Private ruling: commutation of insurance policy
Published: July 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2011

Ruling: Q1: Is a lump sum payment you expect to receive from your insurance policy assessable income? | A1: No.

Relevant facts and circumstances: You were diagnosed with an illness. You underwent treatment which resulted in you being unable to return to work. You lodged income protection and disability insurance claims. Following extensive independent medical examinations by your insurers nominated doctors, you were declared totally and permanently disabled. A disability insurance benefit was paid to you. Your insurer refused to payout the income protection policy and continued to process claims on a month by month basis. After years of continuous benefit payments the insurer increased medical reporting requests. The insurer made requests for a vast amount of information. Your insurer suspended your claim. This decision was contested by you and the matter was referred to the ombudsman. If the ombudsman finds in your favour, a request has been made for commutation of the policy to avoid further stress. A lump sum payment for the balance of the policy would be paid.

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 section 15-30.

Reasons for decision: Summary: The lump sum compensation payment you expect to receive is in settlement of your dispute in relation to your entitlement to weekly income maintenance payments. As your lump sum payment is not paid specifically as compensation for loss of income, we consider the lump sum payment is of a capital nature. Therefore, as the lump sum payment is capital in nature it is not assessable as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). 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, expected, relied upon, and have an element of periodicity, recurrence or regularity. In your case, the compensation you expect to receive is not income from rendering personal services, income from property or income from carrying on a business. The commutation of the policy is a one off payment and thus it does not have an element of recurrence or regularity. A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. Taxation Determination TD 93/58 states that any part of a lump sum compensation amount will only be assessable as ordinary income: (a) if the payment is compensation for loss of income only ..... , or (b) to the extent that a portion of the lump sum is identifiable and quantifiable as income. This is possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature. The lump sum compensation payment you are seeking is in settlement of your dispute in relation to your entitlement to weekly income maintenance payments. As your lump sum payment is not paid specifically as compensation for loss of income, we consider the lump sum payment is of a capital nature. Therefore, as the lump sum payment is capital in nature it is not assessable as ordinary income under section 6-5 of the ITAA 1997. Section 6-10 of the ITAA 1997 includes amounts of statutory income in assessable income, that is, amounts that are specifically listed as assessable income in Division 10 of the ITAA 1997. The two provisions applicable in your case are section 15-30 of the ITAA 1997 and Part 3-1 of the ITAA 1997. Section 15-30 of the ITAA 1997 operates to include in your assessable income an amount received as insurance or indemnity for loss of an amount if the loss amount would have been included in assessable income and the amount received is not assessable as ordinary income under section 6-5 of the ITAA 1997. The compensation amount does not meet this description, as it is not paid for loss of earnings but for settlement of a dispute. Accordingly, the compensation payment that you will receive is not assessable under section 15-30 of the ITAA 1997. | Detailed Reasoning - Capital gains tax: Taxation Ruling TR 95/35 indicates that settlement of a personal injuries claim represents the disposal of an asset, as you have disposed of the right to seek compensation for the losses arising from the injury suffered. Part 3-1 of the ITAA 1997 contains the general capital gains tax (CGT) provisions. The disposal of an asset gives rise to a CGT event. However, paragraph 118-37(1)(b) of the ITAA 1997 disregards payments or receipts for the purposes of the CGT provisions where the amount relates to compensation or damages you received for any wrong, injury or illness suffered by you. In your case, you will receive a lump sum payment that relates to an illness. Accordingly, section 118-37(1)(b) of the ITAA 1997 will apply to the compensation amount so that any capital gain or capital loss will be disregarded.

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