Edited version of your written advice

Authorisation Number: 1051192796710

Date of Advice: 23 February 2017

Ruling

Subject: Lump Sum Payments

Question 1

Is a lump sum payment received under an income protection policy claim, assessable as ordinary income?

Answer

Yes.

Question 2

Can I treat part of the lump sum I receive as a pre-tax payment into my Super fund?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commences on:

1 July 2012

Relevant facts

You were employed in 2012

You had commenced a Personal Income Insurance policy that incorporated a 90 day waiting period.

In 2013 you made a claim under the income insurance policy.

The insurer accepted and paid benefits under the claim.

You made a second claim in 2015 after your condition deteriorated.

After a lengthy dispute with the insurance company, in the 2017 income year you were paid a lump sum payment that comprised of income payments relating to prior years and interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5;

Income Tax Assessment Act 1936 Section 159ZRA;

Income Tax Assessment Act 1997 Section 292-25;

Income Tax Assessment Act 1936 Section 159ZRA(1); and

Taxation Administration Act 1953 Schedule 1 section 12-120.

Reasons for decision

Lump sum payment - salary and wages

A lump sum payment in arrears (LSIA) is a payment received in one tax year that includes income that accrued in previous tax years. As your LSIA is the result of an insurance claim and based on your prior year's salary, it is considered income according to ordinary concepts and is known as ordinary income. This amount is assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Subsection 6-5(2) of the ITAA 1997 provides that assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

An amount paid to compensate for loss generally acquires the same nature of what it is substituting (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82).

Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

Additionally, ordinary income has 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 received as a product of any employment, services rendered, or any business;

are earned;

are received regularly or periodically;

are expected; and

are relied upon.

It is not necessary for all of these characteristics to be present for an amount to be considered ordinary income. A lump sum payment is generally classified as ordinary income if it is simply a lump sum made up of periodic income payments but paid in arrears to cover a certain period.

Income protection policies provide for periodic payments in the event of loss of income caused by the insured becoming disabled through sickness or injury. Specifically, 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 confirmed in Sommer v. FC of T 2002 ATC 4815; (2002) 51 ATR 102 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'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.

The commutation of monthly payments into a lump sum does not change its character of compensation for loss of income.

To alleviate the problem of more tax being payable in the year in which the lump sum is received (than would have been payable if the lump sum had been taxed in each of the years in which it accrued), section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936) allows individual taxpayers who receive certain eligible assessable LSIA payments a LSIA Tax Offset.

To be eligible for the LSIA Tax Offset a taxpayer must satisfy the following conditions:

the taxpayer must have received a lump sum payment of eligible income that accrued, in whole or in part, in an earlier year or years of income, and

the amount of the lump sum which accrued before the year of receipt must not be less than 10% of the taxpayer's normal taxable income of the year of receipt.

Subsection 159ZR(1) of the ITAA 1936 lists the type of payments that are eligible for the LSIA Tax Offset, and includes a payment covered by section 12-120 in Schedule 1 to the Taxation Administration Act 1953. This section states that an eligible payment is:

made for an individual's incapacity for work; and

calculated at a periodical rate; and

not a payment made under an insurance policy to the policy owner.

In your case, you received lump sum payments relating to an income insurance policy claim. As these payments were made under an insurance policy to you, they are not considered eligible payments under subsection 159ZR(1) of the ITAA 1936, and an arrears tax offset cannot apply to those payments.

Can I retrospectively pay this money into a superannuation fund tax free?

The Commissioner's view on the taxation and superannuation implications of salary sacrifice arrangements (SSAs) is discussed in Taxation Ruling TR 20001/10 (TR 2001/10) Income Tax: fringe benefits tax and superannuation guarantee: salary sacrifice arrangements.

A salary sacrifice arrangement is an arrangement between an employer and an employee whereby the employee agrees to forgo part of their future remuneration entitlement in return for a benefit of a similar value. The consequence of such an arrangement is that the employee is assessed on the reduced amount of the salary actually received and the employer is liable for any fringe benefits tax payable on the benefit provided.

TR 2001/10 states that an effective salary sacrifice arrangement details the amount of income to be sacrificed, and must be entered into before the employee becomes entitled to be paid.

An ineffective salary sacrifice arrangement involves an employee directing an entitlement to receive salary or wages that has been earned to be paid in a form other than as salary or wages. Benefits provided under an ineffective salary sacrifice arrangement are generally regarded as assessable income.

Consequently, salary sacrifice arrangements require a contractual relationship between an employer and employee. The contract between the two parties, employer and employee, is required prior to services being performed.

As stated above, an effective SSA requires a contractual relationship between the employer and the employee that must be negotiated prior to performing the employment services for which remuneration is received.

Conclusion:

Payments received from an insurer as a result of an income protection insurance policy are considered a substitute to your ordinary income. As a result these payments will be subject to marginal tax rates in the financial year that they are received.

You are not eligible for LSIA tax offset as the lump sum payment was made to you under an insurance policy for, for which you were the policy owner.

Any payments received from the insurer which are deposited to your superannuation fund are not salary sacrificed amounts. The amounts are assessable income to you and need to be included in your income tax return.

On the basis of the facts provided, a superannuation fund should treat any amounts paid as non-concessional contributions in that they are amounts correctly payable to you which you intend to merely redirect to the superannuation fund.