Edited version of your written advice

Authorisation Number: 5010050600776

Date of advice: 30 May 2018

Ruling

Subject: Lump sum insurance payment

Question 1

Is the lump sum payment you will receive to finalise your income protection insurance policy claim, assessable as ordinary income?

Answer

Yes.

Question 2

Is the lump sum payment you will receive to finalise your income protection insurance policy claim, included in assessable income under the capital gains provisions?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2018

The scheme commenced on

1 July 2017

Relevant facts and circumstances

You are the policy owner of a Life Insurance policy which provided cover for Income Protection insurance.

You had an accident which resulted in you having to stop working and closing your business.

You have received Income Protection payments from your insurer for a period of time.

You have a Deed of Settlement from your insurer that offers to pay you a sum in full and final settlement of the Income Protection cover under your insurance policy.

The Income Protection component of your insurance policy has now been cancelled.

You release the insurer from any further liability under the terms of the Income Protection cover of the insurance policy.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

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

Income Tax Assessment Act 1997 Section 6-10

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

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 earnings.

This view has been subsequently confirmed in Sommer v. FC of T 2002 ATC 4815; (2002) 51 ATR 102 (Sommer’s case) where a lump sum paid to a doctor in settlement of his claim under an income protection policy was assessable on the basis that it was in substitution for his original claim under the policy for lost income. The taxpayer argued that the amount comprised an undissected aggregation of both income and capital and, therefore should be treated as capital.

The taxpayer’s case was dismissed in the Federal Court and it was held that the commercial reality of the payment was that it was a full and final settlement of all the taxpayer’s income claims. The fact that it was a lump sum did not change its revenue nature.

The Sommer decision was followed in Gorton v. FC of T 2008 ATC 10-018, where a lump sum payment received by a former medical practitioner from his insurer in settlement of his professional income replacement claims was held to be assessable income.

You situation is similar to the above cases as the lump sum you will receive will be a payout of your remaining benefit and finalisation of your claim.

The commutation of the periodic income payments into a lump sum does not change its character of compensation for loss of income. The lump sum is a receipt of income only, that is, there is no capital component in the payment.

Therefore, the lump sum payment you will receive from the insurer is an advance of your future periodical payments and is assessable under section 6-5 of the ITAA 1997 as ordinary income in the year it is received.

The capital gains tax (CGT) provisions do not apply to the lump sum finalisation payment as it is otherwise included in your assessable income, as ordinary income.