Court rules damages are not income

by Stanley Drummond, partner Thomson Geer*

The NSW Supreme Court has found an income protection policy's offset clause did not entitle the insurer to reduce the claimant's monthly income benefits by an amount she had received in settlement of work injury damages claim against her employer.

Justice White found the settlement amount was not a form of income. Nor was it "other disability income" within the meaning of that term in the policy.

Susan Buswell was a member of the NSW Police Force from 1989 until 2014, when she was medically discharged. In 2013 she had ceased performing duties as a police officer.

Ms Buswell brought a claim for work injury damages for psychological damages against the NSW Police Force under the Workplace Injury Management and Workers Compensation Act 1998 (NSW) .

In 2017 the claim was settled. Ms Buswell, her employer and its insurer entered into a settlement deed. The deed provided that, without admission of liability, the claim would be settled on the basis the insurer would pay $350,000 including costs and clear of workers' compensation payments in full and final satisfaction of the claim.

The sum of $350,000 was in addition to all payments made to Ms Buswell under the Workers Compensation Act 1987 (NSW). She received $300,000 after deduction of costs of $50,000.

As a member of the NSW Police Force, Ms Buswell was a member of a superannuation scheme.

In 2012, the scheme trustee had taken out an income protection policy which included an offset clause. It provided for monthly benefits to be reduced if an insured received "any other disability income".

In 2014, the insurer accepted Ms Buswell's claim for income protection benefits.

In 2017, the insurer became aware of the settlement of her claim for work injury damages. The insurer said the settlement amount was other disability income, invoked the offset clause, and reduced the monthly benefit by $5,000.

Ms Buswell launched proceedings against the insurer. The trustee was not a party.

The court found the offset clause did not operate to reduce the amount of Ms Buswell's monthly income protection benefit.

The insurer did not dispute that, for taxation purposes, the settlement amount would be treated as capital, not income. Nor did it dispute that common law damages were not "benefits".

Rather, the insurer argued the definition used the word "income" in a wide sense and extended to any benefits received by the insured, whether or not those benefits would be classified as income for the purposes of income tax law.

The insurer also argued the settlement amount could fairly be seen as income derived through a benefit under the workers' compensation scheme because that scheme was the source of the right to sue for modified common law damages which was released under the settlement deed.

The insurer also argued the definition of "other disability income" in the policy contemplated it could be a lump sum.

The court described Ms Buswell's submissions as "straightforward". A damages award for personal injury is not income, but capital and therefore could not be said to be income for the purposes of the definition of other disability income.

Damages are awarded not for the loss of income as such, but for the loss of earning capacity which creates financial loss. Earning capacity is a capital asset. An award of damages is not taxable because it does not fall within the ordinary concept of income.

Ms Buswell said the payment for her damages claim was not a benefit under a workers' compensation scheme or under workers' compensation legislation.

Although the Workers Compensation Act modified the damages that can be awarded for an injury caused by the negligence or other tort of a worker's employer and the Workplace Injury Management and Workers Compensation Act 1998 (NSW) regulated the steps to be taken in bringing a claim for work injury damages, neither Act provides the source of the right to bring the claim for damages.

The claim is brought under the common law.

The court rejected the insurer's submissions. Justice White said: "… according to ordinary concepts the receipt of damages for personal injury, or a settlement sum in compromise of a claim for damages for personal injury, is capital and not income. The reason that income tax is not payable on the settlement sum is not because of any special provision peculiar to taxation law, but because it is not income according to ordinary concepts."

The court concluded that the amount received in settlement of Ms Buswell's claim for work injury damages was not income. Nor was it a benefit under workers' compensation legislation. Nor was it any other income. It therefore did not fall within the definition of other disability income and the offset clause did not operate to reduce the amount of Ms Buswell's monthly income protection benefit.

Income protection insurance (also called salary continuance insurance) provides protection against loss of income. The insured person's pre-disability income stream is replaced by a stream of payments under the policy, up to a percentage limit (typically 75%) of the insured's pre-disability income which is set by the policy. The purpose of the percentage limit on benefits is to ensure the insured retains an incentive to return to work.

An income protection benefit is "income according to ordinary concepts" and therefore "assessable income" for tax purposes, irrespective of whether the policy is held by a superannuation trustee or is held outside superannuation.

Income protection insurance is contrasted with total and permanent disablement (TPD) insurance. Usually, ie where the insured person is working, TPD provides protection against loss of earning capacity. The benefit is paid as a lump sum (although some policies provide for the benefit to be split into two or more instalments). A TPD benefit paid outside superannuation is not assessable income for tax purposes.

Although the cover provided by an insurance policy always depends on the particular words used and the potential application of certain sections of the Insurance Contracts Act, ordinarily one would not expect the benefits provided by an income protection policy to be reduced by reference to benefits received by the insured person for loss of earning capacity, as opposed to loss of income. To achieve this result (if this result is intended), clear words must be used.

Buswell v TAL Life Ltd [2018] NSWSC 1507

*Stanley Drummond is Adjunct Head of Superannuation & Wealth Management at Thomson Geer.