Edited version of your written advice

Authorisation Number: 1012802324598

Ruling

Subject: foreign source income

Question 1

Are your monthly sickness and incapacity benefits paid under an insurance policy assessable income in Australia?

Answer

Yes.

Question 2

Are you entitled to a deduction for your medical and recovery costs?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2013

Relevant facts

You are an Australian resident for tax purposes.

You took out a Sickness and Permanent Incapacity Policy with entity A while you were living in country A. The policy included trauma cover as well as sickness, hospital, permanent incapacity and occupation specific incapacity.

You pay a monthly premium to maintain continuity of the policy.

You were diagnosed with an illness.

You received a trauma lump sum benefit from the policy for a specific diagnosed illness.

You also receive periodic payments from the policy. The policy pays you a monthly sickness benefit and a monthly incapacity benefit.

The payments are not assessable in country A.

Information on the website in relation to the sickness and permanent incapacity benefit states that the Sickness and Permanent Incapacity benefit is a monthly benefit that pays out should a member (as life insured) not be able to perform their usual professional duties due to a sickness or condition. The benefit payment is designed to replace or supplement the professional's income.

The sickness benefit is designed to support the professional during the initial sickness period. The sickness benefit covers a policyholder for a period of two years for every condition that is not the same, consequential or related.

The sickness benefit covers personal income at up to XX%.

The permanent incapacity benefits compensate for the loss of ability to generate earnings. No permanent incapacity benefit is payable from the day you attain the age of XX years.

No proof of loss of income is required at claim stage.

There is no aggregation or payment offset against any other income earned or benefits received.

You do not need to submit invoices of your medical expenses.

The funds have been deposited in your overseas bank account.

You are not able to bring any of the funds into Australia from country A at present due to foreign exchange regulations.

Some of the money was used to bring out and support a family member to care for you during the critical part of your medical treatment.

When the funds are released into Australia you will use the funds to cover living, medical and other expenses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1.

International Tax Agreements Act 1953

Reasons for decision

Sickness and incapacity benefits

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The courts have identified a number of factors which indicate whether an amount is regarded as ordinary income. Characteristics of ordinary 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.

One or more of the following characteristics will combine with periodicity to give an amount an income nature:

n it is made in substitution of income

n it is made to provide financial support, for example, as an income supplement, or

n it is received in circumstances where the recipient has an expectation of receiving the payment on a regular basis so that the recipient is able to depend upon the payment for his or her regular expenditure.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82) (Dixon's case). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

In Dixon's case it was found that even if the receipts are not directly attributable to employment or services rendered, the expected regular periodical payments had the character of ordinary income.

Periodic sickness benefits received during a period of total or partial disability under an insurance policy are assessable on the same principle as salary and wages. This is because the benefits are a replacement of employment income during the period of total or partial disability (FC of T v. D.P. Smith (1981) 147 CLR 578; 81 ATC 4114; 11 ATR 538).

In FC of T v. Blake (1984) 75 FLR 315, the characteristics of the payments in question were looked at to decide if they were assessable income. The periodical nature of the payment, the recipient's reliance or otherwise on the payment for regular expenditure on himself and his dependents, led to the decision that the payments were assessable income.

In FC of T v. The Myer Emporium Ltd 87 ATC 4363, the Full High Court said (at p 4370): 

The periodicity, regularity and recurrence of a receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind.

Another basic principle is that the character of the receipt must be determined from the point of view of the recipient and not from the standpoint of the payer or some other person.

In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

To determine the character of an insurance policy payment, it is necessary to consider the terms of the particular policy and the reason for making the payment.

In your case, you are receiving monthly sickness and incapacity benefits. Although you did not have to prove your loss of income when claiming your benefits, the sickness benefit covers your personal income up to 66% and is designed to support you during your sickness. The sickness and incapacity benefits provide a substitute for the income which would otherwise have been earned. The payments will provide you with an income support which you will be able to rely on for your day to day living expenses. The regularity of your payments and the full circumstances surrounding your case indicate an income nature. The monthly payment is expected and relied upon.

It is acknowledged that due to foreign exchange regulations you were unable to transfer your funds to Australia immediately upon payment. However, this does not change the nature of the payment.

Your monthly sickness and incapacity benefits have the major characteristics of ordinary income identified above and the payments are assessable under subsection 6-5(2) of the ITAA 1997.

As the payments are not excluded by the operation of Australian tax laws it is necessary to look at the terms of any international agreement between Australia and country A. That is, in determining liability to Australian tax on income it is necessary to consider not only the income tax laws, but also any applicable tax agreement contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 and the ITAA 1997 so that those Acts are read as one.

Section 5 of the Agreements Act lists the current agreements Australia has with other countries. Included in that list is the tax treaty between Australia and country A.

Country A Agreement operates to avoid the double taxation of income received by Australian and country A residents.

Article 18 of the relevant Agreement provides that pensions and annuities arising in country A and paid to a resident of Australia are exempt from tax in country A to the extent that such pensions and annuities are included in taxable income in Australia.

The term 'pension' is not defined in the Agreement. Article 3(2) of the Agreement provides that any term not defined shall, unless the context otherwise requires, have the meaning that it has under the law of that State concerning the taxes to which the Agreement applies.

It is acknowledged that your payments are not regarded as an annuity.

However, in relation to the meaning of the term 'pension', Taxation Determination TD 93/151 Income tax: are periodic workers' compensation payments made by Comcare, 'pensions' for purposes of the pensions articles in Australia's double taxation agreements (DTAs)? states at paragraph 1:

A pension is defined in the Macquarie Dictionary as '1. A fixed periodical payment made in consideration of past services, injury or loss sustained, merit, poverty etc. 2. An allowance or annuity.' The meaning of the term 'pension' was considered by Hill J. in the Federal Court in Tubemakers of Australia Ltd v. FCT (1993) 25 ATR 183. His Honour concluded that the essential characteristic of a pension is that there be periodical payments.

Your sickness and incapacity benefit payments fall within the Macquarie dictionary meaning of 'pension' in that they are a fixed periodical payment made in consideration of injury or loss of income. That is, the payments have the essential characteristic of a pension as they are periodical payments made monthly.

The sickness and incapacity benefits made to you from country A are therefore a pension for the purposes of the relevant Agreement. As such they may be taxed in Australia.

Please note that even if the benefits aren't covered by article 18 of the Agreement, then the income would still be taxable in Australia under article 21 as other income. Under article 21, income from country A received by a resident of Australia that is not covered by any of the other articles in the Agreement is assessable for tax in Australia.

As stated above, your sickness and incapacity benefit payments are ordinary income and are included in your assessable income under subsection 6-5(2) of the ITAA 1997.

There are no provisions in the ITAA 1997 that make your sickness and incapacity benefits exempt income in Australia. Therefore the sickness and incapacity benefits form part of your assessable income and should be declared on your relevant tax returns.

Allowable deductions - medical expenses

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

• it must have the essential character of an outgoing incurred in gaining

assessable income or, in other words, of an income-producing expense

(Lunney v. FC of T; (1958) 100 CLR 478 (Lunney's case)),

• there must be a nexus between the outgoing and the assessable income so

that the outgoing is incidental and relevant to the gaining of assessable

income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

• it is necessary to determine the connection between the particular outgoing

and the operations or activities by which the taxpayer most directly gains or

produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v.

FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

A person does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some causal connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred "in the course of" gaining or producing the assessable income (Lunney's case). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3.

Where a person receives assessable income, they are not able to automatically claim a deduction for expenses relating to earning this income.

Generally medical expenses have no direct connection to the gaining or producing of assessable income. The expenses are a prerequisite to the earning of assessable income in the same manner as travel expenses to and from work. Also medical expenses relate to a personal medical condition and are private in nature, even if the medical condition is caused by, or at, your place of employment. Medical expenses have an insufficient connection to the gaining or production of assessable income for a deduction to be allowed as the expenditure is too remote.

The deductibility of expenses associated with medical treatment was considered in Rossitto v. Federal Commissioner of Taxation 39 ATR 1019; 98 ATC 2093. In that case, the taxpayer severely damaged his knee in a work related injury and liability was accepted for compensation. The taxpayer argued that the cost of regular travel by motor vehicle to his doctor, physiotherapy treatment and specialist doctors was necessarily incurred in deriving the compensation income. He further argued that the payment of compensation was conditional on the maintenance of a rehabilitation program. However, the claim for travel costs failed as they did not have the required nexus with the derivation of assessable income and were found to be of a private or domestic nature. It was difficult to separate the private and personal nature of medical treatment and its relationship with the derivation of income. The case concluded that, in the same way as travelling to a place of employment is not deductible, travel to receive medical treatment, even if it could be said that such medical treatment is a prerequisite to earning income, is equally non-deductible.

Although your situation is different to the above case, the principles are relevant. You incur medical and recovery expenses while receiving your sickness benefits. Such expenses were not incurred in gaining or producing your assessable income and the medical costs are of a private nature. Therefore, the expenses are not an allowable deduction under section 8-1 of the ITAA 1997.