Private ruling: Income - income protection policy - lump sum payment in arrears tax offset
Date of advice: 12 September 2025
Published: 10 November 2025
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is a lump sum received under an income protection insurance policy assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the 20XX income year? | A1: Yes. | Q2: Is the taxpayer entitled to a tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936)? | A2: No. | Q3: If the offset does not apply, is the Commissioner able to exercise discretion under any provision of the ITAA 1936 or ITAA 1997 including section 370-5 of Schedule 1 of the Taxation Administration Act 1953 (TAA 1953) to allow the amount to be apportioned across the income years to which the payment relates? | A3: No.

Relevant facts and circumstances: On DD MM YYYY, you took out an income protection policy with an insurer as the policy holder. Under the terms of the policy, if you (or an insured member) became totally or partially disabled and met the required conditions, the insurer would pay a total disability benefit or partial disability benefit, as applicable. The policy also included provisions for specific injury benefits. The disability benefit was calculated as X% of your income, payable on a monthly basis. In YYYY, you were the owner and director of Business 1 and Business 2. On DD MM YYYY, you were involved in a motor vehicle accident that resulted in a traumatic injury. On DD MM YYYY, you lodged a claim with your insurer. On DD MM YYYY, your insurer accepted your claim for income protection. The insurer assessed you as totally disabled under the policy. On DD MM YYYY, you received a letter from your insurer advising that they had made an error and confirming your entitlement to additional income protection benefits for the period DD MM YYYY to DD MM YYYY. On DD MM YYYY and DD MM YYYY, you received a lump sum catch-up payments with a total amount paid to you as $XX.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1936 section 159ZRA | Taxation Administration Act 1953 section 12-120 | Taxation Administration Act 1953 section 370-5

Reasons for decision: Summary: A lump sum payment received as compensation for lost income such as backdated monthly salary from income protection insurance is considered ordinary income under section 6-5 of the ITAA 1997 and is assessable in the year it is received. | Detailed Reasoning - Detailed reasoning: Subsection 6-5(2) 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. An amount paid to compensate for loss generally acquires the same nature of what it is substituting ( 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). 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 received as a product of any employment, services rendered, or any business; • are earned; • are received regularly or periodically; • are expected; and • are relied upon. It is not necessary for all of these characteristics to be present for an amount to be considered ordinary income. A lump sum payment is generally classified as ordinary income if it is simply a lump sum made up of periodic income payments but paid in arrears to cover a certain period. Income protection policies provide for periodic payments in the event of loss of income caused by the insured becoming disabled through sickness or injury. These payments are assessable as income under section 6-5 of the ITAA 1997, as they are paid to take the place of lost salary or wage earnings. This view has been confirmed in Sommer v. FC of T 2002 ATC 4815; (2002) 51 ATR 102 (Sommer) 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. Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings considers the appropriate method of determining when income is derived under subsection 6-5(2) of the ITAA 1997 where income is earned in one tax year but received in another. Paragraph 42 of TR 98/1 states that salary and wages or other similar remuneration is assessable on a receipts basis. This is irrespective of whether that income relates to a past or future income period. Similarly, a lump sum amount of assessable income in arrears is included in a taxpayer's assessable income in the year you receive the payment. In your circumstances, the lump sum payment you received in the 20XX-XX income year represents backdated monthly amounts from DD MM YYYY to DD MM YYYY and is assessable under section 6-5 of the ITAA 1997. As the payment substitutes lost income, its lump sum nature does not alter its character, it remains ordinary income with no capital component and is taxable in the year it is received. | Summary: Individual taxpayers may be eligible for a lump sum in arrears tax offset under section 159ZRA of the ITAA 1936 if the payment includes eligible income accrued in earlier years and meets specific threshold criteria. However, because you are the owner of the insurance policy, the lump sum you received is excluded from the definition of eligible income and does not qualify for the offset. | Detailed Reasoning - Detailed reasoning: Individual taxpayers who receive assessable lump sum payments containing an amount that accrued in earlier income years may be entitled to a tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936). The lump sum payment in arrears (LSPIA) tax offset is intended to overcome the problem of the lump sum attracting more tax in the year of receipt than would have been payable if the payment had been taxed in the year in which it accrued. A person is entitled to a lump sum payment in arrears tax offset where: • the assessable income of the taxpayer of a year of income includes an eligible lump sum, and; • the total arrears amount is not less than 10% of the amount (if any) remaining after deducting the total arrears amount from the normal taxable income of the current year. An 'eligible lump sum' is defined as a lump sum payment of 'eligible income' received on or after 1 July 1986 that is included in the assessable income of the taxpayer and accrued, in whole or in part, in an earlier year or years of income. Subsection 159ZR(1) of the ITAA 1936 lists the type of payments that are eligible for the LSPIA Tax Offset, and includes a payment covered by section 12-120 in Schedule 1 to the TAA 1953. This section refers to a compensation, sickness or accident payment that is: (a) made for an individual's incapacity for work; and (b) calculated at a periodical rate; and (c) is not a payment made under an insurance policy to the policy owner. In your circumstances you are the owner of the policy. As such, the lump sum payment you received under the insurance policy is excluded from the definition of eligible income and you are therefore not entitled to a lump sum in arrears tax offset under section 159ZRA of the ITAA 1936. | Summary: The Commissioner does not have the power to exercise discretion to allow the amount to be apportioned across the income years to which the payment relates. | Detailed Reasoning - Detailed reasoning: Section 370-5 of Schedule 1 to the TAA 1953 allows the Commissioner to make decisions on tax administration matters, but it does not provide a general power to override legislative limitations or to apportion income across years. For the Commissioner to apply discretion within a private ruling, there must be a provision outlined in the legislation to allow it. As an example, section 118-195 of the ITAA 1997 outlines that a beneficiary who acquires a house from a deceased estate may sell the dwelling and disregard any capital gain from the sale of the property. Paragraph 118-195(1)(b) of the ITAA 1997 lists conditions that must be applied, nominating specifically "[their] ownership interest ends within 2 years of the deceased's death, or within a longer period allowed by the Commissioner". The addition of "a longer period allowed by the Commissioner" indicates that the Commission has the discretion under the legislation to extend the amount of time in the application and administration of this legislation. In relation to assessable income, there is no such provision to allow the Commissioner any discretion.