Taxation Assignment

Question 1

1.1

Issue

Determine if the disability benefit paid by the insurer to the bank is assessable income to your client. Your answer should reference all applicable sections of the Income Tax Assessment Act 1936 and/or the Income Tax Assessment Act 1997, related cases and/or rulings or other relevant materials from the Australian Taxation Office.

Facts

-Client #1 is a resident of Australia for income tax purpose;

-client has a mortgage protection insurance policy with Mortgage Insurance Australia;

-A housing loan values $5000,000 in relation to the mortgage protection insurance policy;

-Client #1 suffers a heart attack and is unable to perform their usual occupation for a period of seven months due to illness;

-In accordance with the term of the mortgage protection policy, the insurance company pays client #1’s bank the monthly disability benefits as set out the policy;

-The payment to the bank from the insurance company is $30,000.

Relevant law
Section 6.5 of the Income Tax Assessment Act 1997 (the ITAA 1997) states that the assessable income includes income according to ordinary, which is called ordinary income.

Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519; 77 ATC 4255 is an authority for the proposition that for a receipt to be income, it must either:

• have the characteristics of ordinary income such as regular or periodic receipt;
• have a nexus with an earning source (property, business and personal exertion);
• be received as compensation for or in substitution for what clearly would have been an income amount.

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.

Section 118-37(1)(a) of the ITAA 1997 provides that a capital gain or capital loss you make from a CGT event relating directly to compensation or damages is disregarded if:

• any wrong or injury you suffer in your occupation; or
• any wrong, injury or illness you or your relative suffers personally;

Application of Law

• The disability benefit paid by the insurer to the bank is not ordinary income under section 6.5 of the ITAA 1997

• Evidenced by that the payments client #1 received under the insurance policy is a one-off insurance compensation rather than a regular and periodic receipt;
• The payments do not involve any personal exertion (the payments have no nexus with an client providing services);
• the payments paid by the insurer is not ordinary income.

• Section 118-37(1)(a) applies.

• The disability benefit received is more like a capital receipt in this case. The payment relates to personal circumstances that have arisen during the client’s life. Since the client #1 suffers a heart attack and is unable to perform the usual occupation, the insurer paid the $30,000 to fulfill the taxpayer’s repayments. The insurance company paid client #1 the monthly disability benefit as set out in the policy as a compensation for loss of physical abilities. The compensation or damages payments relating to the taxpayer personally will be exempt from capital gains tax implication under section 118-37(1)(b) of the ITAA 1997, which means the disability benefit is non-CGT gains.

Conclusion

The $30,000 insurance payment paid by the insurer is not assessable income in this case because failed all the requirements to be assessable income; furthermore the payment is considered to be an exempt capital gain under section 118-37 of the ITAA 1997.

1.2

Issue

Determine if the lump sum paid by the insurer to your client is assessable income under the ITAA 1936 and/or the ITAA 9197 or relevant cases and rulings.

Facts

• Taxpayer has an income protection policy;
• Insurance company will pay a lump sum to the taxpayer when they are diagnosed with a terminal illness or suffer one of a number of listed trauma events; having a heart attack is one of the listed trauma events;
• The insurance company pays a lump sum $150,000 to the taxpayer in February 2017 which is equal to 12 months of a predetermined monthly benefit and be paid once only.

Relevant law

Section 6.5 of the ITAA 1997 states that the assessable income includes income according to ordinary, which is called ordinary income.

Section 102.5 of the ITAA 1997 states that the assessable income includes the net capital gain for the income year.

Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling provides that an insured's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation.

Section 118-37(1)(a) of the ITAA 1997 provides that a capital gain or capital loss you make from a CGT event relating directly to compensation or damages is disregarded if:

• any wrong or injury you suffer in your occupation; or

-        any wrong, injury or illness you or your relative suffers personally;

Section 6.15(1) of the ITAA 1997 states that if an amount is not ordinary income, and is not statutory income, it is not assessable income (so taxpayers do not have to pay income tax on it).

Application of laws

• The lump-sum paid by the insurer to the client is not ordinary income under section 6.5 of the ITAA 1997

• The lump sum payments is not earned by the client as it does not directly relate to personal exertion; the lump sum relates to the client’s personal circumstances that have arisen during the client’s life;
• The payment is a one-off payment which does not have an element of regularity or periodic receipt;
• The expected payment arises from the investment in insurance rather than from a relationship with personal services performed;
• Thus, the lump sum income is not considered ordinary income.

• TR 95/35 applies in this case

• the whole of the payment amount ($150,000) can be treated as capital proceeds from a capital gains tax event happening to the taxpayer’s right to seek compensation.

• However, Sub-section 118-37(1)(a) of the ITAA 1997 also applies in this case if the client is diagnosed with a terminal illness or suffer one of a number of listed trauma event. The lump sum is equal to 12 months of a predetermined monthly benefit. Therefore, any gain made from the CGT event happening to the taxpayer’s right to seek compensation is disregarded. Thus, it is not statutory income as well.
• Subsection 6.15(1) of the ITAA 1997 applies

• Since the $150,000 is not ordinary or statutory income, it is not assessable income.

Conclusion

No part of the $150,000 received is included in the client #1’s assessable income.

References

ITAA 6.5

ITAA 6.10

ITAA 6.15(1)

ITAA 118-37(1)(a)

Related Rulings and Readings

Taxation Ruling TR 95/35

Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519; 77 ATC 4255