Edited version of private advice

Authorisation Number: 1052175672249

Date of advice: 4 October 2023

Ruling

Subject:Assessable income - gifts and voluntary payment

Question

Will the ex gratia payment of $XX received by the trustee for the estate of the late Dr A (Estate) from Company A be assessable income of the Estate in the income year ended 30 June 2023?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 2023

Relevant facts and circumstances

1.         Dr A held a professional indemnity insurance policy with Company A. Company A is a mutual not-for profit organisation, owned and operated for the benefit of its members.

2.         The membership of Company A is divided into classes of members and includes Voting Members (article 3.1 of Company A's Constitution. A Voting Member of Company A is defined in article 1.1 of the Constitution to mean:

...any health practitioner admitted by the board to membership who:

a)    is practising, or entitled to practise, as such in accordance with the laws of Australia or any of its States or Territories or the laws of another country ...

3.         Dr A was a Voting Member. As a Voting Member, Dr A had the right to any dividends and distributions which may be payable to Voting Members in accordance with article 12 of the Constitution.

4.         Article 12 of the Constitution permits the Directors of Company A to declare or determine that a dividend or distribution is payable that, in the Directors' judgment, the financial position of Company A justifies. A member's entitlement to dividends or distributions which are declared or determined is in proportion to their financial contributions to Company A.

5.         Company A has a Retirement Reward Plan under which a dividend (the Retirement Reward Dividend) may be paid by Company A at the discretion of Company A's board to eligible Voting Members. Broadly, eligibility to be considered for a Retirement Reward Dividend is triggered where the member remains a Voting Member of Company A and permanently retires from medical practice (or is permanently disabled and unable to continue practicing medicine) during the 24 months prior to the Record Date (i.e. 30 June each year).

6.         The Retirement Reward Dividend is designed to recognise the Voting Member's relative contribution to Company A's financial strength through premiums over the period of their continuous membership. However, there is no entitlement under the Retirement Reward Plan. The declaration of a Retirement Reward Dividend is at the sole discretion of Company A's board (considered as part of each end-of-year financial reporting process) and subject to the ongoing financial performance and strength of Company A.

7.         Company A expects Retirement Reward Dividends to be fully franked and has obtained class rulings in relation to the Retirement Reward Dividend. The class rulings conclude (among other things) that the Retirement Reward Dividend must be included in the permanently retired Voting Member's assessable income under subparagraph 44(1)(a)(ii) of the Income Tax Assessment Act 1936 (ITAA 1936) as the dividend is a non-share dividend within the meaning given in section 974-120 of the Income Tax Assessment Act 1997 (ITAA 1997).

8.         In the event of the death of a retired Voting Member prior to the receipt of any Retirement Reward Dividend, the estate of the retired (now deceased) Voting Member may be eligible for an ex gratia payment equivalent to the amount of any Retirement Reward Dividend the Voting Member may have received (if they were eligible). Any such payment to the estate can be applied for and will not include any franking credits or be grossed-up to take into account any franking credits the Voting Member may otherwise have received.

9.         None of the class rulings issued in respect of Retirement Reward Dividends apply to payments by Company A to the estate of a retired Voting Member.

10.      Dr A permanently retired from medical practice in 20xx.

11.      Company A sent an email to Dr A enclosing information relevant to his retirement. In relation to the Retirement Reward Plan, the email noted:

As a voting member of [Company A], you are automatically eligible to participate in the Retirement Reward Plan (RPP). To be considered for a dividend payment, you need to ... complete the RRP nomination form...

Please note that there are no guaranteed entitlements under the Retirement Reward Plan. The declaration of dividends is at the sole discretion of the [Company A] Board and subject to the ongoing financial performance and strength of the [Company A] Group.

You currently have a notional allocation of [$XX] under the RRP.

12.      On XX XX 2021, Mr B (in his capacity as Dr A's power of attorney), forwarded a copy of the Retirement Reward Plan Notification of Retirement via email to Company A confirming Dr A's permanent retirement from paid medical practice in 20xx.

13.      Dr A passed away in late 20xx.

14.      In June 2022, Company A sent an email to Mr B, acknowledging the death of Dr A and advising:

Retirement Reward Plan

The current notional allocation is [$XX] Our Board meets in September 2022, and if dividend payments are approved, you will receive the payment in October 2022 by cheque ...

Please note that there are no guaranteed entitlements under the RRP. The declaration of dividends is at the sole discretion of the [Company A] Board and is subject to the ongoing financial performance and strength of the [Company A] Group. The Retirement Reward Plan is subject to change, suspension or termination by the Board at any time.

15.      In October 2022, Company A sent a letter to the Estate stating:

You may be aware that Dr [A] was a member of [Company A] and was entitled to a payment under [Company A's] Retirement Reward Plan for their contribution to [Company A] throughout their membership.

Under the Retirement Reward Plan terms, when a member passes away, a payment equivalent to their Retirement Reward dividend is paid to their estate.

Enclosed is a cheque made out to the estate of Dr [A] for the sum of [$XX]

We would like to acknowledge Dr [A] for their dedication to the medical profession. This dividend is in recognition of their commitment and contribution to [Company A's] success, and their years of practice. [emphasis added]

16.      Attached to the letter was an invoice for $XX with the description 'Retirement Reward Plan Div/Ex-Gratia' and a cheque to the order of the Estate for that same amount.

17.      Both the Estate and Company A are residents of Australia for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1936 subparagraph 44(1)(a)(ii)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 974-120

Reasons for decision

Summary

The ex gratia payment of $XX received by the Estate from Company A is assessable income of the Estate under subparagraph 44(1)(a)(ii) of the ITAA 1936.

Detailed reasoning

Section 6-5 and section 6-10 of the ITAA 1997 provide that the assessable income of a resident taxpayer includes ordinary and statutory income derived directly and indirectly from all sources during the income year.

An amount is ordinary income if it meets the ordinary meaning of income while an amount is statutory income if it is not ordinary income but is specifically included in assessable income by a provision of the Income Tax Assessment Act (the Act).

The term 'ex gratia' is not defined in the Act. The Macquarie Dictionary defines the term to mean something granted as a favour and not because of a legal obligation.1 An ex gratia payment is therefore one that is given as a favour or gift.

The term 'gift' is also not defined in the Act and takes its ordinary meaning. Rather than attempting to define a 'gift', the courts have described a gift as having the following characteristics and features:

•         there is a transfer of the beneficial interest in property;

•         the transfer is made voluntarily;

•         the transfer arises by way of benefaction; and

•         no material benefit or advantage is received by the giver by way of return.

After considering the full circumstances of the ex gratia payment made to the Estate, it is considered that the payment is not a true 'gift', but is intended to be, and is in fact, a substitute for the Retirement Reward Dividend which would have been paid to Dr A under the Retirement Reward Plan as an eligible Voting Member permanently retired from medical practice.

This is evidenced by the fact that entitlement to the payment only arose upon the death of Dr A; was subject to Dr A not already having received a Retirement Reward Dividend; and the amount of the payment being equivalent to the amount of any Retirement Reward Dividend to which Dr A would have been entitled.

As such, the payment is income (even though it is paid by Company A voluntarily) and acquires the character of that for which it is substituted.

Accordingly, the amount of $XX is considered to be a non-share dividend within the meaning given in section 974-120 of the ITAA 1997 and assessable income of the Estate under subparagraph 44(1)(a)(ii) of the ITAA 1936.

Note: ATO Interpretative Decision ATO ID 2003/263 demonstrates that an ex gratia payment can be considered income. In ATO ID 2003/263 the payer had no obligation to make the payment that they did but it was considered to be income of the recipient as the payment was meant to substitute for part of the recipient's salary.

1 Macmillan Publishers Australian 2023, Macquarie Dictionary online https://www.macquariedictionary.com.au/features/word/search/?search_word_type=Dictionary&word=ex-gratia accessed 4 October 2023.