Edited version of private advice

Authorisation Number: 1051910061478

Date of advice: 22 October 2021

Ruling

Subject: Assessable income - lump sum payment in arrears

Question 1

Are the lump sum payment in arrears (LSPIA) amounts you received from your income protection insurance policy assessable income in the financial year ended 30 June 20XX?

Answer

Yes.

Question 2

Are you eligible to receive the lump sum payment in arrears (LSPIA) tax rebate to reduce your tax payable for the financial year ended 30 June 20XX?

Answer

No.

This ruling applies for the following period:

For the income year ended 30 June 20XX

The scheme commenced on:

DDMMYYYY

Relevant facts and circumstances

You are an Australian resident for tax purposes.

Due to personal illness, you were unable to work in full time capacity so you worked part time hours.

You made a claim on your income protection insurance policy as a replacement of the wages that you would have otherwise been able to earn were it not for your illness.

You are the individual policy owner and the monthly insurance premiums were/are paid by you, with no contribution from any other person or your employer.

The insurance policy is not held under your superannuation fund or by your employer.

The sum you are insured for is $X per month for income protection. This is not a monthly insured benefit that would be provided to you as for a total and permanent disability, as there is an incentive for you to work more hours and earn more income overall.

The insurer calculated the amount payable to you by factoring into their calculation your earnings, that is, the more you earn in part time wages, the less the income protection payment.

You received the lump sum payment in arrears amounts detailed below which related to the following income periods:

Date received Amount received Year of income

DDMMYYYY $X DDMMYYYY to DDMMYYYY

DDMMYYYY $X DDMMYYYY to DDMMYYYY

DDMMYYYY $X DDMMYYYY to DDMMYYYY

The total lump sum amount of $X received from your insurer solely represents the replacement of wages in the relevant income years.

Pay as you go (PAYG) withholding amounts were not withheld from the lump sum payments you received.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 159ZRA

Income Tax Assessment Act 1936 subsection 159ZR(1)

Taxation Administration Act 1953 section 12-80

Taxation Administration Act 1953 section 12-120 of Schedule 1

Income Tax Assessment Act 1997 section 6-5

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

Reasons for decision

Summary

Lump sum payment in arrears (LSPIA) amounts are included in a taxpayer's assessable income in the financial year you receive the payment.

Detailed reasoning

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, whether in or out of Australia, 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 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 of time.

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 salary or wage earnings.

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings considers the appropriate method of determining when income is derived under subsection 6-5(2) of the ITAA 1997 where income is earned in one tax year but received in another. Paragraph 42 of TR 98/1 states that salary and wages or other similar remuneration is assessable on a receipts basis. This is irrespective of whether that income relates to a past or future income period. Similarly, a lump sum amount of assessable income in arrears is included in a taxpayer's assessable income in the year you receive the payment.

In your case, you received lump sum payment in arrears amounts in the 20XX-XX financial year, relating to 20XX and previous income years from 20XX-20XX. Under section 6-5 of the ITAA 1997 the payments are included in your assessable income for the 20XX-XX financial year, the year you received the payments.

To work out where to report any LSPIA amounts in your tax return, see myTax 2021 Salary, wages, allowances, tips, bonuses etc. at ato.gov.au and search for quick code 'QC 65244'.

Summary

The lump sum payment in arrears (LSPIA) tax rebate is not available to reduce your tax payable in 20XX-XX year of income.

Detailed reasoning

An individual who receives certain assessable lump sum payments containing an amount that accrued in earlier income years may be entitled to a lump sum payment in arrears (LSPIA) tax rebate (or tax offset) under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936).

The tax offset is intended to overcome the problem of the lump sum attracting more tax in the year of receipt than would have been payable if the payment had been taxed in each of the years in which it accrued. The tax offset is broadly calculated as the difference between the extra amount of tax payable in the year of receipt because of the lump sum and the amount of tax that would have been payable if the lump sum had been taxed as it accrued.

Section 159ZRA of the ITAA 1936 allows a lump sum payment in arrears tax offset where the taxpayer's assessable income in a year of income includes one or more 'eligible lump sums'.

An 'eligible lump sum' is defined as a lump sum payment of 'eligible income' received on or after 1 July 1986 that is included in the assessable income of the taxpayer and accrued, in whole or in part, in an earlier year or years of income (subsection 159ZR(1) of the ITAA 1936).

'Eligible income' is defined in subsection 159ZR(1) of the ITAA 1936 to mean certain specified types of income. The definition includes compensation, sickness, or accident payments.

Paragraph 159ZR(1)(c) of the ITAA 1936 includes in this definition payments covered by section 12-80 or section 12-120 in Schedule 1 to the Taxation Administration Act 1953 (TAA 1953). Section 12-120 in Schedule 1 to the TAA 1953 refers to a compensation, sickness or accident payment that is:

•         made in respect of an incapacity for work; and

•         is calculated at a periodical rate; and

•         is not a payment made under an insurance policy to the policy owner.

In your case you are the policy owner. You received lump sum payments under an individual income protection insurance policy which was not a group policy held under your superannuation fund or by your employer. PAYG withholding does not apply to payments made by an insurer to the owner of a relevant policy. The amount paid was not calculated at a periodical rate as a multiple of the monthly insured benefit of you being unable to work for a period of time due to sickness.

Therefore, the lump sum payment amounts you received that accrued in earlier years of income are not considered 'eligible income' under section 159ZR of the ITAA 1936. You are not eligible for the lump sum payment in arrears tax rebate under these circumstances.

For more information on ato.gov.au search for quick code 'QC 63791' and '50695'.