Edited version of private ruling

Authorisation Number: 1011594828971

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Ruling

Subject: Lump sum amount and capital gains

Questions and Answers:

Is the lump sum amount you received assessable as ordinary income?

No

Can you disregard any capital gain or loss that has resulted from the payment that you received?

No

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You had legal fees insurance.

You were paid a sum of money in compensation for legal expenses you incurred in seeking compensation from a previous claim.

You declared the amount in your tax return.

You have had lengthy discussions and correspondences with your legal insurer over the last ten years.

You were paid you a further sum of money. This amount was paid in a lump sum, no tax was withheld and it was paid by cheque.

Details of the payment were provided:

The details from the email are as follows:

An offer of settlement for a sum of money.

This amount was based on what your legal insurer believed they would be liable to pay you under your legal insurance cover if you were able to prove (via legal advice) that you have a good case and thereby become entitled to payment for legal representation.

The insurer advised they are not legally obliged under the policy to make the payment to you but offer it to close your file.

The offer had an expiry date.

The offer is full and final settlement of any claim, which you have against your insurer.

If you accept the offer your file would be finalised once payment was made.

You accepted the payment which was paid as a favour or goodwill gesture from your insurer and not because of legal obligation.

The payment was paid to you to close your file and help fund potential future claims.

The payment is a one off payment.

You consider that the payment is regarded as a client-orientated gift

The payment was not for expenses incurred but to finalise procrastinated correspondences.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1936 Section 160M(7)

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).

Based on case law, it can be said that ordinary income generally includes receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity

In your situation, the payment that you received was to finalise and close your file with your insurer and to fund your potential future claim. The payment was not earned by you as it does not relate to services performed. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. Accordingly, the payment is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

Statutory income

Section 6-10 of the ITAA 1997 provides that some amounts which are not ordinary income may be included in assessable income by another provision. These amounts are called statutory income. A lump sum payment may be capital in nature. Capital gains are included in assessable income by section 102-5 of the ITAA 1997 as statutory income. You make a capital gain or capital loss if a CGT event happens. Many CGT events involve a CGT asset, some relate directly to capital receipts.

Capital gains

You make a capital gain when a capital gains tax (CGT) event occurs and the capital proceeds from the disposal of the CGT asset are more than the cost base of the CGT asset.

Taxation Ruling TR 95/35

This Ruling applies to a person who receives an amount as compensation. It considers the CGT consequences for the recipient of the amount, and whether the amount should be included in the assessable income of the recipient under Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936).

Compensation for disposal of notional asset

TR 95/35 considers if the compensation amount does not relate to either an underlying asset or the disposal of a right to seek compensation, then the Commissioner considers that section 160M(7) of the ITAA 1936 may apply. In such a case there is a deemed disposal of a new notional asset. This notional asset is acquired immediately before the occurrence of the relevant act, transaction or event (i.e the breach of contract, personal injury or wrong, commencement of proceedings, obtaining of a judgement, or reaching of a settlement). The asset is disposed of at the time of the relevant act, transaction or event, and the consideration on disposal is the amount of compensation.

Section 160M(7) of the ITAA 1936 may apply for example, where there is an ex gratia payment made in circumstances where there is no 'right' to seek compensation.

In your case, the payment made to you was not paid under any legal obligation and you did not have a legal right to receive the payment from your insurer.

TR 95/35 provides an example (example 10) as to how a payment such as an ex gratia payment made in circumstances where there is no 'right' to seek compensation is treated for purposes of CGT and the treatment of compensation receipts.

Example 10

Alf is an interior designer who works from spacious offices, showrooms and workshops attached to his home, with space for customer parking on the premises. The business commenced in 1989 and Alf has a substantial client base and is well known in the industry. Alf's clients generally visit the showrooms to choose styles and approve orders. Early in May 1994 the local council commences road works which block the road on either side of Alf's premises for fourteen weeks. During this time he has no vehicular access to his premises. The council offers Alf $12,000 as compensation for the inconvenience and loss of access. Alf had not sought any compensation from the council; the offer of $12,000 was not solicited. Alf accepts the offer and receives payment on 28 May 1994.

In the example above the Commissioner will treat the $12,000 as a capital gain under section 160M(7).

In applying the above example to your circumstances, the amount you received was made by them in a goodwill gesture to you in regard to on-going lengthy discussions regarding your legal fees claim.

Summary

You entered into a settlement agreement whereby you received a sum of money in exchange for surrendering your right to seek any further demands or take any further actions or proceedings against your insurer. This money is not ordinary income but is assessable as a capital gain under section 160M(7).

For further information refer to the Tax Office website and search for Taxation Ruling 95/35 and the Guide to capital gains tax.

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