Assessability of a lump sum payment received under a mortgage protection policy

Is a lump sum payment received by a taxpayer under the terms of a mortgage protection policy, to be included in assessable income as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or as statutory income under section 6-10 of the ITAA 1997?

No. A lump sum payment received by the taxpayer under the terms of a mortgage protection policy is not assessable as either ordinary income under section 6-5 of the ITAA 1997 or statutory income under section 6-10 of the ITAA 1997.

The taxpayer has a mortgage protection policy.

The taxpayer suffers a total permanent disablement.

In accordance with the terms of the mortgage protection policy, the insurance company pays the taxpayer a lump sum amount in respect of the taxpayer's claim against the mortgage protection policy.

The taxpayer accepts the lump sum payment in full settlement of their claim and agrees to discharge the insurance provider of all liability under the mortgage protection policy in respect of their total and permanent disablement.

Subsection 6-5(2) of the 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.

Based on case law, it can be said that ordinary income generally includes receipts that: • are earned • are expected • are relied upon, and • have an element of periodicity, recurrence or regularity.

Characteristics of a capital receipt include: • being paid in a lump sum, that is, not received periodically • being a one-off payment, that is a payment made once and for all, and • being expected but not relied upon.

The lump sum payment is not earned by the taxpayer as it does not directly relate to services performed. Rather the lump sum relates to personal circumstances that have arisen during the taxpayer's life. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the terms of the insurance policy. As such, the lump sum payment is not considered to be ordinary income and is therefore not assessable under subsection 6-5(2) 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 and are also included in assessable income. Statutory provisions about certain types of insurance receipts and capital gains may apply to the payment received.

Section 15-30 of the ITAA 1997 includes in assessable income amounts received by way of insurance or indemnity for the loss of an amount if: • the lost amount would have been included in the taxpayer's assessable income, and • the amount received is not assessable under section 6-5 of the ITAA 1997.

The lump sum amount is paid to the taxpayer in satisfaction of the surrendering of their capital rights. The taxpayer does not receive the lump sum in respect of income which has been lost. Therefore, section 15-30 of the ITAA 1997 does not apply to the lump sum amount paid to the taxpayer.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts indicates that settlement of a personal injuries claim represents the disposal of an asset, as the taxpayer has disposed of the right to seek compensation for losses arising from the injury suffered.

The disposal of an asset gives rise to a CGT event.

However, subparagraph 118-37(1)(a)(ii) of the ITAA 1997 entitles a taxpayer to disregard any capital gain or loss made from a capital gains tax event relating directly to compensation or damages received for any injury, illness or wrong the taxpayer suffers personally.

Taxation Ruling TR 95/35 refers to using the 'look-through' approach to determine the most relevant source of a compensation payment.

Using this approach, the taxpayer's personal injury or illness can reasonably be regarded as the real source of the lump sum payment. Subparagraph 118-37(1)(a)(ii) of the ITAA 1997 will apply to the lump sum amount so that any capital gain or capital loss that the taxpayer makes will be disregarded. Therefore, any capital gain resulting from the payment will not be assessable as statutory income.

Accordingly, the lump sum payment is not included in assessable income as it is neither ordinary income nor statutory income (subsection 6-15(1) of the ITAA 1997).

Date of amendment Part Comment 26 February 2016 Reasons for Decision Updated wording for clarity. Updated legislative reference. Removed reference to ATO ID 2002/244 (withdrawn).

Date of amendment | Part | Comment

26 February 2016 | Reasons for Decision | Updated wording for clarity. Updated legislative reference. Removed reference to ATO ID 2002/244 (withdrawn).