Edited version of your private ruling

Authorisation Number: 1012539716128

Ruling

Subject: Medical expense tax offset and lump sum compensation payment

Question 1

Are you entitled to a medical expenses tax offset for medical expenses paid by your insurer, where the amount is recovered from your personal injury settlement?

Answer

No.

Question 2

Is the lump sum compensation settlement payment you received for your personal injury claim assessable income?

Answer

No.

This ruling applies for the following period

Year ended 30 June 213

The scheme commences on

1 July 2012

Relevant facts and circumstances

You were injured in a motor vehicle accident and you lodged a claim for damages.

Your insurer reimbursed you for the medical expenses you initially paid prior to acceptance of your claim.

You accepted a lump sum payment inclusive of costs, in full and final satisfaction of all present and future claims against the insurer.

There is no formal legal document showing the breakdown of your settlement payment. However your solicitor has provided the following information in relation to your settlement structure:-

The amount of compensation for past or future economic loss was calculated in part by reference to your estimated employment income that you would have earned had you not been injured. It also refers to deprivation and impairment of earning capacity.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 159P

Income Tax Assessment Act 1936 Subsection 159P(1)

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

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

Reasons for decision

A medical expenses tax offset is available under subsection 159P(1) of the Income Tax Assessment Act 1936 (ITAA 1936) where the taxpayer pays eligible medical expenses in an income year for themselves or a dependant who is an Australian resident, to the extent that they are not reimbursed, or are eligible to be reimbursed, from a government or public authority or a society, association or fund. This also includes reimbursements from general insurance companies.

The meaning of the words 'paid by the taxpayer' was dealt with in Case U223 87 ATC 1231; Case 144 (1987) 18 ATR 4055. In that case a taxpayer was injured in an accident and was awarded damages. The insurer of the other party to the action paid the taxpayer's medical expenses. That amount was deducted from the final damages award. The taxpayer claimed the medical expense tax offset under section 159P of the ITAA 1936 in respect of the medical expenses paid by the insurer. The Administrative Appeals Tribunal stated that the taxpayer was not entitled to the tax offset as the taxpayer did not 'pay' medical expenses as required by subsection 159P(1) of the ITAA 1936. 

In your case, you were reimbursed by your insurer for the medical expenses you initially paid. Your insurer paid for all your medical expenses in relation to the accident.

Your situation is similar to the above case as your settlement of claim was inclusive of costs and a portion was set aside to repay Medicare and your insurer for your medial expenses.

The amounts paid directly to Medicare and your insurer by the insurer of the other party to the action are not payments of 'medical expenses' as defined and you have not 'paid' the medical expenses as required under subsection 159P(1) of the ITAA 1936.

Therefore, you are not entitled to include theses costs in your calculation of the medical expense tax offset as you are not out of pocket for the medical expenses. They have been paid by the insurer of the other party to the action and are a recoupment of costs.

Personal injury lump sum payment

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources 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.

Other characteristics of income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon

· have an element of periodicity, recurrence or regularity.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411.

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 Ruling IT 2193 deals with the issue of compensation of the loss of earning capacity arising from a motor vehicle accident. IT 2193 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 your case, the compensation lump sum included an amount for past loss of earnings and future economic loss.

The payment was not earned by you as it does not relate to services performed or income from property or income from carrying on a business. The payment is also a one-off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the personal injury resulting from the accident, rather than from a relationship to personal services performed.

Medical expenses are a private expense. Therefore, reimbursement of this amount does not give rise to assessable income.

The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Capital gains tax arising from the compensation payment

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision. Capital gains are one form of statutory income.

Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a look-through approach, which identifies the most relevant asset to which the compensation amount is most directly related. 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 the taxpayer of the right to seek compensation.

The disposal of a taxpayer's right to seek compensation triggers the capital gains tax provisions and the settlement amount is treated as capital proceeds.

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

In your case, you will not be subject to capital gains tax in respect of the amount you have received to compensate you for the injuries you received in your motor vehicle accident.

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