Private ruling: Income Protection- lump sum payment- settlement
Date of advice: 17 May 2018
Published: July 2018
Ruling period: financial year ended 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is your lump sum payment assessable as ordinary income or as a capital gain? | A1: No

Relevant facts and circumstances: You were the policy owner of an income protection insurance policy. The policy entitled you to income replacement payments should you meet its conditions for a claim. You suffer from a medical condition which resulted in the cessation of your career. As a result of your condition, you made an income protection claim against the policy. You claimed that you were unable to work because of your medical condition. Your insurer denied liability on basis of ‘pre-existing condition’ exclusion clause in the policy. You filed a Statement of Claim against the insurer in a local court. You claimed entitlements to income protection benefits and also sought refund of premiums, compensation for suffered loss and taxation consequences, interests and costs. Your insurer denied that they are liable in any way to you in respect of the claims. Without any admission of liability, both parties agreed to resolve the claim by executing a deed of release. Your insurer paid you an agreed amount inclusive of damages, costs and interests in consideration of you releasing and discharging your insurer from all causes of action, claims or demands which you have in connection with the policy. Your tax agent advised us that there were costs but no interest in the amount paid. You incurred legal expenses.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5, | Income Tax Assessment Act 1997 section 6-10 and | Income Tax Assessment Act 1997 paragraph 118-37(1)(b).

Reasons for decision: Detailed Reasoning - Ordinary Income: Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes ordinary and statutory income derived directly and indirectly from all sources during the income year. Ordinary income has generally 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 earned ● are expected ● are relied upon ● have an element of periodicity, recurrence or regularity. The lump sum payment you accepted is not income from rendering personal services, income from property or income from carrying on a business. The payment is also not earned, expected, relied upon and is a one off payment and thus it does not have an element of recurrence or regularity. Your settlement is a result of you initiating a proceeding in the Courts where entitlement to receive an Income Protection payment was in dispute. It is not a lump sum payment which substitutes for an income stream but rather for entering into a settlement agreement with the insurer for the purpose of surrendering your rights under the policy. The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Capital gains tax: Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. Receipt of a lump sum payment may give rise to a capital gain. However paragraph 118-37(1)(b) of the ITAA 1997 disregards payment or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness. The lump sum you received is considered to be exempt from CGT under paragraph 118-37(1)(b). | Detailed Reasoning - Conclusion: As the amount is not ordinary or statutory income it is not assessable income. Therefore no part of the settlement amount is required to be included in your income tax return.