Edited version of private ruling

Authorisation Number: 1011581249722

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Assessability of compensation payment for personal injury

1. Is the lump sum payment received from an Insurance Commission for personal injuries arising out of a motor vehicle accident included in your assessable income?

No.

2. Is the lump sum payment an assessable capital gain?

No.

This ruling applies for the following period:

30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You made a personal injury claim due to a motor vehicle accident.

You received lump sum compensation for damages for bodily injuries.

In consideration of payment of the settlement money, you released the parties from any other claim for bodily injury that arises out of the motor vehicle accident.

Before the accident, you worked as a caretaker.

Due to the accident, you were unable to continue to work as caretaker.

Working as a car taker enabled you to get exemption from paying maintenance fee that other residents paid.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Paragraph 118-37(1)(b) of the Income Tax Assessment Act 1997

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).  

Ordinary income has generally been held to include three categories of receipts, namely receipts from rendering personal services, receipts from property and receipts from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: 

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.  

The assessability of a compensation payment depends upon a consideration of all the circumstances surrounding it. It is the character of the receipt in the hands of the recipient that must be determined. In determining the character of a receipt, what most often has to be decided is whether it has the character of an income or capital receipt. In the case of a lump sum payment, this distinction will arise from a consideration of whether the receipt is to replace lost income or is for the loss or impairment of income earning capacity. The former will result in income, the latter capital. 

There are many cases which explain the distinction between payments of a capital nature (that is, for a loss or impairment of income-earning ability) and payments of an income nature (that is, for loss of income). Those referred to here all pre date the introduction of capital gains tax. 

In Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411 and Federal Commissioner of Taxation v. Smith (1981) 147 CLR 578; (1981) 81 ATC 4114; (1981) 11 ATR 538 it was established that payments made in substitution for lost income which could otherwise have been earned were assessable as ordinary income. Concerning compensation for economic loss, the question that needs to be considered is whether the payment is a substitution for lost or foregone income, or, whether it is compensation for something else.  

The amount you received was compensation for personal injuries. Gibbs J of the Supreme Court of Queensland in Groves v. United Pacific Transport Pty Ltd Qd. R. 62 at 65 held that personal injuries compensation was really awarded for the impairment of the plaintiffs earning capacity that has resulted from his injuries. 

This view was supported by Barwick CJ of the High Court in Atlas Tiles Ltd v. Briers (1978) 144 CLR 202 where His Honour held that earning capacity was a capital asset. The fact that the loss was measured by a consideration of the actual earnings foregone was merely an exercise in the valuation of the loss and did not change its capital character.  

The distinction between payments of a capital nature and a payment of an income nature was also considered in Cullen v. Trappell (1980) 145 CLR 1, where Barwick CJ said:

In the first place, the replacement of the capacity to earn money by damages was, by the very statement of the problem, not an exercise in replacing the wages which were currently being earned or which might be expected to be earned by the injured person. The problem is to value the capital asset of the injured person, namely, his capacity to earn money.

The Full Federal Court concluded in FC of T v. Slaven 84 ATC 4077; (1983) 15 ATR 242 (Slaven's case) that, whether a receipt constitutes income or capital depends upon a consideration of all the circumstances. It is the character of the receipt in the hands of the taxpayer as a recipient that must be determined. The Court held in Slaven's case that the payments were made to compensate the taxpayer for the loss of a capital asset (her earning capacity) and that consequently the payments were capital receipts in her hands and were not assessable income. 

Taxation Ruling IT 2193 provides the Commissioner's current opinion on compensation payments for the loss of earning capacity following from a motor vehicle accident. The ruling makes it clear that compensation for loss of earning capacity will not lose its character as a capital receipt simply because the amount of compensation is calculated by reference to the amount of income the taxpayer would have earned. The loss is of earning capacity, not of income itself.  

In your situation, you have received an amount for general damages following bodily injuries suffered in a motor vehicle accident, which led to you having to ultimately resign from working as a caretaker. The payments you received were not for lost income, rather they were for damages as a result your injuries.

Consequently, your payment is not assessable under section 6-5 of the ITAA 1997.

In addition, your compensation payment was awarded in respect of general damages which are considered to be capital in nature.

Therefore, the lump sum compensation payment that you received from the Insurance Commission does not need to be included in your assessable income under section 6-5 of the ITAA 1997.

Capital gains tax (CGT)

Taxation Ruling TR 95/35 indicates that settlement of a personal injuries claim represents the disposal of an asset, as you have disposed of the right to seek compensation for the losses arising from the injury suffered.

Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by you of the right to seek compensation.

As the amount you are to receive is not in respect of any underlying asset, the whole of the settlement amount is treated as capital proceeds from a CGT event (CGT event C2) happening to your right to seek compensation.

However, paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any 'wrong, injury or illness you ... suffer personally'.

Accordingly, the compensation you are to receive for personal injury will not be an assessable capital gain.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).