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Ruling

Subject: Personal compensation

Question

Is any portion of your compensation payment assessable income?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commenced on:

1 July 2010

Relevant facts and circumstances

You were involved in a motor vehicle accident with another party and sustained personal injuries.

You were not at fault.

You lodged a compensation claim with the other party's insurance provider.

Your legal representatives put forward a claim for settlement for a payment to include amounts for past economic loss, interest on past economic loss, future economic loss, loss of future superannuation and other damages.

You agreed to a settlement of a lump sum payment offered by the insurance provider.

The release document provided by the insurance company acknowledges that the lump sum settlement includes an amount for past and future economic loss.

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 118-37

Reasons for decision

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

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.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. Damages awarded for past or future loss or impairment of earning capacity is not ordinary income (Groves v. United Pacific Transport Pty Ltd [1965] Qd R 62).

Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income:

You received your compensation payment as a result of lodging a motor vehicle personal injury claim, in respect of injuries you sustained in a motor vehicle accident.

Taxation Ruling IT 2193 deals with the issue of compensation for loss of earning capacity received as a result of a motor vehicle accident. IT 2193 discusses the decision in FCT v. Slaven 84 ATC 4077; 15 ATR 242 (Slaven's case), and makes it clear that compensation for loss of earning capacity will not lose it's 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.

In Slaven's case, the taxpayer was injured in a motor vehicle accident which left her unable to work for a period of nine months. She received compensation for the deprivation or impairment of her earning capacity from the Motor Accidents Board, under the Motor Accidents Act (Vic) 1973. The Board, in determining an adequate amount of compensation to be paid to an injured person, had to have regard to the loss of earnings actually suffered and to the likely loss of future earnings. The Federal Court held that the essential character of the compensation was compensation for loss or impairment of earning capacity, a capital asset, and that it was not liable to income tax.

IT 2193 states that the decision in Slaven's case will extend to payments made by other compensation boards where the payments made are in the nature of compensation for deprivation or impairment of earning capacity.

In your case, the compensation lump sum included an amount for past and future economic loss.

We consider the payment was paid to compensate you for diminished capacity to earn income rather than the actual loss of income. The capacity to earn income is a capital asset and compensation for the loss of a capital asset is a capital receipt.

It is considered that no component of the amount you received was received to compensate you for loss of income. Therefore, your compensation is not assessable as ordinary income under section 6-5 of the ITAA 1997.

However, as the compensation for past and future loss of earning capacity is a capital receipt, it is also necessary to consider the provisions of the income tax law which deal with capital receipts.

Statutory income

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997. The list includes capital gains, which are included in assessable income by virtue of the capital gains tax (CGT) provisions.

Taxation Ruling TR 95/35 considers the CGT consequences for a person who receives an amount as compensation. The ruling states that a right to seek compensation is an asset for the purposes of the CGT provisions, and that a right to seek compensation is:

TR 95/35 states that compensation received under a policy of insurance relates to a right to seek compensation.

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

In your case, paragraph 118-37(1)(b) of the ITAA 1997 applies. This means that the compensation you received for personal injury from a motor vehicle accident is not included in your assessable income by virtue of the CGT provisions.

The compensation payment you received is not ordinary income and is not statutory income. Accordingly, you are not required to include any portion of the payment in your assessable income.

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