Edited version of private ruling

Authorisation Number: 1011873293689

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Ruling

Subject: capital gains tax and undissected lump sum compensation payment

Question 1:

Is the compensation payment received under a Deed of Release assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

Question 2:

Is any capital gain made upon the surrender of your right to seek compensation under a Deed of Release disregarded?

Answer:

No.

This ruling applies for the following periods

Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You were involved in a vehicular accident after 20 September 1985.

The driver of the other vehicle involved was insured by an insurance company.

The accident resulted in the amputation of a limb.

The extent of incapacitation of the body as outlined in the Statutory Declaration of the claimant's draft statement of loss and damage.

Other body and mental issues accounted for a further loss of function. The total loss of function exceeded 50%.

You held an income protection policy with another insurer who paid you 75% of your usual salary per week.

You engaged a firm of lawyers to undertake legal action seeking compensation for your loss.

You provided a copy of the statutory declaration; submitted by your lawyers to the insurance company, detailing your schedule of economic loss claim as follows:

· General damages

· Past economic

· Interest

· Past Loss of Superannuation

· Interest

· Future Economic Loss

· Future Economic Loss of Superannuation

· Past Care & Services

· Interest

· Future Care & Services

· Future Prosthetics

· Home Modifications

· Future Expenses

· Travelling Expenses

· Pharmaceutical Expenses

· Out of Pocket - Other

· Interest

At the conclusion of the compulsory settlement conference, you were awarded a sum of money as a one off payment from the insurer. You provided a copy of the Release Discharge Indemnity document between yourself, and the insurer, detailing the terms of payment.

A payment less costs was credited to your nominated bank account from the trust account of your lawyers.

You did not receive any documentation in relation to the payment after the initial negotiations and actions. The insurer did not provide a break up of the final compensation amount.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,
Income Tax Assessment Act 1997 Section 6-10,
Income Tax Assessment Act 1997 Section 10-5,
Income Tax Assessment Act 1997 Section 104-25,
Income Tax Assessment Act 1997 Section 118-37,
Income Tax Assessment Act 1936 subsection 25(1) and
Income Tax Assessment Act 1936 subsection 26(j).

Reasons for decision

Question 1:

Ordinary and statutory income

Subsections 6-5(1) and 6-5(2) of the ITAA 1997 explain that the assessable income of a resident taxpayer includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources during the income year.

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income also includes statutory amounts that are not ordinary income, but are included in assessable income by another provision of the income tax legislation, for example, capital gains tax (CGT).

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income 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.

When considering the receipt of compensation payments, Taxation Ruling IT 2193 (IT 2193) discusses the loss of earning capacity and whether compensation for that loss is assessable income. In particular the ruling discusses Slaven v. Federal Commissioner of Taxation (1983) ATC 4387 (Slaven case). At paragraph 6 the ruling advises that:

In the Slaven case the taxpayer received five irregular payments totalling $4,360 as
compensation in respect of the deprivation or impairment of her earning capacity
suffered as a result of a vehicle accident which left her unable to work for a
period of nine months.

Capital vs Revenue

The Slaven case sought an appeal of the decision treating compensation payments as assessable income. The appeal was dismissed with the Supreme Court holding that the payments made to compensate the taxpayer for the loss of a capital asset (her earning capacity) and that consequently the payments were non-assessable capital receipts in her hands and were not assessable either under subsection 25(1) or 26(j) of the Income Tax Assessment Act 1936 (ITAA 1936). The Commissioner appealed to the Full Federal Court contending that the payments were income according to ordinary concepts and assessable under subsection 25(1) of the ITAA 1936 as income derived by the taxpayer. The payments were said to have been made and received for the purpose of providing recoupment of income lost by the taxpayer. Whilst the appeal was dismissed, consideration should be given to the judgement in respect of ATC 4085 as follows:

The Parliament of Victoria cannot determine by its own legislation whether the receipt of a statutory payment answers the description of income or capital in the hands of the recipient within the meaning of sec. 25 of the Assessment Act, a Commonwealth Act. But the purpose of a statutory payment, as disclosed by the terms of the statute itself, must be a powerful, though not conclusive, aid to the determination of the character of the payment and in particular as to whether its receipt constitutes income in the hands of a taxpayer.

In the Slaven case, the claim was in relation to the taxpayer's capacity to earn assessable income, the capital asset, rather than the actual income forfeited, as revenue resulting from the capital asset. It therefore follows that the compensation payment received was of a capital nature. However, in your case, your claim included economic loss, interest, ongoing medical costs and travel rather than the capital asset of your ability to earn assessable income in isolation.

Summary

Your 'statement of claim' included benefits of an income nature together with medical costs, travel and interest. The undissected payment was based on a mixture of income and capital items; and made as a full and final settlement of your right to seek compensation. As the undissected lump sum payment encompassed more than income alone and cannot be apportioned, the payment is not assessable under Section 6-5 of the ITAA 1997 as ordinary income.

Question 2:

Capital gain tax

The right to seek compensation is considered to be a CGT asset. The timing of the event is when you acquired the right. In your circumstances, the accident that occurred after 20 September 1985 gave rise to the CGT asset, being your right to seek compensation.

Paragraph 11 of TR 95/35 advises that:

If any compensation is not received is respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. Accordingly, any capital gain arising on the disposal of that right is calculated using the cost base of that right.

Paragraph 157 of TR 95/35 further advises that the cost base of the right to seek compensation includes the legal fees and charges connected with and incurred during the course of proceedings may be included in the cost base of the asset.

Settlement of your statement of claim resulted in the disposal of a CGT asset; the right to seek compensation. You received consideration for the disposal as an undissected lump sum payment; with a direct credit to your nominated bank account.

Paragraph 21 of TR 95/35 provides guidance if undissected lump sum compensation payments are received for a number of claims, including a personal injury claim, and its individual components cannot be determined, or reasonably estimated, and no part of the compensation can be quantified as relating to the personal injury of the taxpayer. Accordingly, as an undissected lump sum payment can not be apportioned, there is no exemption applicable to any part of the compensation received in consideration of the disposal of the right to seek compensation.

In your situation, a CGT event occurred in relation to your right to seek compensation when you entered into the Deed of Release. The payment was undissected; with no ability to determine or estimate any part of the compensation payment relating to your personal injury. It therefore follows the amount has been received for the disposal of the right to seek compensation and is assessable under CGT provisions. No exemption is available where the payment is undissected and the capital gain made upon receipt of the payment can not be disregarded.

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