Edited version of your written advice

Authorisation Number: 1051422867111

Date of advice: 30 August 2018

Ruling

Subject: Insurance proceeds

Question 1

Is the insurance payout assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997?

Answer

No.

Question 2

Is the amount of the insurance received for deductible repairs regarded as an assessable recoupment?

Answer

Yes.

Question 3

Is the amount of insurance received for the destruction of capital works an assessable recoupment?

Answer

No.

Question 4

Is the amount of insurance received for the destruction of capital works assessable income under another provision?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2018

The scheme commenced on

1 July 2017

Relevant facts

You purchased a rental property.

The property was available for rent upon settlement and you have claimed rental property expenses since then.

A flood occurred and damaged the property.

You received insurance payouts which were used for repairing and replacement of damaged areas of the property.

The payments related to repairs and capital works.

The repair work was completed.

The property has since been advertised for rent and property currently has tenants.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 Section 25-10

Reasons for decision

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset then it will be regarded as a capital receipt and not ordinary income.

Rent is regarded as ordinary assessable income, however your insurance payout does not relate to rent or other ordinary income. As the insurance payments you received are not for loss of income, the payments are not assessable as ordinary income under subsection 6-5(2) of the ITAA 1997.

Statutory income

Amounts that are not ordinary income, but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997). The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list is Subdivision 20-A of the ITAA 1997 (assessable recoupments).

Assessable recoupment

Under subsection 20-20(2) of the ITAA 1997, an amount received as a recoupment of a loss or outgoing is an assessable recoupment if:

a. you received the amount by way of insurance or indemnity; and

b. you can deduct an amount for the loss or out going for the current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act.

Section 25-10 of the ITAA 1997 provides that expenditure incurred on repairs to a rental property are deductible.

Therefore, an amount received by way of insurance is an assessable recoupment if it is paid to cover the cost of repairs to a rental property and the deduction can be claimed in the current year or in an earlier income year.

Accordingly, your insurance payout received that relates to deductible repairs to your rental property is an assessable recoupment and forms part of your assessable income.

Capital works

Under paragraph 20-20(2)(b) of the ITAA 1997, recoupment of a loss or outgoing is only an assessable recoupment if you can deduct an amount for the loss or outgoing for the current year, or has deducted or is able to deduct an amount for it for an earlier income year, under any provision of the ITAA 1997.

The phrase "for the loss or outgoing" in paragraph 20-20(2)(b) of the ITAA 1997 requires a connection between the deduction and the loss or outgoing for which the taxpayer had been recouped.

In your case, the relevant loss or outgoing includes an amount for the destruction of the capital works.

Whilst you may be able to deduct an amount in relation to the original construction of the capital works under section 43-40 of the ITAA 1997, or in relation to a future construction of replacement capital works under section 43-10 of the ITAA 1997, these are not deductions for the loss referred to in paragraph 20-20(2)(b) of the ITAA 1997. No outright deduction is available for the loss of the capital works.

Accordingly, any insurance payout that relates to the capital works of your rental property is not an assessable recoupment under section 20-20 of the ITAA 1997.

Such amounts are not assessable under any other provision of the ITAA 1997.

Please see Australian Taxation Office Interpretative Decision ATO ID 2011/82 for further details.

Other information

Where an amount of insurance proceeds is received in relation to the destruction of all or part of a capital gains tax asset, there may be capital gains tax implications, such as cost base adjustments.