Issue
Are the proceeds from a life insurance policy, payable on the death of the insured person, assessable income under sections 6-5, 6-10, 15-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. The proceeds from the life insurance policy are not assessable income as they are a receipt of capital.
Facts
The partners entered into a business succession agreement to ensure both that the business is preserved for the surviving partners and that the estate of the deceased partner receives an amount equivalent to the worth of the partner's equity in the business.
Under the terms of a business succession agreement, each of the partners of a business takes out life insurance policies on their own lives, with the other partners as the beneficiaries of the policies. The agreement provides that on the death of a partner, the remaining partners have the right to acquire the interests in the business of a deceased partner at an agreed market value. Conversely the legal personal representative of the estate of the deceased partner has the right to require the surviving partners to purchase the interest of the deceased partner.
The surviving partners use the proceeds (a lump sum payment) from the life insurance policy to fund the acquisition of the interests in the business of the deceased partner.
Reasons for Decision
The courts have had occasion over the years to examine the meaning of 'a policy of life insurance'. It has been found that life insurance policies exhibit the following characteristics: • the insurer agrees to pay the insured a sum of money when a particular event occurs • the particular event is contingent on the duration of human life, and • in consideration for the payment at a later date the insured pays the insurer a smaller amount or a number of smaller amounts (premiums).
The courts have also examined the nature of the proceeds from life insurance policies. In Marac Life Assurance Ltd v. Commissioner of Taxation [1986] 1 NZLR 694 the Court of Appeal concluded: Nothing in the Income Tax Act 1976 specifically exempts proceeds of life insurance policies from income tax, but it is common ground that traditionally such proceeds have been treated as capital; and this view is supported by In re The Income Tax Acts (1900) 26 VLR 297.
The decision in Marac Life Assurance was applied by the Federal Court of Australia in NM Superannuation Pty. Ltd. v. Young & Anor (1993) 41 FCR 182; (1993) 7 ANZ Insurance Cases 61-163.
Ordinary Income and Statutory Income.
Section 6-5 of the ITAA 1997 provides that the assessable income of Australian residents includes the ordinary income derived directly or indirectly from all sources. Ordinary income includes 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, and • have an element of periodicity, recurrence or regularity.
Although the proceeds from a life insurance policy can be said to be expected and relied upon, this expectation arises from taking out an insurance policy, rather than from a relationship within which personal services are performed. The payment is made in a lump sum so it does not have an element of periodicity, recurrence or regularity. The proceeds from a life insurance policy do not relate to personal services, property or the carrying on of a business.
Therefore, the proceeds are not considered to be income according to ordinary concepts under section 6-5 of the ITAA 1997.
Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income. Payments made under a life insurance policy may come under compensation - insurance or indemnity for loss of assessable income under section 15-30 of the ITAA 1997.
The proceeds from a life insurance policy represent payment of a benefit contingent on the termination of human life. The compensation amount generally bears the character of that which it is designed to replace. The compensation in this particular case is to replace the capital asset and will be regarded as capital receipt.
Section 6-15 of the ITAA 1997 provides that if an amount is not ordinary income and is not statutory income, it is not assessable income.