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Edited version of your written advice
Authorisation Number: 1051375758903
Date of advice: 24 May 2018
Ruling
Subject: Assessable income
Question
Is the lump sum payment you will receive to finalise your income protection insurance cover and claim, assessable as ordinary income?
Answer
Yes.
This ruling applies for the following period:
Year ending 30 June 20XX
Year ending 30 June 20XX
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
You entered into an income protection policy.
You were receiving monthly income protection payments due to an injury sustained in XXXX.
In XXXX you were subsequently diagnosed with a terminal illness.
Your monthly income protection payments continued.
You were offered a lump sum settlement for the amount of $XXXX to settle your claim by a Deed of Release (the Deed).
The Deed does not make mention that the lump sum payment is in relation to your terminal illness.
You accepted the lump sum and your monthly income protection payments ceased.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Reasons for decision
Summary
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 Income Tax Assessment Act 1997 (ITAA 1997), as they are paid to take the place of lost earnings.
The commutation of the monthly payments into a lump sum does not change its character of compensation for loss of income. The amount of $XXXX will need to be declared on your income tax return the financial year that you received the payment.
Detailed reasoning
Subsection 6-5(2) of the 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 insurance replaces an individual’s regular salary or earnings if they are unable to work for a period of time due to sickness or injury, by providing a regular income stream for an agreed period of time. As mentioned above, these payments are assessable as income under section 6-5 of the ITAA 1997.
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.
In your case, the Deed advises that the settlement of the claim is in relation to your claim for income protection payments that you began receiving after you ceased work due to an injury. The Deed makes no mention of the payment being made in relation to your terminal illness. Therefore the payment is considered to finalise your income protection insurance cover, not in relation to loss of earning capacity, pain and suffering and medical expenses.
We acknowledge your medical condition and the hardships you have subsequently endured, however the commutation of the monthly payments into a lump sum does not change its character of income. The amount of $XXXX will need to be declared on your income tax return the financial year that you received the payment. The Commissioner is bound by the law and does not have the discretion to allow a claim if the expense does not fall within the legislation.