Private ruling: Taxation treatment of lump sum settlements
Published: April 2015
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Questions and Answers | 1. Is the whole of a lump sum settlement amount paid by an insurer to you assessable as a capital gain in the year it is received? | No | 2. Is part of a lump sum settlement equating to 20% of the amount paid by an insurer to you assessable as a capital gain in the year it is received? | Yes, however, you are entitled to the 50% capital gains tax (CGT) discount for this gain. | 3. Is part of the lump sum settlement equating to 80% of the amount paid by an insurer to you exempt under the capital gains provisions relating to personal injury? | Yes.

Relevant facts and circumstances: As member of a retail superannuation fund, you were entitled to payments from the fund in connection with the happening of various events including total and permanent disablement. The trustee of the superannuation fund maintained a policy of life insurance with an Insurer under which the Insurer was obliged to pay a benefit to the Trustee of the superannuation fund in connection with the happening of a total and permanent disablement of a member. You directly purchased through the same insurer a separate additional insurance policy, which provided cover for trauma, income protection and total and permanent disability. You suffered from various illnesses. As a result of your illness you made a total permanent disability (TPD) claim more than 12 months ago through the trustee of your superannuation fund. No assessment of your claim was completed by either the Insurer or the Trustee. As a result of your illness, you made a claim for the payment of monthly benefits under the policy you held directly with the insurer, to which they commenced payment. You are not seeking a private ruling on these payments. As a result of your illness, you made a claim for a total permanent disability lump sum under the policy you held directly with your Insurer. No assessment of your claim was completed by the Insurer. You commenced legal proceedings against both the Trustee and the Insurer in a court of Law in relation to the pending insurance claims. The heads of claim state the amounts you were claiming under the TPD lump sum provisions. You have also advised that you were in receipt of an income stream being paid under the income protection part of your insurance plan. You were entitled to receive these payments until age 65. This has ceased now that the lump sum has been paid. The parties entered into a Release Agreement confirming the release of liability and the payment of the lump sum. You have provided a copy of the Release Agreement. Without any admission of liability by any party, you, the Trustee of the superannuation fund and the Insurer agreed to settle the total permanent disability claim on the basis that the Insurer pay you a lump sum amount inclusive of all costs and interest in exchange for you releasing the Insurer and the Trustee of the superannuation fund from all actions, suits claims or demands that you had or may have had in the future relating to your Court proceedings. You have asserted that you believe 80% to be a reasonable proportion of the lump sum that is directly attributable to your personal injury.

Relevant legislative provisions: Section 6-5 of the Income Tax Assessment Act 1997 | Section 6-15 of the Income Tax Assessment Act 1997 | Section 104-25 of the Income Tax Assessment Act 1997 | Section 116-40 of the Income Tax Assessment Act 1997 | Section 118-37 of the Income Tax Assessment Act 1997 | ATO view documents | Taxation Ruling TR 95/35 | ATO ID 2002/578 | ATO ID 2003/707

Reasons for decision: Summary: Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or 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 and relied upon, and • Have an element of periodicity, recurrence or regularity. The lump sum payment you received is not income from rendering personal services, income from property or income from carrying on a business. The payments are also one-off payments and thus do not have an element of recurrence or regularity. A payment of the nature described in your facts generally bears the character of that which it is designed to replace. If the lump sum payment 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 Ruling TR 95/35 considers the treatment of compensation receipts. Note that the Ruling is written in terms of the Income Tax Assessment Act 1936 (ITAA 1936). The CGT provisions in that Act required that there be a disposal of an asset in order for there to be a capital gain, and so it was necessary to find a notional asset which could be disposed of. The current CGT provisions no longer require that there be a disposal of an asset. Rather, specific events are listed and the treatment for each is outlined. Therefore, it is no longer necessary (or useful) to consider a notional asset in relation to compensation receipts. A 'compensation receipt', for the purposes of the Ruling, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not: • in relation to any underlying asset • arising out of court proceedings, or • made up of dissected amounts. Therefore, any amount received by a taxpayer in relation to a claim they have made for a wrong or injury will be 'compensation', regardless of whether the payer admits to any specific liability. From the recipient's point of view, the amount is received for their claim for injury, wrong, breach of contract, etc. If the compensation receipt is directly in respect of an underlying CGT asset - for the disposal of, loss of, permanent damage to, or permanent reduction in the value of, that asset - the approach in the Ruling allows the taxpayer to look through the right to seek compensation and treat the amount as having been received in relation to the underlying asset. For example, if compensation is received because a tangible asset is lost or destroyed, then the compensation receipt will be treated as capital proceeds for CGT event C1 happening to the asset. If there is no underlying asset to which the compensation receipt directly relates, the receipt will be capital proceeds for CGT event C2 - the ending of the right to seek compensation. The cost base will generally be limited to legal costs incurred in pursuing the claim. Where the compensation is received for the ending of such a right, and that right arose only in relation to either a wrong or injury suffered in the taxpayer's occupation or any wrong, injury or illness the taxpayer or their relative suffers personally, any capital gain arising under CGT event C2 will be disregarded under section 118-37 of the ITAA 1997. If compensation is received in relation to multiple heads of claim, the ruling allows a reasonable apportionment of that payment. This is a reflection of the capital proceeds apportionment rule (modification 2) in section 116-40 of the ITAA 1997. For example, if a payment is both for personal injury and related damage to a CGT asset, the payment may be apportioned between the two heads of claim. The part of the payment that can reasonably be attributed to personal injury will be treated as capital proceeds for the ending of the right to seek compensation, and any capital gain arising will be disregarded under section 118-37 of the ITAA 1997. The part of the payment that can reasonably be attributed to damage to the asset will be applied to reduce the cost base of the underlying asset. Any additional amount that cannot be attributed to the underlying asset will be capital proceeds for the ending of the right to seek compensation, and no concessions will apply to a resulting capital gain. However, if the payment is truly an undissected lump sum - that is, no reasonable apportionment can be made - it can only be capital proceeds for the ending of the right to seek compensation, and no concessional treatment can be applied. | Detailed Reasoning - Application to your circumstances: You have accepted a lump sum amount under the terms of a Release Agreement. As noted in that Release Agreement, the settlement was reached without any admission of liability by any party and the claim was settled on the basis that you released the Insurer and the Trustee of the superannuation fund from all actions, suits, claims or demands you had. Where liability is not accepted, we seek to distinguish whether the payment was made to settle the claim for injury or if it was paid to release the claim from the settlement. Having regard to the facts that you have provided, it is clear that the lump sum amount is one that is capable of dissection. The Release Agreement read in conjunction with the heads of claim enables the lump sum to be apportioned between the payment made for personal injury from the payment made to end the right to seek compensation. The settlement amount you received incorporates payments due to the claim under the TPD insurance, both from the Insurer and Trustee. There is also a payment in relation to the cessation of the income protection payments you were entitled to receive until age 65, as well as legal costs, interest and finally, an amount which related directly to the giving up of any further right to sue or seek compensation. Thus, it is clear that there is an ability to dissect the lump sum and allocate a proportion of that lump sum as directly relating to personal injury. In this case, we accept your assertion that 80% of the amount received is a reasonable apportionment of the lump sum received. Therefore, 80% of the lump sum received will be exempt from taxation as it was paid to you for a wrong or injury suffered under the terms of your insurance policy in accordance with paragraph 118-37(1)(b) of the ITAA 1997 as it relates directly to your personal injury. Consequently, 20% of the lump sum received will be subject to CGT under CGT event C2 relating to the cessation of the right to seek compensation. | Detailed Reasoning - Eligibility for CGT discount: As you acquired the right to seek compensation more than 12 months prior to CGT event C2 happening, you are entitled to use the 50% discount method to calculate your capital gain in relation to the taxable portion of the lump sum.