Edited version of your written advice

Authorisation Number: 1051441927478

Date of advice: 22 October 2018

Ruling

Subject: Lump sum payment - income protection policy

Question

Is the lump sum payment you received under your income protection policy assessable as ordinary income in the year of receipt?

Answer

Yes

This ruling applies for the following periods

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commenced on

1 July 2016

Relevant facts and circumstances

You sustained an injury.

You hold an income protection policy with an insurer.

As a result of the injury you were unable to work and you made a claim on your income protection insurance.

Your insurer advised you that your claim was accepted and you received regular monthly payments.

Sometime later your insurer decided to deny your claim and stopped paying you benefits.

You went to the Financial Ombudsman Service Australia (FOS) and lodged a dispute against your insurer.

The FOS made recommendations in your favour that your insurer:

● assess and pay you disability benefits on an ongoing basis, including arrears from the date it stopped payment

● refund all premiums paid by you after your insurer denied the claim

● pay you interest on the benefits owed, calculated from the date each benefit was due until the date it is paid, and on the premiums repayable, and

● Pay you compensation for non-financial loss.

You received a letter from your insurer confirming your back dated lump sum payment.

The lump sum payment included an interest component.

Your monthly benefits recommenced as per the recommendations of FOS to your insurer.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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

Reasons for decision

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) 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, the lump payment you received is for the backdated monthly payments you should have received. The payment as 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 your 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. Please note that interest income is ordinary assessable income. Therefore the interest component also forms part of your assessable income.