Private ruling: Compensation
Date of advice: 23 February 2019
Published: May 2019
Ruling period: Year ending 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Does the amount received under the Deed of Release constitute ordinary income? | A1: Yes | Q2: Will there be a CGT event C2 when the Deed of Release is executed cancelling the entitlement of future payments under the insurance policy? | A2: Yes, however, any capital gain you made at that time will be reduced to the extent that an amount is assessed as ordinary income.

Relevant facts and circumstances: You made a claim for a salary continuance insurance payments (claim) from your insurer. Your insurer accepted your claim. The benefit payments varied per month. You will sign a Deed of Release and receive a lump sum of $XXX,XXX. On payment of the lump sum you release and discharge your insurer of all sums of money, accounts, claims, actions, proceedings, demands and expenses under the policy.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 6-5 (2) | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 104-35 | Income Tax Assessment Act 1997 s ection 108-5 | Income Tax Assessment Act 1997 section 118-20 Question 1 | Detailed reasoning | Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. | Ordinary income has been held to include income from providing 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 or relied upon | ● have an element of periodicity, recurrence or regularity | ● replace income. | Taxation Determination TD1999/36 Income tax: should salary continuance benefits, paid to a member of a superannuation fund as a result of having a temporary disability, be reported for Reasonable Benefit Limits purposes provides the salary continuance benefits are designed to be paid, in full or in part, to | ● Replace the salary of an employee | ● Provide a minimum level of income to a self-employed person; or | ● Compensate the policy holder for the salary paid to the employee | An amount paid to compensate for loss generally acquires the character of that for which it is substituted ( FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433). | Therefore periodic payments received during a period of total or partial disability under a salary continuance policy are assessable on the same principle as salary and wages. This is because the benefits are a replacement of employment income during the period of total or partial disability ( FC of T v. D.P. Smith 81 ATC 4114; (1981)11 ATR 538). | The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was considered in Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138. In that case Mathews J found that payments made to replace income take on the character of the payment they replace and that the method of payment does not alter the character of the payment. Mathews J held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing redemption of those future weekly payments was also income. | In your case, you received a lump sum salary continuance insurance payment from your insurer. The purpose of the payment is to replace your salary. Therefore, the payments are ordinary assessable income. When you receive a lump sum payment as settlement as replacement for continued salary continuance insurance payments it is seen that the lump sum retains the character of the replaced individual payments. Therefore, the lump sum payment is considered ordinary assessable income. | Question 2 | Detailed reasoning | A CGT asset is: (a) any kind of property; or (b) a legal or equitable right that is not property. When you sell or otherwise dispose of an asset it's called a capital gains tax (CGT) event (Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997)). This is when you make a capital gain or loss. CGT event C2 happens if a taxpayer ' s ownership of an intangible CGT asset ends because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited. Section 104-25 ITAA 1997 contains the rules dealing with CGT event C2. | However, if there are any amounts assessable under some other provision, eg as ordinary income, the capital gain would be reduced in accordance with s 118-20 ITAA 1997. | In your case the treatment of the lump sum payments is as ordinary assessable income, the capital gain from the CGT event C2 is reduced, by the amount of the assessable income, to nil.