Edited version of your written advice

Authorisation Number: 1013100814047

Date of advice: 10 October 2016

Ruling

Subject: Assessable income

Question 1

Is the lump sum settlement payment you received from an income protection policy dispute resolution assessable as income?

Answer

No.

Question 2

Is the lump sum settlement payment you received from an income protection policy dispute resolution assessable under capital gains tax (CGT) provisions?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 20ZZ

The scheme commences on

1 July 20YY

Relevant facts and circumstances

You had an Income Protection Policy (the policy) with an insurance company.

In 20XX you made a claim for payment of an income protection benefit under the policy due to an injury.

In 20XX your income protection claim was accepted and payments commenced.

In 20XY you made a claim for rehabilitation benefits under the Rehabilitation Costs feature of the policy.

Your rehabilitation claim was denied.

In 20YY you stated concerns relating to your insurers' management and conduct during the assessment of your income protection claim and the denial of the rehabilitation claim. You requested a review of these concerns (complaint).

In 20YY your insurer responded to your complaint. You responded with further concerns.

In 20YY you lodged a dispute with the relevant service in relation to the income protection claim, the rehabilitation claim and the complaint.

You and your insurer agreed to settle the income protection claim, rehabilitation claim, any past or future rights and obligations under the policy without admission of liability.

The Deed of Release was signed in 20YY.

The settlement payment you received included reimbursement of legal costs and settlement of the income protection claim, rehabilitation claim, the surrender of the policy and the complaint.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 118-37

Reasons for decision

Ordinary Income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) advises that the assessable income of a resident taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include 3 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.

Taxation Determination: TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? explains that only lump sum settlements representing compensation for losses of an income nature will be assessable 'according to ordinary concepts'.

In your case, the lump sum is un-dissected and, while a portion of the lump sum is for income replacement, we are unable to determine the amount. Therefore, the whole amount of the lump sum payment is not assessable under subsection 6-5 of the ITAA 1997.

Capital gains

Part 3-1 of the ITAA 1997 contains the capital gains and capital loss provisions commonly referred to as the CGT provisions. You make a capital gain or capital loss if a CGT event happens in respect of a CGT asset.

Taxation Ruling TR 95/35 Income tax: Capital gains: treatment of compensations receipts deals with the capital gains treatment of compensation receipts. Paragraph 18 states that 'if the amount of compensation received is an un-dissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation'.

Further at paragraph 21:

If compensation is received by a taxpayer in a lump sum paid in settlement of a number of claims, including a personal injury claim, and its individual components cannot be determined or reasonably estimated, no part of the compensation can be quantified as relating to the personal injury of the taxpayer.

This ruling confirms that an insured person's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation. The whole of the settlement amount is thus treated as capital proceeds from a capital gains tax (CGT) event happening to your right to seek compensation.

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens on the ending of the right to seek compensation, that is, the right to take legal action.

CGT Exemption

Paragraph 118-37(1)(a) of the ITAA 1997 allows a capital gain to be disregarded if it is compensation or damages you receive for any wrong or injury you suffer in your occupation.

Paragraph 118-37(1)(b) of the ITA 1997 allows a capital gain to be disregarded if it is compensation or damages you receive for any wrong, injury or illness you suffer personally.

These provisions would have clear and direct application in relation to an insurance policy against a specific injury or illness. For example, trauma insurance that pays a lump sum if the person loses a limb or suffers a heart attack. Such a payment would be disregarded for CGT purposes under section 118-37 of the ITAA 1997.

The Commissioners approach to un-dissected lump sum payment was confirmed in Dibb v. Commissioner of Taxation [2004] FCAFC 126 which found that no part of a genuinely un-dissected lump sum could be said to be paid in relation to personal injury. The exemptions in paragraphs 118-37(1)(a) and (b) of the ITAA 1997 cannot apply if the compensation amount is received as a lump sum (and that lump sum is truly un-dissected) but there were rights to income type payments as well as rights relating to personal injury that are extinguished in the settlement.

Applications to your circumstances

Your lump sum settlement is accepted as an un-dissected settlement amount that includes income replacement and potential capital benefits. Therefore the lump sum payment is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Your lump sum payment has been received for entering into a contract to end your rights to compensation from the insurer. Whilst your rights to seek compensation arose from your injury, the payment is considered to be a payment for the ending of your claim for compensation with XYZ. As stated above, this gives rise to CGT event C2. Your payment cannot be said to be a single defined payment for an injury.

Although your compensation may have been triggered by a personal injury, the actual lump sum payment is not a personal injury payment. The un-dissected lump sum payment covers a loss of various rights and entitlements, including a loss of income. Therefore the lump sum payment is assessable as a capital gain and the exemption contained in section 118-37 of the ITAA 1997 cannot apply.