Private ruling: Taxation of lump sum settlement
Published: May 2012
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Will any part of your settlement amount be treated as assessable income? | A1: No. | Q2: Will any part of your settlement amount be assessable under the capital gains tax (CGT) provisions? | A2: No.

Relevant facts and circumstances: You held an income protection policy with an insurance company. You claimed benefits on this policy and received regular payments for several years. Your claim was ceased by the insurance company from 2010 as it was claimed you were no longer incapacitated for work and no further payments were received by you. After 1 July 2010 you made a further claim for a medical condition and this claim was rejected by the insurance company. You disputed the rejection of both of these claims and an agreement was reached to resolve the matters. You received a lump sum payment from the insurance company in after 1 July 2010. This payment was made by the insurance company to settle your claims and was made without an admission of liability and it was a global amount and was without apportionment. In accepting the payment you gave up your right to benefits under the policy and to take further action against the insurance company.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 6-10 | Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)

Reasons for decision: Summary: 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 · are expected · are relied upon · have an element of periodicity, recurrence or regularity. The lump sum payment you accepted is not income from rendering personal services, income from property or income from carrying on a business. The payment was a one off payment and thus it does not have an element of recurrence or regularity. The nature of the payment described in the scheme 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. Your settlement is a result of a negotiated agreement where entitlement to receive income from the income protection policy was in dispute. It is not a lump sum payment which substitutes for an income stream but rather for entering into a Deed of Release with your insurer for the purpose of surrendering your rights under the policy. The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997. Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but may be assessable under another provision called statutory income. | Detailed Reasoning - Capital gains tax (CGT): Amounts received in respect of personal injury which are not direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the CGT provisions of the ITAA 1997. Receipt of a lump sum payment may give rise to a capital gain (statutory income). However, paragraph 118-37(1)(b) of the ITAA 1997 disregards payment or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness. Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. When settling with a lump sum payment you surrendered your rights, not only to recover any such benefits in the action, but also to claim any further benefits to which you might now or in the future have an entitlement under your policy. As each of these claims relate to your incapacity, any capital gain or loss arising from the surrender of your rights under your policy will be disregarded. Applying paragraph 118-37(1)(b) of the ITAA1997 to your circumstances, the lump sum payment would not be considered as an assessable capital gain.

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