Edited version of your written advice

Authorisation Number: 1012761765960

Ruling

Subject: Lump sum payment

Question 1

Is the lump sum payment you will receive to finalise your income protection insurance policy claim, assessable as ordinary income?

Answer

Yes.

Question 2

Is the lump sum payment you will receive to finalise your income protection insurance policy claim, included in assessable income under the capital gains provisions?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2015

The scheme commences on

1 July 2014

Relevant facts and circumstances

You are the policy owner of the income protection insurance policy.

Due to ill health you have been unable to return to the workforce.

You have been in receipt of monthly income protection payments, which have been returned in your income tax returns as income.

At no stage has the insurer disputed your eligibility to the payments.

You are currently in negotiations with the insurer to have your policy paid out as a lump sum.

The lump sum will finalise your claim for monthly payments.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

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

Income Tax Assessment Act 1997 Section 6-10

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.

Income protection policies provide for periodic payments in the event of loss of income caused by the insured becoming disabled through sickness or injury. These payments are assessable as income under section 6-5 of the ITAA 1997, as they are paid to take the place of lost earnings.

This view has been subsequently confirmed in Sommer v. FC of T 2002 ATC 4815; (2002) 51 ATR 102 (Sommer's case) where a lump sum paid to a doctor in settlement of his claim under an income protection policy was assessable on the basis that it was in substitution for his original claim under the policy for lost income. The taxpayer argued that the amount comprised an undissected aggregation of both income and capital and, therefore should be treated as capital.

The taxpayer's case was dismissed in the Federal Court and it was held that the commercial reality of the payment was that it was a full and final settlement of all the taxpayer's income claims. The fact that it was a lump sum did not change its revenue nature.

The Sommer decision was followed in Gorton v. FC of T 2008 ATC 10-018, where a lump sum payment received by a former medical practitioner from his insurer in settlement of his professional income replacement claims was held to be assessable income.

Your situation is similar to the above cases as the lump sum you will receive will be a payout of your remaining benefit and finalisation of your claim.

The commutation of the monthly payments into a lump sum does not change its character of compensation for loss of income. The lump sum is a receipt of income only, that is, there is no capital component in the payment.

Therefore, the lump sum payment you will receive from the insurer is an advance of your future monthly payments and is assessable under section 6-5 of the ITAA 1997 as ordinary income in the year it is received.

The capital gains tax (CGT) provisions do not apply to the lump sum finalisation payment as it is otherwise included in your assessable income, as ordinary income.