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Edited version of your written advice
Authorisation Number: 1012911421311
Date of advice: 13 November 2015
Ruling
Subject: Ex - gratia payment
Question and Answer
1. Will the ex-gratia payment you received from an insurance company (the insurer) for agreeing to both surrender all of your rights under an income protection policy and cancel the policy be included in your assessable income for the 2014-15 income year?
No
2. If not, will the ex-gratia payment amount be subject to capital gains tax (CGT)?
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 received a payment as a settlement Sum out of a dispute you had with an insurance company.
The dispute was handled by the Financial Industry Ombudsman on your behalf.
The cause of the complaint was as a result of your Income Protection Policy being cancelled by the insurer due to the non-disclosure of information by you.
You lodged the complaint as you considered that the behaviour and handling of the matter raised some questions over the professional conduct of the Insurance Company.
The Financial Ombudsman Service had identified some areas below industry standards and recommended a serious settlement be considered to prevent further legal proceedings.
As a result of these findings a settlement offer was made by the insurance company.
Without admission of liability under the Income Protection Policy an Ex- Gratia amount was offered to settle any further or future action sought by you against the Insurance Company.
The Deed of Release was created and signed under the supervision of the Ombudsman.
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 Paragraph 118-37(1)(b).
Reasons for decision
Ex-gratia payment
Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer who is a resident of Australia for taxation purposes includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
Periodic payments made under an income protection policy are considered to be ordinary income because they replace lost income, are periodic and are an income supplement (Tinkler v. Federal Commissioner of Taxation (1979) 40 FLR 116; 79 ATC 4641; (1979) 10 ATR 411 and Federal Commissioner of Taxation v. D P Smith (1981) 147 CLR 578; 81 ATC 4114; (1981) 11 ATR 538). Consequently, monthly payments received under an income protection policy are ordinary income and therefore assessable under subsection 6-5(2) of the ITAA 1997.
In your case, the ex gratia payment that you received has the characteristics of a capital receipt (not an income receipt) as you did not earn it and it does not directly relate to services that you performed. The payment is also a one-off payment (it does not have the elements of periodicity, recurrence or regularity). Any expectation and reliance upon the payment arises from the investment in the policy.
The ex gratia payment was not paid to compensate you for future income maintenance payments under the policy. Rather, the ex gratia payment was paid to you in full and final settlement of any claims, cost and interest against the policy. As such, you received the ex gratia payment as compensation for giving up your capital rights.
Accordingly, the ex gratia payment is not considered ordinary income and therefore, not assessable under subsection 6-5(2) of the ITAA 1997.
CGT
Section 6-10 of the ITAA 1997 provides that assessable income also includes statutory income, that is, income which is not ordinary income that is included in assessable income by another provision of the income tax legislation. Certain types of insurance receipts and capital gains are examples of statutory income.
Settlement of a personal injuries claim represents the disposal of an asset, as the taxpayer has disposed of the right to seek compensation for losses arising from the injury suffered (Taxation Ruling TR 95/35). The disposal of an asset gives rise to a CGT event.
In your case, the ex gratia payment amount relates to compensation or damages a taxpayer received for any personal wrong, injury or illness and is exempt under paragraph 118-37(1)(b) of the ITAA 1997.
Conclusion
The ex gratia payment that you received is a capital payment which is not assessable to you under either the ordinary or statutory provisions.