Issue
Are payments received by an Australian resident under an income protection policy, to replace salary and wages income that was exempt under subsection 23AF(1) of the Income Tax Assessment Act 1936 (ITAA 1936), assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. Payments received by an Australian resident under an income protection policy to replace salary and wages income that was exempt under subsection 23AF(1) of the ITAA 1936, are not assessable under subsection 6-5(2) of the ITAA 1997.
Facts
The taxpayer is a resident of Australia for income tax purposes.
The taxpayer worked on an 'approved project' as defined in subsection 23AF(18) of the ITAA 1936 for a period of not less than 91 days. The approved project was located in China.
As an employee of an eligible contractor for the purposes of section 23AF of the ITAA 1936, the taxpayer received salary and wages income that was directly attributable to the taxpayer's personal services in connection with the approved project.
Due to ill-health directly related to the conditions he worked under in China, the taxpayer returned to Australia.
The taxpayer received monthly payments under an income protection insurance policy for a period of two years, which was the remainder of the life of the approved project.
The income the taxpayer received from the income protection policy was paid as part of an insurance policy that was independently taken out by the taxpayer. The income was paid by the insurance company and not by the employer and did not relate to eligible leave accrued while the taxpayer was working on the approved project.
The income protection policy only covered the period during which the taxpayer would have worked on the approved project.
Reasons for Decision
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.
Payments of salary and wages are income according to ordinary concepts for the purposes of subsection 6-5(2) of the ITAA 1997.
Subsection 6-15(2) of the ITAA 1997 provides that if an amount is exempt income it is not included in assessable income. Section 11-15 of the ITAA 1997 lists those provisions dealing with income which may be exempt. Included in this list is section 23AF of the ITAA 1936 which deals with income from an approved overseas project.
Subsection 23AF(1) of the ITAA 1936 provides that where an individual taxpayer has been engaged on 'qualifying service' on a particular approved project for a continuous period of not less than 91 days, any 'eligible foreign remuneration' derived by the person that is attributable to that qualifying service will be exempt from tax in Australia.
In the present case, the taxpayer has been engaged on 'qualifying service' because the requirements of paragraph 23AF(3)(a) of the ITAA 1936 are satisfied. That is, the person was outside Australia (in this case, China) and was engaged in the performance of personal services in connection with the approved project. This was for a continuous period of not less than 91 days, as required by subsection 23AF(1) of the ITAA 1936.
According to the definition under subsection 23AF(18), 'eligible foreign remuneration' includes salary and wages income derived by a resident individual in his or her capacity as an employee of an eligible contactor that is directly attributable to qualifying service by the person on the approved project. This includes any payments received in lieu of eligible leave that accrued in respect of a period during which the person was engaged on qualifying service on the project. The salary and wages income received by the taxpayer from the eligible contractor in the present case is therefore exempt under subsection 23AF(1) of the ITAA 1936.
The income the taxpayer received from the income protection policy, on the other hand, was paid as part of an insurance policy that was independently taken out by the taxpayer to ensure that quality of life did not deteriorate in the event that the taxpayer was unable to work. These payments did not relate to eligible leave accrued while the taxpayer was working on the project.
Nor is the income salary, wages, or any form of income listed within the subsection 23AF(18) definition. Therefore, the income received as part of the income protection insurance policy is prima facie not exempt under subsection 23AF(1) of the ITAA 1936.
In Commissioner of Taxation v Dixon (1952) 86 CLR 540; (1952) 10 ATD 82; (1952) 5 AITR 443 ( Dixon ), the taxpayer received regular voluntary payments from his former employer to make up the level of his wartime pay to the amount the taxpayer would have received had he not enlisted in the war. The High Court held that the payments were a substitute for income and therefore of the same nature as the income it replaced. Dixon is authority for the principle that an amount paid to compensate for loss generally acquires the character of that for which it is substituted. As stated by Fullagar J in Dixon : What is paid [in the facts of Dixon] is not salary or remuneration [which is ordinarily assessable income], and it is not paid in respect of or in relation to any employment of the recipient. But it is intended to be, and is in fact, a substitute for - the equivalent pro tanto of - the salary or wages which would have been earned and paid if the enlistment had not taken place. As such, it must be income ... It acquires the character of that for which it is substituted and that to which it is added.
Therefore, if payments are made to a taxpayer to replace or substitute income that is ordinarily assessable, those payments are included in the taxpayer's assessable income.
Likewise, if the payments are made to a taxpayer to replace or substitute income that is ordinarily exempt income, those payments are also exempt from tax.
The facts in the present case can be distinguished from the facts of Dixon on the basis that, unlike the present case, the source of income in Dixon does not change. In Dixon , the employer was the source of both the original salary and wages income and the income that substituted the salary and wages income. In the present case, the employer is the source of only the salary and wages income that is exempt under section 23AF of the ITAA 1936. The source of the payments under the income protection policy is the insurance company.
A proper application of the substitution of income principle established by Dixon, however, requires that the substituted amount takes on all aspects of the character of the original amount that the substituted income is intended to replace. That is, all features of the original amount must be transposed to the substituted amount.
Accordingly, the income protection policy receipts then become properly substituted so that the requirements of section 23AF of the ITAA 1936 are maintained as follows: • The income protection policy payments obtain the character of the original salary and wages, which is included within the definition of 'eligible foreign remuneration' under subsection 23AF(18) of the ITAA 1936; and • The income protection policy payments obtain the source of the original payments. That is, the income is derived by the taxpayer as an employee of an eligible contractor that is directly attributable to qualifying service by the taxpayer on an approved project as required by the definition of 'eligible foreign remuneration' under subsection 23AF(18) of the ITAA 1936.
The payments received as part of the income protection policy are therefore also exempt under subsection 23AF(1) of the ITAA 1936, because they acquire the exempt character of the salary and wages income they are designed to replace.