Edited version of your private ruling

Authorisation Number: 1012162932236

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Ruling

Subject: Assessability of fortnightly and lump sum payments

Question and answers

Is the loss of earnings capacity payment of $X per fortnight assessable income?

Yes.

Will the loss of earning capacity portion of the lump sum payment be assessable income?

No

Will the loss of earning capacity portion of the lump sum payment be an assessable Capital Gain?

No.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

01 July 2010

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 motor vehicle accident on the after 1 July 2009.

Due to the resulting injuries you are unable to work.

You have been granted a Serious Injury Certificate which allows you to pursue a Common Law claim.

Prior to any common law claim you received a taxable loss of income payment.

This payment was then transferred to a loss of earnings capacity fortnightly payment after 1 July 2011 of $X per fortnight, which has not been taxed.

You are currently claiming through Common Law for loss of earnings capacity which is expected to be settled no later than 30 June 2012.

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.

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.

The periodical compensation payments received by the taxpayer are income according to ordinary concepts, given that they have an element of periodicity, recurrence or regularity (ATO Interpretative Decision 2001/553). Although these are essentially capital in nature payments, due to the regularity they take on the definition of income (Coward v FC of T (1999) 41 ATR 1138(1999 54 ALD 83)). Due to the fact that these payments have been paid regularly since after 1 July 2011, these payments are considered to be of an income nature and not capital.

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:

· if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or

· to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

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.

However, due to the fact that the compensation has been paid by fortnightly payments, the regularity of the receipt of those fortnightly amounts means they are income according to ordinary concepts when received.

However, any lump sum 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:

· acquired at the time of the compensable wrong or injury, and

· disposed of when it is satisfied, surrendered, released or discharged.

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 any compensation you may receive as a lump sum for personal injury from a motor vehicle accident is not included in your assessable income by virtue of the CGT provisions.

Any lump sum compensation payment you receive will not be ordinary income and will not be statutory income. Accordingly, you are not required to include any portion of the lump sum payment in your assessable income.

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