Federal Court dismisses appeal in tax dispute over settlement payment
The court has upheld an earlier AAT decision, ruling that a $1 million settlement payment made by an insurer to a doctor was assessable income.
A taxpayer has lost an appeal against a decision by the Administrative Appeals Tribunal which found that a settlement payment was assessable income as the settlement amount represented the commutation of the taxpayer's income protection benefit into a lump sum payment.
The decision handed down last week, Sladden v Commissioner of Taxation [2024] FCAFC 122, involved a $1 million insurance settlement sum that was received by the taxpayer, Dr Sladden, under a deed of release between her and her insurer, AMP Life Ltd.
In an income tax assessment for the year ended 30 June 2020, the ATO included the settlement sum of $1,000,000 in Dr Sladden's assessable income as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (Cth) (1997 Act). Dr Sladden objected to the income tax assessment.
After the Commissioner of Taxation disallowed Dr Sladden's objection to the assessment, she then applied to the Tribunal for a review of the Commissioner's decision.
In November 2023, the Tribunal upheld the Commissioner's decision, concluding that the settlement sum of $1,000,000 was paid to Dr Sladden to commute or settle her claim under an income protection plan and was income in nature.
Dr Sladden first entered into two linked policies with National Mutual Life Association of Australasia Limited in April 1999 which included a life protection plan and a professional income protection plan.
The Policy provided the following cover:
(a) A Life Protection Plan:
(i) With a commencement date of 13 April 1999;
(ii) With an expiry date of 3 April 2068; and
(iii) For a sum insured payable on death or trauma which sum diminished over time and was $27,471.96 when the deed of release was entered into.
(b) A Professional Income Protection Plan:
(i) with a commencement date of 13 April 1999;
(ii) with an expiry date of 3 April 2038;
(iii) for a sum insured which varied over time and was $2,979.21 per month when the deed of release was entered into; and
(iv) for a benefit period to age 65 for injury or sickness.
In February 2013, the Dr Sladden was diagnosed with cancer.
In March 2013, she made a claim for an income protection benefit under the Income Protection Plan, following which she received monthly benefits under the Income Protection Plan.
The life insurance business of National Mutual, which was at that stage owned by the Axa Group was transferred to AMP in January 2017.
Dr Sladden sought a possible commutation of her income protection insurance benefit. AMP was willing to offer $1,000,000 in full and final settlement of her claim, with the policy to be surrendered. She accepted the offer of $1,000,000 in July 2019.
Before the Tribunal, it was agreed that the monthly benefits that Dr Sladden was receiving under the Income Protection Plan were assessable income.
However, Dr Sladden contended that the settlement sum was not assessable as ordinary income because it was an undissected lump sum comprising capital and income and, as such, it was all on capital account.
The Tribunal rejected Dr Sladden’s submission that the nature of the consideration for which the settlement sum was to be paid was to be determined entirely by the terms of the deed of release.
The Tribunal stated that the terms of the deed were not determinative of the issue.
"Instead regard may be had to the facts and circumstances that led to the deed being executed, notwithstanding the deed is not a sham, so as to determine the true nature of the settlement sum including whether it was income according to ordinary concepts," it said.
The Tribunal noted that when Dr Sladden expressed her willingness to accept AMP’s offer of $1,000,000, both Dr Sladden and AMP considered, and had communicated, that what became the settlement sum represented what AMP would pay for the commutation or settlement of Dr Sladden’s income protection benefits.
It was only when the draft deed of release was drawn up and Dr Sladden sought taxation advice, that any consideration was given to the life cover or other matters, it said.
The Tribunal said that although Dr Sladden agreed under the deed of release to surrender the life cover, and release AMP from any claims she may at any time have or have had against it, the settlement sum remained $1,000,000.
While Dr Sladden engaged an actuary to value the income protection benefits for the purpose of gauging AMP’s offer of $1,000,000, she did not take any similar steps to value the life cover before entering into the deed of release.
The latter had only occurred when Dr Sladden engaged an actuary for the purpose of providing a report in the proceeding before the Tribunal, the AAT said.
The Tribunal stated that there was “an air of unreality and artificiality” about Dr Sladden’s contention that there was a capital element involved in the settlement sum.
Instead, the Tribunal found that the reality was that Dr Sladden and AMP negotiated and resolved to commute her entitlements in respect of the income protection claim in consideration of payment of the settlement sum.
"No other claim or entitlement was considered by either party in reaching agreement on the amount AMP was to pay," the Tribunal said in its decision.
The Tribunal found that the lump sum received by way of settlement in this case was not “incapable of dissection between income and capital” because the settlement sum was only in respect of commutation of Dr Sladden’s monthly benefits payable under the Income Protection Plan.
In conclusion, the Tribunal found that, on the totality of the evidence, it was not satisfied that the settlement sum related to claims, entitlements or benefits of a mixed income and capital nature and that Dr Sladden assented to acceptance of the settlement sum of $1,000,000 to commute or settle her claim under the Income Protection Plan. The Tribunal therefore affirmed the objection decision.
In the appeal decision handed down last week, the Federal Court rejected the submission made on behalf of Dr Sladden that the Tribunal erred in law by not confining itself to the deed of release or in having regard to the parties’ subjective state of mind.
"Dr Sladden has not demonstrated that the Tribunal made an error of law in characterising the settlement sum as having been paid to Dr Sladden to commute or settle her claim under an Income Protection Plan and as income in nature," said Justice Hespe.
