Private ruling: Compensation payment - income protection insurance – assessability - cost base of a right to seek compensation
Date of advice: 17 May 2018
Published: July 2018
Ruling period: financial year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is the compensation payment you received to buy back your Income Protection Insurance assessable as a capital gain? | A1: Yes | Q2: Does the total amount incurred as expense in respect to the income protection insurance claim form part of the cost base? | A2: Yes

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. At a certain date you lodged a claim for benefits under the policy. The Insurer paid all the benefits due under the policy for all relevant periods. However, at a later date, the Insurer denied liability for the claim. You were in dispute with the Insurer. Without admission of liability, you and the Insurer agreed to resolve the dispute by executing a deed of release. You agreed to the Insurer purchasing the policy and wholly extinguishing your rights and entitlements and purported rights and entitlements under the policy. Payment was in consideration of you releasing and discharging the Insurer from all causes of action, claims or demands which you have in connection with the policy. A settlement sum was paid to you. The settlement sum was inclusive of interest and costs less any applicable tax required to be deducted by law (if any). You incurred a total expenditure of $xx,xxx relevant to this matter. The fees include: ● independent assessment fee of $x,xxx to comply with the Insurer’s requirements ● forensic report fee of $x,xxx to comply with the Insurer’s requirements. You also incurred legal expenses of $xx,xxx in pursuing the claim against the Insurer.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 115-25 | Income Tax Assessment Act 1997 section 115-100 | Income Tax Assessment Act 1997 section 118-37 | Income Tax Assessment Act 1997 section 118-300

Reasons for decision: Detailed Reasoning - Capital Gains Tax: Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) explains a CGT asset is any kind of property or a legal or equitable right that is not property, such as a right to enforce a contractual obligation. Paragraph 104-25(1)(b) of the ITAA 1997 states CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. For certain CGT events, including CGT event C2, section 115-25 of the ITAA 1997 provides for a discount capital gain where the capital gain results from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event. The discount percentage for an amount of a discount capital gain is 50% if the gain is made by an individual who is an Australian resident (section 115-100 of the ITAA 1997). Section 118-37 of the ITAA 1997 exempts compensation or damages (from CGT a capital gain you make from a CGT event) you directly receive for any wrong or injury you suffer in your occupation or for compensation or damages you receive for any wrong, injury or illness you suffer personally. Section 118-300 of the ITAA 1997 also exempts a capital gain you make from a CGT event happening in relation to a CGT asset that is your interest in rights under certain insurance policies but not a disability income insurance policy. Taxation Ruling TR 95/35 is about capital gains and the treatment of compensation receipts. In having regard to sections 104-25 and 118-37 of the ITAA 1997, paragraphs 3, 11, 18 to 20 of TR 95/35 state: An undissected lump sum compensation receipt is any amount of compensation received by the taxpayer where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated. If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. Accordingly, any capital gain arising on the disposal of that right is calculated using the cost base of that right. If the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation. Compensation received by an individual for any wrong or injury suffered to his or her person or in his or her profession or vocation is exempt from CGT… Exemption…is available if the taxpayer receives compensation in an undissected lump sum which relates wholly to the personal wrong or injury suffered by the taxpayer. In your case, your claim against the insurer was not related to personal injury. Instead, your claim was related to your contractual rights under the relevant policy. Although the settlement figure may have been triggered by a personal illness, the actual lump sum payment is for disposal of your right to seek compensation (CGT event C2). Therefore the exemption contained in section 118-37(1)(b) of the ITAA 1997 cannot apply and the payment will be a taxable capital gain. As your right to seek compensation (a CGT asset) was acquired over twelve months prior to your settlement, your capital gain qualifies for the 50% capital gains general discount. | Detailed Reasoning - Cost Base for a CGT asset: In determining the cost base of a right to seek compensation, paragraph 103 of TR 95/35 states: … expenditure or an outgoing forms part of the cost base of a right to seek compensation if there is a direct and substantial link between the expenditure or outgoing and the arising of the right to seek compensation. The following indicators are considered in determining whether there is a direct and substantial link (TR 95/35 paragraph 101) ● the necessity for the payment of money or the giving of property; ● the degree of temporal relationship between the payment of money or the giving of property and the acquisition of the asset; ● the purpose (objective and subjective) of the payment of money or the giving of property; ● the nature of the asset; ● the circumstances of the acquisition of the asset including: ● parties (e.g., whether money paid or property given to a third party); ● terms of the contract or agreement; and ● arising from a wrong or by a lack of consent; ● the extent of causation; ● whether money paid or property given is in proportion to the value of the asset; and ● whether the degree of connection is diminished if money is paid or property is given for multiple benefits rather than solely to acquire the asset (e.g., for services). Any amounts for which you could have had a deduction for are excluded from your cost base (sections 110-40 and 110-45 of the ITAA 1997). In your case, the amount which you spent on the independent assessment, forensic report and legal fees were necessary in processing and pursuing the claim. Thus the expenditures form part of the acquisition costs of your right to seek compensation from the insurer.