Edited version of private advice

Authorisation Number: 1051748620394

Date of advice: 10 September 2020

Ruling

Subject: Lump sum compensation payment

Question 1

Is the lump sum compensation payment you received assessable income as per section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No.

Question 2

Has capital gains tax (CGT) event C2 occurred when you entered into an agreement of release and indemnity as per section 104-25 of the ITAA 1997?

Answer 2

Yes.

Question 3

Is the lump sum compensation payment you received disregarded from CGT under subparagraph 118-37(1)(a)(ii) of the ITAA 1997?

Answer 3

No.

Question 4

Are you entitled to use the CGT 50% discount for the gain as per section 115-100 of the ITAA 1997?

Answer 4

No.

This ruling applies for the following period:

Year ended 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

You held a life and income insurance policy with an insurance company (the insurer).

You made a claim for income protection benefits under the policy due to an illness you suffered.

The insurer approved your claim for income protection and commenced paying you a monthly benefit.

You have declared your payments under the income protection policy as income on your income tax returns with the Australian Taxation Office (ATO).

You may be entitled to income protection benefits until the policy until the expiry date.

You experienced financial difficulties.

You subsequently requested the insurer pay your benefits in advance instead of arrears to assist you.

In or around the XXXX the insurer notified you that a hold would be placed your benefits under the policy for a period while the insurer returned to making your payments in arrears.

The time period was based on you paying back the benefits you had received in advance.

The change in the payment terms of your benefits aggravated your illness further.

In or around the XXXX you requested that the insurer make a lump sum payment to you in full and final settlement of your rights under the policy.

You lodged a complaint with the Australian Financial Complaints Authority (AFCA) in relation to the delay with the insurers claims and the insurers response to the changes of the frequency of your payments.

The insurer offered you a lump sum compensation payment without admission of liability via a agreement of release and indemnity in full and final satisfaction of the claim, any rights under the policy and the AFCA Complaint on the terms set out in this agreement.

The parties came to the agreement in relation to the compensation figure by negotiation.

The parties did not dissect the payment into a breakdown.

You signed agreement of release and indemnity on the XXXX.

You received the lump sum compensation payment on or around the XXXX.

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 15-30

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 115-15

Income Tax Assessment Act 1997 section 115-20

Income Tax Assessment Act 1997 section 115-25

Income Tax Assessment Act 1997 section 115-100

Income Tax Assessment Act 1997 section 118-37

Income Tax Assessment Act 1936 subsection 160ZB

Reasons for decision

Assessable income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (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.

A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount, then it will be regarded as a capital receipt and not ordinary income.

In your case you received a compensation payment that is not income from rendering personal services, income from property or income from carrying on a business.

The payment is a one-off payment and does not have an element of recurrence or regularity. Although the payment can be said to be expected and perhaps relied upon, this expectation arises from the pain and suffering resulting from the injury, rather than from a relationship to personal services performed.

Accordingly, the lump sum payment is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

Capital gains tax arising from the compensation payment

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Section 15-30 of the ITAA 1997 lists those provisions. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains.

C2 event right to seek compensation

Section 104-25(1) of the ITAA 1997 states that capital gains tax (CGT) event C2 happens if a taxpayer's ownership of an intangible CGT asset ends because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts provides the Commissioner's view as to the CGT consequences of receiving a compensation payment.

Paragraph 11 of TR 95/35 states that if the compensation amount is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation and CGT event C2 will occur.

In this instance, the relevant asset is the right to seek compensation.

The right was disposed of upon you entering into the agreement of release and indemnity on XXXX with the insurer to release and discharge the insurer from all claims.

Therefore, the Commissioner considers that CGT event C2 has occurred when you entered into the agreement of release and indemnity on XXXX.

Disregarding a capital gain

Paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made where the amount relates to compensation or damages you receive for any wrong, injury or illness you suffer personally.

In your case, you have received a compensation payment in settlement of a long-term dispute in relation to the handling of your claim. The parties came to the agreement in relation to the compensation figure by negotiation and you agreed to settle and drop the Australian Financial Complaints Authority (AFCA) complaint and surrender your insurance policy.

Whilst you claim that the AFCA complaint was lodged due to the insurance company contributing to the deterioration of your illness, the fact that the insurance company did not cause your initial illness needs to be considered when applying paragraph 118-37(1)(b) of the ITAA.

As your illness was not caused by the actions of the insurance company and your illness was a pre-existing condition, the compensation payment cannot be determined as made in relation to any wrong, injury or illness you suffered personally.

Accordingly, paragraph 118-37(1)(b) of the ITAA 1997 does not apply to your situation.

50% capital gain discount

The capital gain arising from CGT event C2 is a discount capital gain and would be eligible for the 50% discount pursuant to section 115-100 of the ITAA 1997 for the following reasons:

(a) The capital gain was made after 21 September 1999, pursuant to section 115-15;

(b) The capital gain does not have an indexed cost base, pursuant to section 115-20; and

(c) The capital gain resulted from a CGT event (CGT event C2) happening to a CGT asset (the right to seek compensation) that was acquired at least 12 months before the CGT event, pursuant to section 115-25.

Paragraph 3 of TR 95/35 states

The right to seek compensation is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged.

As previously advised, the Commissioner does not consider that the insurance company caused your initial illness. Therefore, the right to pursue compensation was not acquired in XXXX when you were diagnosed with your illness.

The right to pursue compensation should be taken to have been acquired on or around the time the you lodged your complaint with AFCA and the subsequent negotiations between the parties commenced.

You lodged a complaint with the AFCA on the XXXX and signed the agreement of release and indemnity on XXXX.

The right to seek compensation was not held for more than 12 months.

Accordingly, any capital gain arising from CGT event C2 will not be a discount capital gain, and not eligible for the 50% discount.