Edited version of your written advice

Authorisation Number: 1051504527978

Date of advice: 10 April 2019

Ruling

Subject: Income Lump Sum – Income Protection

Question:

Will the lump sum payment you receive in finalisation of your income protection policy be assessable as income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commenced on:

1 July 20XY

Relevant facts and circumstances

You made a claim for payment under an income protection policy which was accepted. You have been receiving regular income protection payments since then.

You have asked the insurer to commute the income protection payments by converting these payments into a lump sum. The insurer has offered to commute all future benefits under the policy to a one off payment in a deed of release which was offered to you. The insurer is now offering to commute these income protection payments as a single lump sum payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Reasons for decision

Summary

The lump sum payment you will receive from your 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 has been received.

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.

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 generally 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 was 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 un-dissected 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.