Sommer and Commissioner of Taxation

[2001] AATA 901

DECISION AND REASONS FOR DECISION [2001] AATA 901

ADMINISTRATIVE APPEALS TRIBUNAL)
  Nº VT2001/72
TAXATION        APPEALS      DIVISION)

Re:         STEVEN JULIUS SOMMER

Applicant

And:       COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal:       Mr B.H. Pascoe, Senior Member

Date:15 August 2001

Place:Melbourne

Decision:The Tribunal affirms the decision under review.

(sgd) B.H. Pascoe
  Senior MemberINCOME TAX — private ruling — professional income replacement insurance policy — disability from sickness — denial of claim for monthly payments — settlement after legal action — whether lump sum settlement assessable income
Taxation Administration Act1953 ss.14ZAI, 14ZAL(1), 14ZAM, 14ZAN, 14ZAQ, 14zva
Income Tax Assessment Act 1997   ss.118-37
CTC Resources NL v Commissioner of Taxation (1994) 48 FCR 397
McLaurin v Federal Commissioner of Taxation (1961) 104 CLR 381
Allsop v Federal Commissioner of Taxation (1965) 113 CLR 341
Commissioner of Taxation v Smith (1981) 147 CLR 578
Reuter v Federal Commissioner of Taxation (1992) 111 ALR 716

REASONS FOR DECISION

15 August 2001  Mr B. H. Pascoe, Senior Member

1. This is an application to review a decision of the respondent which disallowed an objection to a private ruling issued pursuant to Part IVAA of the Taxation Administration Act1953 ("the TA Act").   The applicant had sought a private ruling as to whether an amount of $140,000 received from an insurer was assessable income and whether amendment of prior years returns or deduction in the year of repayment of social security benefits was allowable.   The ruling stated that:

   1.The payment of $140,000 was assessable.

   2.Amendments for prior years returns can be made to exclude any accounts paid back to the Department of Social Security as a result of the payment.

2. At the hearing the applicant, Dr Sommer, was represented by Mr L. Baring, solicitor, and the respondent by Mr T. Murphy, of counsel.   As the application related to a private ruling, the facts were limited to those found by the respondent in his ruling and the hearing was limited to whether the ruling on those facts was correct.

3. The arrangement identified by the respondent was that set out in the application for the ruling, and which stated:

   1.Dr Steven Sommer was, until 1996, as a qualified Medical Practitioner specialising in Stress Management, employed by the Clayton Whole Health Medical Clinic and engaged as a part-time senior Lecturer in this field at Monash University Medical School.   He also practised as a Stress Management Consultant and produced cassette tapes.

   2.He had an annual contract of disability/professional income replacement with Australian Casualty & Life Ltd.   This policy, inter alia, provided that the Insurer would pay to the Insured in the event of the Insured being totally or partially disabled as a result of sickness monthly benefit of $4,000 for the period during which the Insured was totally or partially disabled.

   3.Dr. Sommer apparently fell victim to his own speciality from 1993 onwards until 1996 when he was no longer able to work.   He was diagnosed as suffering from gluten enteropathy with multiple food allergies, malabsorption and intestinal candidiasis.   He developed anxiety type symptoms involving constant panic, serious insomnia and emotional disturbance and ceased work in August 1996 and is still unable to work.

   4.A claim was made on the Insurers, medical reports were forthcoming and on (perhaps automatic) denial of the claim, litigation ensued.

   5.The Statement of Claim was for:

   n1     $96,000 being for the period August 1996 to July 1998 (24 months @ $4000 per month)

   n.2    Interest

   n.3    $4,000 per month from August 1998 until the Insured is able to return to work (an open ended claim for a lump sum to be determined – our words);

   6.Since 1996 Dr. Sommer has existed on the proceeds of the sale of his home, emergency drawings on all of his superannuation entitlements and social security.   At the time of settlement he had exhausted all of his financial reserves with his only remaining significant asset being a $10,000 car.   He is now trying to slowly recuperate and re-establish himself in the work force.   It is as yet unknown whether he will be able to return to his previous professional life or whether his illness will prevent that.

   7.After considerable effort the claim was finally settled on 23 July 1999 (effectively on the Courthouse steps).   The Terms of Settlement (a copy of which is enclosed) contains the consideration as follows "Without admission of liability and in consideration for the cancellation of the policy upon which the Plaintiff's claim is based".

   8.The amount paid was $140,000 plus $10,000 for costs.   The legal fees alone were $6,933.30, and as yet we do not have details of other costs.

   9.Clearly the Insurer was confronted with a claim which could continue ad infinitum (to age 65 years) and would have made the appropriate provision in its accounts.   The long-term uncertainty would have been a major factor in the compromise to settle the claim before formal court proceedings began so as to cancel the policy and limit the ongoing risk.

   10.As a result of receipt of the payment of $140,000 a claim for repayment of monies paid by Department of Social Services has been made on the Taxpayer.   This sum approximates $20,000 and is now being analysed.   [existing emphasis]

The Terms of Settlement were as follows:

1.Without admission of liability and in consideration for the cancellation of the policy of insurance upon which the plaintiff's claim is based the defendant shall pay to the plaintiff the sum of $140,000.

2.Payment of the above amount shall be made within 14 days from the date hereof by cheque payable to the plaintiff and to be given to the plaintiff's solicitor.

3.The policy the subject of the action, being Policy 2159093, is cancelled with immediate effect and the plaintiff shall enjoy no further rights under the policy.

4.The defendant shall pay the plaintiff's costs of the action in the agreed sum of $10,000, payable together with the capital sum.

5.Upon payment of the capital sum and the costs the proceedings shall be dismissed with no order as to costs.   The solicitors for the parties shall execute an order pursuant to order 43 Rule 16 of the Rules of the Supreme Court to give effect hereto.

The respondent obtained a copy of the policy of insurance from the applicant prior to issuing the ruling and had regard to the terms of the policy in formulating that ruling.

1. It was submitted for the applicant that the lump sum payment received on settlement represented an undissected aggregation of both income and capital components and that the entire sum is capital and exempt from being an assessable capital gain under section 118-37 of the Income Tax Assessment Act 1997.   Alternatively, it was argued that the payment represented consideration for the cancellation of the insurance policy and the surrender by the applicant of all further rights under such policy and the payment was, therefore, a capital payment.

2. For the respondent, it was submitted that the payment was in settlement of claims for monthly benefits and interest and there was no evidence in the material before the respondent that there was any capital component.   As such, it was said that the payment was in satisfaction of an entitlement to income and was itself income.   Alternatively, it was submitted that the matter should be remitted to the respondent for reconsideration because he could not have properly made the ruling without further information such as the statement of claim, the defence and other documents filed in legal proceedings and details of the costs incurred by the applicant.

3. It is appropriate to deal firstly with the submission of the respondent that the matter should be remitted. The relevant provisions of Part IVAA of the TA Act state:

   14ZAI     An arrangement to which an application applies may be:

   (a)an arrangement that has been carried out; or

   b)an arrangement that is being carried out; or

   (c)a proposed arrangement.

   . . .

   14ZAL(1) Subject to section 14ZAQ, the Commissioner must comply with an application unless not required to do so because of section 14ZAN.

   (2)The Commissioner may comply with an application even though not required to do so because of section 14ZAN, not being an application to which paragraph 14ZAN (f) or (fa) applies.

   14ZAM    If the Commissioner considers that:

   (a)a private ruling cannot be made without further information; and

   (b)if that information were given, there would be no reason for the Commissioner not to comply with the application for the ruling;

   the Commissioner must request the applicant to give that information to the Commissioner.

   14ZAN     The Commissioner is not required to comply with an application for a private ruling if:

   . . .

   (i)in the opinion of the Commissioner, the applicant has not given sufficient information, in spite of a request under section 14ZAM, to enable the ruling to be made; or

   . . .

   14ZAQ    If the Commissioner considers that the correctness of a private ruling would depend on which assumptions were made about a future event or other matter, the Commissioner may:

   (a)decline to make the ruling; or

   (b)make such of the assumptions as the Commissioner considers to be most appropriate.

In CTC Resources NL v Commissioner of Taxation (1994) 48 FCR 347

. . .
An "assumption" in s 14ZAQ would not ordinarily be a fact or matter which, if given the Commissioner by the applicant, would assist the Commissioner to comply with the application for a private ruling.
. . . the Commissioner should not make assumptions as to information which the applicant might be given the opportunity to provide under s 14 ZAM.   . . .  

1. In this matter the request for ruling was made in relation to a set of facts which had occurred.   There was no need for any assumptions to be made about a future event and none were made.   While there may have been more detail available from the full statements of claim and defence or other documents filed in relation to the legal proceedings, the facts on which the applicant sought a ruling were, in my view, adequately set out in the application.   It is accepted that the precise amount of costs incurred relative to the receipt of $10,000 as costs on settlement was not provided but this should not have caused difficulty in ruling on the law applying to such receipt and payment in relation to costs.   As a consequence it is not appropriate to remit the matter to the respondent.

2. The applicant's submission that benefits payable under the policy were a mixture of income and capital sums referred to rehabilitation expenses, hospitalisation expenses, death benefit and benefit for specific accidents.   It is difficult to regard any of these benefits as being of a capital nature.   The policy was described as "Professional Income Replacement" and, primarily, provided for a monthly sum in the event of disability from injury or sickness.   While the benefits referred to were in addition to such monthly sums, the hospitalisation benefit was to be one-thirtieth of the monthly sum for each day in hospital, the death benefit was a continuation of the monthly sum for a further 3 months after death and the benefit for dismemberment or fractures of limbs, etc, was a specific period of monthly sums ranging from 1½ months to 24 months.   The rehabilitation benefit was the expenses of an approved rehabilitation programme after three consecutive months of total disability benefits.   None of these benefits appear to have the attributes of capital and none were said to be included in any claim made by the applicant on the insurer.

3. It is clear that an undissected lump sum containing both income and capital components without any apportionment between the two components is of a capital nature (McLaurin v Federal Commissioner of Taxation (1961) 104 CLR 381, Allsop v Federal Commissioner of Taxation (1965) 113 CLR 341). It is equally clear that payments of monthly sums under the relevant policy, if received by the applicant, would have constituted assessable income (Commissioner of Taxation v Smith (1980-1981) 147 CLR 578). Further, where a taxpayer is paid a lump sum amount in satisfaction of a right to income (whether past or in the future), that amount is itself income.

4. The alternative argument for the applicant was that the lump sum settlement was capital in that it was at least, in part, consideration for the termination of the policy and ongoing right of the applicant to future benefits.   The policy was described in the application for the ruling as "an annual contract of disability/professional income replacement".   It is clear from Part 2 of the policy documentation that the policy was an annual policy renewable for successive annual periods upon the payment in advance of a renewal premium.   Consequently, any continuation of the policy beyond each anniversary date was conditional upon the payment of a further annual premium.   It is a question, therefore, as to whether it can be said that the policyholder had significant long-term rights.   There was no evidence of age of Dr Sommer which may be a relevant factor given that the policy would clearly terminate on the renewal date following the insured's 65th birthday.

5. Mr Baring argued that, in the absence of sham, the character of the receipt of the payment is to be determined prima facie by the character of the consideration identified in the agreement and that the settlement agreement had identified that the sum paid was ". . . in consideration for the cancellation of the policy insurance".   He acknowledged, however, that Hill J had said in Reuter v Federal Commissioner of Taxation (1992) 111 ALR 716, at p.729, that:

   . . . the court was not bound to restrict itself to the deed pursuant to which the amount in question was paid in characterising whether the payment itself was income.   Rather, the court was entitled to look at the whole of the circumstances pursuant to which the amount was paid.  

It would seem that this is such a case where it is appropriate to consider the whole of the circumstances leading to the payment of the settlement sum.   Prior to the date of the settlement and subsequent receipt of the lump sum, Dr Sommer was claiming some three years of monthly payments of $4000 per month.   On the information set out in the application for ruling this total amount to July 1999 would have been $144,000 (36 months at $4000 from August 1996).   It appears that the sum paid on settlement was very close, if not precisely, the entitlement under the policy to the date of settlement.   Given it was a contested matter between Dr Sommer and the insurance company, it is not unreasonable to regard the amount paid as being in consideration of all entitlements to monthly payments up to the date of settlement in consideration of no further claims being made thereafter.

1. On balance I am of the opinion that the lump sum of $140,000 was paid in settlement of a right to income and the respondent was correct in his ruling that, on the facts given to him, the $140,000 is assessable income.   No objection was taken to the second part of the ruling relating to refunds of social security payments and it is unnecessary for me to deal with that part of the ruling.

2. While having no difficulty in maintaining the view that the respondent was able to make a ruling on the information provided by the applicant and it is inappropriate to remit the matter to the respondent, there is inevitable concern when the Tribunal is required to review a decision on an objection to a private ruling. This concern arises from section 14ZVA of the TA Act which provides that, if there has been an objection to a private ruling, the right of objection against an assessment relating to a matter ruled is limited to a right to object on grounds that neither were, nor could have been, grounds for the taxation objection against the ruling. Given that any ruling is based on the terms of an arrangement identified by the Commissioner in his ruling, it is clearly possible that additional facts not included in the identified arrangements could lead to a different view of the taxation result. It would appear much more satisfactory and enable a complete examination of all of the facts if a taxpayer awaits the relevant assessment, which gives effect to the ruling before objecting. While not necessarily suggesting any different result in this matter, there is an inevitable lingering concern that all relevant facts are not able to be examined when dealing with an objection to a private ruling.

3. In this case, the decision under review should be affirmed.

   I certify that the fourteen [14] preceding paragraphs are a true copy of the reasons for the decision herein of
   Mr B.H. Pascoe, Senior Member

   (sgd)       Catherine Thomas
                 Clerk

   Date of Hearing:  21.05.01
   Date of Decision:  15.08.01
   Solicitor for the Applicant:           Mr L. Baring, Maddock Lonie & Chisholm
   Counsel for the Respondent:       Mr T. Murphy

   Solicitor for the Respondent:       Mr D. Babovic, Advocate with Australian Taxation Office