Edited version of your written advice

Authorisation Number: 1051393686606

Date of advice: 20 September 2018

Ruling

Subject: Lump sum payment – Income protection policy

Question 1

Is the lump sum payment that you received through your income protection policy assessable as ordinary income?

Answer

Yes

This ruling applies for the following period:

Period ending 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You were diagnosed with xxxx at the end of xxxx.

You had surgery for the xxxx at the beginning of xxxx.

You were unable to work while you recovered xxxx.

You submitted a claim under your income protection policy.

You have a xxxx policy with xxxx.

Your policy states “For income protection, the premiums payable are tax deductable and benefits received form part of assessable income. However, premiums paid for the xxxx Option and xxxx Option are not tax deductible and benefits received are not assessable for income tax.”

On xxxx you received advice from xxxx that your claim has been accepted and finalised. The advice states:

● xxxx accepted your claim from xxxx and is treating it as a sickness claim.

● Your benefit period is from xxxx, the benefit is xxxx.

● The advice also states “Your benefit payment is part of your assessable income and should be declared in your next tax return. As xxxx does not deduct tax or issue a group certificate, you should keep this letter to help you complete your next tax return.”

● Your premium was waived during the benefit period that applies to your benefit payment. However you’ll need to start paying your premium again from the date your claim was finalised.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Reasons for Decision

These reasons for decision accompany the Notice of private ruling for xxxx.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Detailed reasoning

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident 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).

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. 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.

In your situation, your income protection policy provides a monthly income in the event of sickness or disability. You received a lump sum payment in full settlement of the sickness claim made under the income protection plan policy. The payment received under your policy replaced lost earnings (salary) while you were unable to work. That is, the lump sum was paid to substitute for loss of income which otherwise would have been earned.

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 received from the insurer is the payment of loss of income 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 included in your assessable income, as ordinary income.

We acknowledge your specific circumstances, however as your lump sum was not paid as an accident option or as a specific illness benefit, the lump sum is assessable in the year of receipt.