Private ruling: Assessable income – lump sum
Date of advice: 25 August 2017
Published: December 2017
Ruling period: Year ending 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Is the lump sum payment you will receive to finalise your income protection insurance cover and claim, assessable as ordinary income? | A1: Yes.

Relevant facts and circumstances: You were the policy owner of an income protection insurance policy. The policy provided you with the following benefits. ● Income Protection (IP cover) and ● Critical illness (CI cover). Due to a work related injury you made a claim under the income protection benefit of the IP cover. Your claim was accepted and you have been in receipt of monthly income protection benefit payments. At no stage has the insurer disputed your eligibility to the payments. Under a Deed of Release it has been agreed that the IP cover under the policy would be cancelled and you would no longer be an insured person under the IP cover of the policy. You have been offered a lump sum payment in full and final settlement of the IP cover under the policy and claim.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(2)

Reasons for decision: Summary: Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year. Income protection insurance replaces an individual’s regular salary or earnings if they are unable to work for a period of time due to sickness or injury, by providing a regular income stream for an agreed period of time. 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. Your 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 monthly 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 monthly 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 payment as it is otherwise included in your assessable income, as ordinary income.