Edited version of private advice

Authorisation Number: 1052368207163

Date of advice: 6 March 2025

Ruling

Subject: Income protection payments

Question 1

Are the income protection benefit payments received by the Company under the insurance policy personal services income of Person A within the meaning of section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No.

Question 2

Are the income protection benefit payments received by the Company under the insurance policy base rate entity passive income within the meaning of section 23AB of the Income Tax Rates Act 1986 (ITRA)?

Answer 2

No.

Question 3

If the funds from the income protection benefit payments received by the Company under the insurance policy are retained and invested by the Company rather than paid out as dividends or benefit payments to Person A, will the Commissioner determine under section 177F of the Income Tax Assessment Act 1936 (ITAA 1936) that the whole or a part of those income protection benefit payments are assessable income of Person A?

Answer 3

No.

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Relevant facts and circumstances

The Company was incorporated by Person A in 1999 to operate a business in which Person A was the principal professional.

Person A is and has always been the sole director of the Company and the sole shareholder in the Company.

Person A was one of a number of employees of the Company working in the business. The other employees included reception staff and other professionals.

There has been no formal contract of employment between the Company and Person A, nor any official employment policies regarding benefits to be provided to employees (including sickness/accident benefits). Person A has been paid a salary by the Company since it commenced the business.

In 2011, the Company (as policy owner) acquired an income protection insurance policy in respect of the life of Person A (the Policy). The Policy was offered under the policy terms of a Product Disclosure Statement.

Under the Policy acquired by the Company, the Company is entitled to a 'monthly amount insured' determined by reference to Person A's annual income at the time of acquisition and payable upon Person A's total disablement due to illness or injury. The monthly amount insured was originally $XX, payable monthly in arrears.

Person A suffered significant injury in an accident in the 20XX income year and has subsequently been assessed as totally disabled, meaning that due to that injury Person A is not working in any gainful occupation, unable to perform one or more duties necessary to produce income from their regular occupation, and is following the advice of a medical practitioner in relation to the injury. As such, the Company has been paid the monthly amount insured by the insurance company since 2015.

The period of time the Company is entitled to be paid a benefit for any one illness or injury while Person A is totally disabled (the benefit period) starts at the end of the 30 day waiting period and continues until the earlier of the date Person A is no longer totally disabled, the date of Person A's death, the cover expiry date or the end of the benefit period shown on the Policy Schedule (i.e. to age 70). It is expected that the monthly amount insured will continue to be paid to the Company under the Policy until Person A reaches age 70.

The monthly amount insured has been utilised by the Company to pay Person A's salary since their injury, as well as fund dividends paid to Person A by the Company. A summary of the salary paid to Person A, the profit of the Company after that salary, the dividend paid to Person A and the Company's retained profits at year end for the period 20XX to 20XX was provided to the Commissioner. All of the insurance proceeds received by the Company under the Policy since 20XX have been included in the assessable income of the Company in the year of receipt.

The business was sold by the Company in 20XX pursuant to a Contract of Sale to an unrelated party.

The Company proposes to invest some or all of the monthly amount insured it receives under the Policy (for example, in term deposits), rather than pay the insurance proceeds immediately as dividends (or some other form of payment) to Person A (the Proposed Scheme).

There is no plan to make any change to the shareholding of the Company.

Assumption

The Proposed Scheme does not comprise of any steps, events or transactions which are not referred to in this ruling.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 paragraph 177C(1)(a)

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 paragraph 177F(1)(a)

Income Tax Assessment Act 1997 Part 2-42

Income Tax Assessment Act 1997 section 84-5

Income Tax Rates Act 1986 section 23AA

Income Tax Rates Act 1986 section 23AB

Reasons for decision

Question 1

Summary

The benefits paid to the Company under the Policy is not Person A's personal services income for the purposes of section 84-5 of the ITAA 1997 because they are not payments made mainly as a reward for Person A's personal efforts or skills.

Detailed reasoning

Section 84-5 of the ITAA 1997 defines personal services income (PSI) as follows:

Your ordinary income or statutory income, or the ordinary income or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income).

The reference to 'or would mainly be such a reward if it was your income' applies to situations where the income is legally derived by a personal services entity (PSE) and not the individual. If a PSE fails to meet a personal services business (PSB) test in respect of a test individual, the net PSI is deemed to be the income of the test individual and is attributed to that individual.

The meaning of 'mainly' is explained at paragraph 37 of Taxation Ruling TR 2022/3 as follows:

The use of the word 'mainly' means that the income referred to needs to be 'chiefly', 'principally' or 'primarily' a reward for the provision of the personal efforts or for the exercise of the skills of an individual. That is, more than half (50%) of the ordinary or statutory income received is required to be a reward for the personal efforts and skills of an individual rather than being generated by the use of assets, the sale of goods or by a business structure.

The definition of PSI requires an analysis of the statutory or ordinary income of an individual or PSE to determine those amounts that are mainly a reward for an individual's personal efforts or skills. It is only the income that has that character that can be subject to Part 2-42 of the ITAA 1997.

The Explanatory Memorandum for the New Business Tax System (Alienation of Personal Services Income) Bill 2000 gives the following examples of personal services income (at paragraph 1.27):

•                     salary or wages;

•                     income of a professional person practising on his or her own account without professional assistance (for example, a medical practitioner in a sole practice);

•                     income payable under a contract which is wholly or principally for the labour or services of a person;

•                     income derived by a professional sports person or entertainer from the exercise of their professional skills. This does not include income from endorsement by the person of a sponsor's products; and

•                     income derived by consultants or engineers, for example, from the exercise of personal expertise.

PSI does not include income mainly generated from the supply and sale of goods, the supply and use of income-producing assets and income from the business structure of an entity.

The PSI rules do not apply to income received as an employee, except where the test individual is an employee of the PSE providing the service to the service acquirer and none of the PSB tests are met in respect of that test individual's PSI.

While the benefits paid to the Company under the Policy remain income of the Company, Person A is no longer capable of performing their duties as a medical practitioner as a consequence of their injury, and the Company is no longer a PSE following the sale of the business in 2023.

The benefits are merely paid to the Company pursuant to its contract of insurance with the insurance company; it is not paid to the Company as a reward for Person A's personal efforts or skills, and therefore is not Person A's PSI under section 84-5 of the ITAA 1997.

Question 2

Summary

The benefits paid to the Company under the Policy are not base rate entity passive income (BREPI) as defined in section 23AB of the ITRA.

Detailed reasoning

For a company to qualify as a 'base rate entity', it must meet the following criteria under section 23AA of the ITRA:

(a)           no more than 80% of its assessable income for the year of income is base rate entity passive income; and

(b)           its aggregated turnover (within the meaning of ITAA 1997) for the year of income, worked out as at the end of that year, is less than $50 million.

Section 23AB of the ITRA defines BREPI as assessable income that is any of the following:

•                     a distribution by a corporate tax entity, other than a non-portfolio dividend;

•                     an amount of a franking credit on such a distribution;

•                     a non-share dividend by a company;

•                     interest (or a payment in the nature of interest), royalties and rent;

•                     a gain on a qualifying security;

•                     a net capital gain; or

•                     an amount included in the assessable income of a partner in a partnership or of a beneficiary of a trust, to the extent that the amount is referable directly or indirectly to another amount that is BREPI.

The benefits paid to the Company by the insurance company under the Policy are not a payment of a type which falls under any of the categories of assessable income listed in section 23AB of the ITRA and are therefore not BREPI.

Question 3

Summary

The Commissioner will not make determination under section 177F of the ITAA 1936 in connection with the Proposed Scheme that the whole or part of the benefits paid to the Company under the Policy is assessable income of Person A.

Detailed reasoning

Part IVA of the ITAA 1936 applies to an arrangement where the following elements exist:

(a)           there is a scheme as defined in subsection 177A(1) of the ITAA 1936;

(b)           there is a tax benefit that, in relation to assessable income, is defined in paragraph 177C(1)(a) of the ITAA 1936 as an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out;

(c)           having regard to the 8 objective matters identified in subsection 177D(2) of the ITAA 1936, it would be concluded by a reasonable person that the person, or one of the persons, who entered into or carried out the scheme (or any part of it) did so for the dominant purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme; and

(d)           the Commissioner makes a determination under paragraph 177F(1)(a) of the ITAA 1936 that the whole or part of that amount shall be included in the assessable income of the taxpayer of that year of income.

The Proposed Scheme will result in Person A receiving less to no income as the Company will retain and invest the payments received under the Policy instead of paying such amounts to Person A in the form of a dividend or any form of assessable income.

Having regard to the matters in subsection 177D(2) of the ITAA 1936, it is not a scheme entered into or carried out for the dominant purpose of enabling Person A (and/or the Company) to obtain a tax benefit in connection with the scheme.