide income during a period where you are unable to work. The fact that the deceased was receiving their normal salary does not change the character of the benefit from one of income replacement.

The no claim bonus is an amount that is payable depending on the number of years where no claim has been made. In this case, the amount is based upon a 25% increase of the monthly benefit for up the first year of claim. Therefore the amount is directly connected to the monthly benefit.

The escalating claim benefit is also based on the monthly benefits.

The income protection policy was designed to protect and provide income in the event of illness or disability. The amount paid under the policy was earned because of the deceased's rights under the policy. The payment received is based on the period after the deceased was diagnosed and prior to their death.

Therefore, all the payments related to the payments have the characteristics of ordinary income identified above. The payments are assessable under subsection 6-5(2) of the ITAA 1997.

Double benefits for specified sicknesses and the death benefit payment

The deceased did not earn the double benefits for specified sicknesses and the death benefit as it does not directly relate to services performed. Rather the payment relates to personal circumstances that have arisen as a result of illness and death. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the investment in insurance, rather than from a relationship with personal services performed. Thus, the payment received in relation to the double benefits for specified sickness and the death benefit is not considered ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997. The list includes capital gains, which are included in assessable income by virtue of the capital gain tax (CGT) provisions.

Section 102-5 of the ITAA 1997 provides that your assessable income includes your net capital gain (the total of capital gains for the income year, reduced by certain capital losses).

However, amounts otherwise included in your assessable income do not form part of a net capital gain (section 102-1 of the ITAA 1997).

Taxation Ruling TR 95/35 considers the CGT consequences for a person who receives an amount as compensation. The ruling states that a right to seek compensation is an asset for the purposes of the CGT provisions, and that a right to seek compensation is:

• acquired at the time of the compensable wrong or injury, and

• disposed of when it is satisfied, surrendered, released or discharged.

TR 95/35 states that compensation received under a policy of insurance relates to a right to seek compensation.

Any capital gain or capital loss made is disregarded where the amount relates to compensation or damages you receive for any wrong or injury you suffer in your occupation, or for any wrong, injury or illness you suffer personally (subsection 118-37(1) of the ITAA 1997).

In this case, the payment for the double benefits for specified sicknesses and the death benefit are an amount received for an illness that the deceased suffered. Therefore the double benefits for specified sicknesses and the death benefit is not required to be included in the assessable income of the trust.

Recoupment

Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss or outgoing is an assessable recoupment if:

• you received the amount by way of insurance or indemnity, and

• you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act.

In this case, the estate received an amount of $xxx as a premium refund. Although the estate has not claimed the deduction, they could have and therefore the premium refund is assessable.