Edited version of private advice

Authorisation Number: 1052156941354

Date of advice: 16 August 2023

Ruling

Subject: CGT event C2

Question 1

Is any part of the Capital Benefit Payout received by the deceased under the Product assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the relevant capital gains tax asset in relation to the Capital Benefit Payout the Licence?

Answer

Yes.

Question 3

Did a capital gains tax event C2 occur when the Licence was cancelled?

Answer

Yes.

Question 4

Is any capital gain resulting from the Capital Benefit Payout received by the deceased under the Product disregarded?

Answer

No.

This ruling applies for the following period:

Financial year ended 30 June 20YY

The scheme commenced on:

XX/MM/CCYY

Relevant facts and circumstances

On XX/MM/CCYY, the deceased obtained insurance described as a Loss of Licence Product (the Product) from the Benefit Fund with respect to their licence.

Under the Product Disclosure Statement for the Product, the purpose of the Product was to provide financial support to licence holders who are unable to exercise the privileges of their licence due to the failure to meet the standards required by the relevant authority as a result of an illness or injury. One of the benefits provided in the Product is a payment of a lump sum Capital Benefit.

In examining a claim for a Capital Benefit, the trustee of the Benefit Fund must apply the Rules which are in effect at the time of the date of disability. Relevantly, eligibility for a Capital Benefit is governed by Rule 8(a) of the Rules which states that: Where a Member's (required standards) is Permanently Lost, a Member may be entitled to payment of the Capital Benefit Balance, subject to this Rule.

On XX/MM/CCYY, the deceased was employed by a company.

On XX/MM/CCYY, the deceased suffered an injury and was severely incapacitated. An administrator was appointed on the deceased's behalf who subsequently made a claim under the Product with Benefit Fund.

On XX/MM/CCYY, the deceased's licence (the Licence) was cancelled.

On XX/MM/CCYY the trustee of the Benefit Fund determined that the deceased was entitled to claim a Capital Benefit of $XXX,XXX being the Capital Benefit Payout under the Product.

On XX/MM/CCYY, the Capital Benefit Payout of $XXX,XXX was received by the deceased.

On XX/MM/CCYY, the deceased passed away.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 104-25(1)

Income Tax Assessment Act 1997 Section 104-5

Income Tax Assessment Act 1997 Section 108-5

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

Reasons for decision

Question 1

Is any part of the Capital Benefit Payout received by the deceased under the Product assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Summary

Based on the information provided the payout received under the product does not have the character of ordinary income and will therefore not be assessable under section 6-5 of the ITAA 1997.

Detailed reasoning

Ordinary income

Section 6-5 and section 6-10 of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary and statutory income (such as capital gains) derived directly and indirectly from all sources, whether in or out of Australia during the income year.

The ITAA 1997 does not provide specific guidance on the meaning of ordinary income. However, a substantial body of case law exists which identifies its likely characteristics. Amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income, as are amounts that are the product of any employment of, or services rendered by, the recipient. Further, amounts which compensate for lost income or serve as a substitute for other income are themselves income according to ordinary concepts.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, 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.

Application to your situation

The deceased received a payout as a result of being deemed by the relevant authority as failing to meet the standards for the licence that was permanent due to the medical condition. As a result, the deceased was paid a payment, which consisted of a lump sum amount made up of a capital benefit amount.

Based on the information provided the amount included in the payout does not have the nature of income as outlined above. The payout is viewed as being a single lump sum paid for cancellation of a capital asset. Therefore, the payment will not be assessed as ordinary income under section 6-5 of the ITAA 1997.

Question 2

Is the relevant capital gains tax asset in relation to the Capital Benefit Payout the Licence?

Answer

Yes.

Question 3

Did a capital gains tax (CGT) event C2 occur when the Licence was cancelled?

Answer

Yes

Summary

The relevant capital gains tax asset was the Licence and CGT event C2 occurred when the Licence was cancelled.

Detailed reasoning

Capital gains tax asset

Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

For income tax purposes, a compensation amount generally bears the character of that which it is designed to replace. Taxation Ruling, TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts.

TR 95/35 discusses the various scenarios, including:

•         disposal of the underlying asset,

•         compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and

•         disposal of the right to seek compensation.

It is the character of the receipt in the hands of the recipient that must be determined: FCT v. Slaven (1984) 52 ALR 81; 15 ATR 242; 84 ATC 4077 (Slaven's case). Generally, the material factor in determining whether compensation is of an income or capital nature is not the measure of the compensation, but what it is truly paid for: Glenboig Union Fireclay Co Ltd v. IR Commrs (1921) 12 TC 427.

In determining, which is the most relevant asset, it is often appropriate to adopt a 'look-through' approach to the transaction or arrangement which generates the compensation receipt. We regard this concept as the most appropriate basis on which to determine whether any capital gain arises on the disposal of any asset of the taxpayer.

In cases where a dispute between the insurer and the insured is settled by way of the former making a lump sum payment to the latter; it would presumably be the case that the payment is intended to compensate the policy holder for the loss of entitlements under the policy, rather than to compensate the person for their injury or illness or wrong suffered as such.

Taxation Ruling IT 2230 Income tax: loss of licence insurance relates to a situation where the taxpayer had paid premiums in relation to the loss of licence insurance policies which provide for the payment of periodic benefits of an income nature as well as benefits of a capital nature. It outlines that in situations where the benefits are a payment of a capital sum for the loss of the contributor's asset, the CGT asset was the licence.

In Case 67 (1977) 21 CTBR (NS), a licence holder was not entitled to deduct any part of the premium paid under a "loss of licence" insurance policy, where the benefit payable was a lump sum for the permanent loss of the licence, being the capital asset.

CGT event C2

Under subsection 104-25(1) of the ITAA 1997, a CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends by the asset:

•         being redeemed or cancelled

•         being released, discharged or satisfied

•         expiring

•         being abandoned, surrendered or forfeited

•         if the asset is an option - being exercised

•         if the asset is a convertible interest - being converted.

Application to your situation

The deceased was a member of the Benefit Fund and had made contributions to the Fund which entitled them to receive a capital benefit if the relevant conditions for the payment of the benefit were met, which involved loss of the Licence.

The deceased suffered a medical issue and their Administrator made a claim to the Benefit Fund for a payment of the benefit under the Policy with their Licence being cancelled by the relevant authority.

Based on the information provided, and in accordance with the principles contained in section 104-25 of the ITAA 1997, the deceased's CGT asset was the Licence and a CGT event C2 occurred when the Licence was cancelled.

Question 4

Is any capital gain resulting from the Capital Benefit payout received by the deceased under the Product disregarded?

Answer

No

Summary

The personal injury/illness CGT exemption does not apply as the compensation is for the loss of the Licence rather than for the injury itself.

Detailed reasoning

Paragraph 118-37(1)(a) of the ITAA 1997 provides that a capital gain or loss from a CGT event relating directly to an injury or illness suffered by a taxpayer is disregarded.

In the case of Purvis v. FC of T [2013] AATA 58 (Purvis' case), the Administrative Appeal Tribunal considered the tax consequences of a licence holdeer receiving a lump sum insurance payment for the loss of licence. Although the loss of licence came about as a result of illness or injury, the Tribunal found that the payment did not relate directly to compensation or damages within paragraph 118-37(1)(a) of the ITAA 1997. The amount was calculated without regard to the nature of the personal injury suffered, save that the personal injury had to result in the loss of licence.

The termination of the CGT asset, the licence, was due to the nature of a personal injury received. It was a condition of the loss of licence payment to have suffered a personal injury but the payment was for the loss of the licence not for the injury itself. Therefore, the payment received did not directly relate to compensation for damages covered by the exemption in paragraph 118-37(1)(a) of the ITAA 1997, it related to the loss of the licence.

Application to the current situation

In this situation the CGT asset was the Licence. A CGT event C2 occurred when the Licence was cancelled.

Based on the information provided and the case above to the facts of the current situation, it is viewed that the Capital Benefit payout directly relates to the loss of the CGT asset, being the Licence rather than directly to a personal injury.

The Capital Benefit payout is not regarded as income replacement and was paid by the insurer following the claim. In settlement, a lump sum payment was received and it cannot be said to be for a single defined payment for an injury, illness or wrong. As was the case in Purvis' case, although the compensation may have been triggered by an injury, the actual lump sum payment is not a payment for the injury suffered. Therefore, the lump sum payment is assessable as a capital gain and the exemption contained in paragraph 118-37(1)(a) of the ITAA 1997 does not apply.

We note that you contended that Purvis's case can be distinguished from the current situation. However, we do not believe that it can be distinguished in relation to the issue in question. Although the exact calculation mechanisms for the capital amounts in Purvis's case and the current case were different (the former depended on the person's rank and age while the latter was a set amount), the character of the capital amounts is the same in that they were not linked to the nature of the injury/illness itself. This can be contrasted with a capital benefit paid under a sickness and accident insurance policy where the amount is calculated having regard to the nature of the injury or illness itself, for example, the capital benefit amount payable for the loss of a limb may be different to that for a heart attack and in that situation it is clear that the amount is direct compensation for the injury/illness. That situation is different to that in Purvis's case and the current case where the compensation was for the loss of the licence rather than for the injury/illness itself