Edited version of private advice

Authorisation Number: 1051547195150

Date of advice: 16 July 2019

Ruling

Subject: Lump sum payment

Question 1

Will the lump sum payment you received from the settlement of your claims under an income protection policy be assessable as income?

Answer

Yes

Question 2

Will the lump sum settlement payment be subject to the Capital Gains Tax provisions?

Answer

No

This ruling applies for the following periods:

Period ending 30 June 2019

Period ending 30 June 2020

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You entered into Income Protection (IP) and Business Expenses (BE) insurance policies.

Under the IP policy the insurance company was required to pay certain income protection benefits and to refund premiums in defined circumstances.

You were a medical practitioner.

You developed medical symptoms and some years later suffered injuries from an accident.

You were treated for your injuries and later underwent surgery.

You resumed some part time work but were unable to fulfil all of the duties of your position.

The insurance firm paid benefits at the totally disabled rate for a period of time.

The insurance firm paid benefits at the partially disabled rate for a period of time.

These payments were made according to the IP policy.

The insurance firm also paid benefits in accordance with the BE policy.

The insurance firm formed the opinion that you were not totally disabled or partially disabled as defined under the IP policy beyond 20XX and has not paid benefits since that time.

Proceedings were commenced by you claiming payment of the benefits under the IP policy together with costs and interest.

Without any admission of liability you and the insurance firm have now agreed to resolve the claim and proceedings in the form of a Deed Poll.

The release deed initially proposed a payment inclusive of damages, costs and interest.

The agreed sum was inclusive of relevant taxes and the insurance firm made no deduction for any tax.

The deed also released and discharged the insurance firm from any further action.

You are no longer a person insured under the policies and the policies are now void and have no effect.

An amended statement of claim was lodged by you in 20XY.

The amendment was an attempt to obtain reimbursement of premiums paid while injured (as per the policy).

You were unsuccessful in that claim as you had signed the deed poll absolving the insurance firm from any further obligation.

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 Section 118-20,

Income Tax Assessment Act 1997 paragraph 118-37(1)(a).

Reasons for decision

Summary

In your circumstances, the relevant facts that apply to your case are similar to those found in the Sommer case. Your un-dissected lump sum was paid in full settlement of your claim under an income protection insurance policy as a result of the loss of your income stream due to your injuries. The payment is fully assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Question 1

Section 6-5 of the ITAA 1997

Ordinary income

Section 6-5 of the ITAA 1997 deals with receipts of ordinary income. 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 earned;

·   are expected;

·   are relied upon; and

·   have an element of periodicity, recurrence or regularity.

Periodic payments during a period of total or partial disability under a personal accident or disability insurance policy are assessable on the same principle as workers' compensation payments. Weekly or periodic workers' compensation payments (or periodic payments under other legislation) for loss of salary, either whole or in part, are assessable as ordinary income. The intention in taking out the income protection policy is to protect and provide income in the event of illness or disability.

Un-dissected payments

When considering the treatment of un-dissected lump sum payments, McLaurin v. Federal Commissioner of Taxation (1961) 104 CLR 381; (1961) 12 ATD 273; (1961) 8 AITR 180 and subsequently Allsop v. Federal Commissioner of Taxation (1965) 113 CLR 341; (1965) 14 ATD 62; (1965) 9 AITR 724 raised the proposition that where a lump sum compensation payment can be dissected into its constituent income and capital components, the income components may be assessable. The Commissioner confirmed this view in Taxation Determination 93/58 (TD 93/58) and indicated that any part of a lump sum compensation amount will only be assessable as ordinary income:

(a) if the payment is compensation for loss of income only; or

(b)to the extent that a portion of the lump sum is identifiable and

quantifiable as income. This is possible where the parties either

expressly or impliedly agree that a certain portion of the payment

relates to a loss of an income nature.

This view is further confirmed in the Federal Court case, Sommer v FC of T 2002 ATC 4815; 51 ATR 102 (Sommer case) from a decision of the Administrative Appeals Tribunal (AAT).

The case involved a medical practitioner who had taken out a Professional Income Replacement insurance policy. Following rejection of the taxpayer's claim for income replacement payments of $4,000 per month, the matter was settled out of court with the payment of a lump sum to him. The taxpayer argued that the amount was capital as it was paid in consideration of the cancellation of the policy and the surrender of his rights under it. Alternately, he argued that the amount comprised an un-dissected aggregation of both income and capital and therefore should be treated as capital.

In dismissing the taxpayer's appeal it was held that:

1. The terms of the agreement referred to the relevant surrounding circumstances. Accordingly, it was difficult to argue that the surrounding circumstances were not relevant to the characterisation of the settlement amount. The true nature and proper characterisation of the settlement amount was to be determined by having regard to the policy, the taxpayer's claims under the policy, the terms of settlement which settled those claims, and the rights the taxpayer would be surrendering upon cancellation of the policy.

2. The fact that the payment of the monthly benefits was made in one lump sum did not change the revenue character of the receipt if it was essentially designed to compensate the taxpayer in respect of his income replacement claims or was a payment in substitution of those claims. The substance and commercial reality of the settlement was that it was a full and final settlement of the dispute between the taxpayer and the insurer in relation to the taxpayer's past and future claims to be entitled to income replacement benefits as a result of his disability since August 1996.

3. As the settlement amount did not relate to claims, entitlements, or benefits of an income and capital nature the question of apportionment did not arise.

Applying the decision in Sommer to your case, your payment amount cannot be apportioned. Rather this amount is a single un-dissected lump sum. Your 'statement of claim' did include benefits of an income nature and the un-dissected lump sum payment was not based on a mixture of income and capital items. The settlement was made as a full and final settlement of the dispute between yourself and the insurer and released both parties from any past and future claims under the disputed policy.

Question 2

Paragraph 118-37(1)(a) of the ITAA 1997 provides that a capital gain may be disregarded where it arises from compensation or damages you receive for any wrong or injury you suffer in your occupation, or arises from compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally.

In your case, we have determined that your lump sum payment is assessable income under section 6-5 of the ITAA 1997. Your compensation payment was paid to settle legal proceedings with no admission of liability made by the insurer. We consider that the payment did not relate to any wrong, injury or illness you suffered but to the payment of the lost income stream.