Edited version of your written advice

Authorisation Number: 1051386996359

Date of advice: 18 June 2018

Ruling

Subject: Taxability of lump sum payment

Question 1

Is the lump sum payment that you have been offered to finalise your income protection policy claim, assessable as ordinary income?

Answer

Yes.

Question 2

Is the lump sum payment you will receive to finalise your income protection insurance policy claim, included in assessable income under the capital gains provisions?

Answer

No.

This ruling applies for the following periods:

30 June 20xx.

The scheme commences on:

1 July 20xx.

Relevant facts and circumstances

You are the policy owner of an income protection insurance policy.

You submitted an initial claim for income protection benefits in xxxx.

You have been paid income protection benefits under the policy continuously for the period xxxx to xxxx and at no time has the insurer disputed your eligibility for the payments.

These payments have all been declared in tax returns and tax paid since the xxxx tax year.

On xxxx the Federal Court of Australia approved the transfer of the life insurance business of NMLA in Australia and New Zealand to AMPL, as and from xxxx pursuant to Part 9 of the Life Insurance Act 1995 (Cth). The rights and obligations of insureds under their existing policies with NMLA, including the Policy, are unchanged by this transfer, except that those rights and obligations now continue against AMPL.

Without the admission of liability, the parties to the Deed agree to compromise the Claim, the Benefits paid, and any past and future rights and obligations under the Policy for a settlement sum of $xxxx

The lump sum will finalise your claim for monthly payments.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 6-10

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (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.

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).

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. 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 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.

The commutation of the monthly payments into a lump sum does not change its character of compensation for loss of income. The lump sum is a receipt of income only, that is, there is no capital component in the payment.

Therefore, the lump sum payment you will receive from the insurer is an advance of your future monthly payments and is assessable under section 6-5 of the ITAA 1997 as ordinary income in the year it is received.

The capital gains tax (CGT) provisions do not apply to the lump sum finalisation payment as it is otherwise included in your assessable income, as ordinary income.