Edited version of your written advice

Authorisation Number: 1012697582788

Ruling

Subject: taxation treatment of lump sum settlements

Question and Answer

Is the whole of a lump sum settlement amount paid by an insurer to you assessable as a Capital Gain in the year it is received?

Yes

This ruling applies for the following period

Year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

As member of a superannuation fund, you were entitled to payments from the fund in connection with the happening of various events including total and permanent disablement.

The trustee of the superannuation fund maintained a policy of life insurance with an Insurer under which the Insurer was obliged to pay a benefit to the Trustee of the superannuation fund in connection with the happening of a total and permanent disablement of a member.

You directly purchased through the same insurer a separate additional insurance policy which provided cover for trauma, income protection and total and permanent disability.

You suffered from various illnesses.

As a result of your illness you made a total permanent disability claim through the trustee of your superannuation fund. No assessment of your claim was completed by either the Insurer or the Trustee.

As a result of your illness, you made a claim for the payment of monthly benefits under the policy you held directly with the insurer, to which they commenced payment. You are not seeking a ruling on these payments.

As a result of your illness, you made a claim for a total permanent disability lump sum under the policy you held directly with your Insurer. No assessment of your claim was completed by the Insurer.

You commenced legal proceedings against both the Trustee and the Insurer in relation to the pending insurance claims.

Without any admission of liability by any party, you, the Trustee of the superannuation fund and the Insurer agreed to settle the total permanent disability claim on the basis that the Insurer pay you a lump sum amount of $x.xx inclusive of all costs and interest in exchange for you releasing the Insurer and the Trustee of the superannuation fund from all actions, suits claims or demands that you had or may have had in the future relating to your proceedings.

The parties entered into a Release Agreement confirming the release of liability and the payment of the lump sum.

The Release Agreement has not been supplied as it contains a confidentiality clause.

The Release Agreement does not provide for any dissection of the Settlement Amount and you were not given any information by that Insurer that would enable you to dissect the lump sum Settlement Amount.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-15 of the Income Tax Assessment Act 1997

Section 104-25 of the Income Tax Assessment Act 1997

Section 116-40 of the Income Tax Assessment Act 1997

Section 118-37 of the Income Tax Assessment Act 1997

ATO view documents

Taxation Ruling TR 95/35

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 of regularity.

The lump sum payment you received is 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 your facts generally bears the character of that which it is designed to replace. If the lump sum payment is paid for the loss of capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Taxation ruling TR 95/35 considers the treatment of compensation receipts.

Note that the ruling is written in terms of the 1936 Act. The CGT provisions in that Act required that there be a disposal of an asset in order for there to be a capital gain, and so it was necessary to find a notional asset which could be disposed of. The current CGT provisions no longer require that there be a disposal of an asset. Rather, specific events are listed and the treatment for each is outlined. Therefore, it is no longer necessary (or useful) to consider a notional asset in relation to compensation receipts.

A 'compensation receipt', for the purposes of the ruling, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not:

• in relation to any underlying asset

• arising out of court proceedings, or

• made up of dissected amounts.

Therefore, any amount received by a taxpayer in relation to a claim they have made for a wrong or injury will be 'compensation', regardless of whether the payer admits to any specific liability. In the recipient's view, the amount is received for their claim for injury, wrong, breach of contract, etc.

If the compensation receipt is directly in respect of an underlying CGT asset - for the disposal of, loss of, permanent damage to, or permanent reduction in the value of, that asset - the approach in the ruling allows the taxpayer to look through the right to seek compensation and treat the amount as having been received in relation to the asset. For example, if compensation is received because a tangible asset is lost or destroyed, then the compensation receipt will be treated as capital proceeds for CGT event C1 happening to the asset.

If there is no underlying asset to which the compensation receipt directly relates, the receipt will be capital proceeds for CGT event C2 - the ending of the right to seek compensation. The cost base will generally be limited to legal costs incurred in pursuing the claim.

Where the compensation is received for the ending of such a right, and that right arose only in relation to either a wrong or injury suffered in the taxpayer's occupation or any wrong, injury or illness the taxpayer or their relative suffers personally, any capital gain arising under CGT event C2 will be disregarded under section 118-37 of the ITAA 1997.

If compensation is received in relation to multiple heads of claim, the ruling allows a reasonable apportionment of that payment. This is a reflection of the capital proceeds apportionment rule (modification 2) in section 116-40 of the ITAA 1997. For example, if a payment is both for personal injury and related damage to a CGT asset, the payment may be apportioned between the two heads of claim. The part of the payment that can reasonably be attributed to personal injury will be treated as capital proceeds for the ending of the right to seek compensation, and any capital gain arising will be disregarded under section 118-37 of the ITAA 1997. The part of the payment that can reasonably be attributed to damage to the asset will be applied to reduce the cost base of the underlying asset. Any additional amount that cannot be attributed to the underlying asset will be capital proceeds for the ending of the right to seek compensation, and no concessions will apply to a resulting capital gain.

However, if the payment is truly an undissected lump sum - that is, no reasonable apportionment can be made - it can only be capital proceeds for the ending of the right to seek compensation. No concessional treatment can be applied unless the taxpayer is able to prove that the amount received was solely for personal injury.

Application to your circumstances

You have accepted a lump sum amount under the terms of a Release Agreement which you have not provided due to a confidentiality clause. The Release Agreement as stated by you does not provide for any dissection of the Settlement Amount and you have not given any information from the settlement that would enable you to dissect the lump sum Settlement Amount or show how the payment relates to personal injury.

You sought damages under a number of heads of claim however the settlement was reached without any admission of liability by any party. You, the Trustee of the superannuation fund and the Insurer agreed to settle the claim on the basis that the Insurer pay you a lump sum in exchange for you releasing the Insurer and the Trustee of the superannuation fund from all actions, suits claims or demands that you had. Where liability is not accepted, we seek to distinguish whether the payment was made to settle the claim for injury or if it was paid to release the claim from settlement. Based on the information made available to us, we are unable to distinguish the payment as being made to settle the claim.

As the payment is an undissected lump sum and is being paid to end your right to seek compensation, it is therefore not being paid to you for a wrong or injury suffered under the terms of your insurance policy for any wrong, injury or illness you or a relative suffers from, paragraph 118-37(1)(b) of the ITAA 1997 does not apply and the capital gain is not disregarded.