1012709848780 | Legal database

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Edited version of your written advice

Authorisation Number: 1012709848780

Ruling

Subject: Lump sum payment - Statutory income

Question 1

Is the lump sum payment that you received as compensation assessable as ordinary income?

Answer

Question 2

Is the lump sum payment that you received as compensation assessable as statutory income?

Answer

Yes

Question 2

Will any capital gains arising from the compensation payment be disregarded?

Answer

This ruling applies for the following periods:

30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

In 19XX, you were employed as a temporary employee working on a full time basis.

In 19YY you were appointed as a permanent employee

You were never told that you were entitled to be a permanent employee and therefore receive the same benefits of a permanent employee in the form of Superannuation for some or most of the period of your employment as a temporary employee.

You sought legal proceedings.

You were offered an ex-gratia lump sum payment in settlement of the proceedings.

The payment was made to resolve the proceedings and all actions, suits, claims, complaints, demands, costs and other liabilities of any nature.

In accepting a lump sum payment you agreed to release and discharge your employer from all actions, suits, claims, complaints, demands, costs and other liabilities of any nature which you have or at any time may have.

In accepting the lump sum you indemnified your employer against any claims arising out of or in way connected with the subject matter of the proceedings.

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 15-30

Income Tax Assessment Act 1997 Section 118-37

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 199 (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.

Section 6-10 of the ITAA 1997 provides that assessable income also includes statutory income, that is, income which is not ordinary income that is included in assessable income by another provision of the income tax legislation. Certain types of insurance receipts and capital gains are examples or statutory income.

Several types of receipts are not income for taxation purposes as they do not have the characteristics of ordinary income and they are not statutory income.

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.

A capital receipt does not have the characteristics of ordinary income as it is usually:

• not related to work performed or an interest in property, and

• not replacing an income stream.

Characteristics of a capital receipt include:

• being paid in a lump sum, that is, not received periodically

• being a one-off payment, that is a payment made once and for all, and

• being expected but not relied upon.

Whether the payment is a receipt of a capital or income nature in turn depends upon consideration of all the circumstances surrounding the payment.

For income tax purposes, a compensation amount generally bears the character of that which it is designed to replace. Taxation Ruling TR 95/35, Income tax: capital gains: treatment of compensation receipts, in dealing with the taxation treatment of compensation receipts, suggests the assessability of a lump sum in the hands of the recipient depends on whether it is a receipt of capital or income nature. It is the character of the receipt in the hands of the recipient that must be determined: FCT v. Slaven (1984) 52 ALR 81; 15 ATR 242; 84 ATC 4077 (Slaven's Case). Generally, the material factor in determining whether compensation is of an income or capital nature is not the measure of the compensation, but what it is truly paid for: Glenboig Union Fireclay Co Ltd v. IR Commrs (1921) 12 TC 427.

In TR 95/35 the term 'underlying asset' is used. The underlying asset is defined in TR 95/35 as:

the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

The right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. A right to seek compensation is an asset for the purposes of Part 3-1. The right to seek compensation is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged. This disposal triggers a CGT event C2.

Paragraphs 283 and 284 and 285 of TR 95/35 provide the following example:

283. On 4 July 1989 Marty acquired a rental property. In January 1990 Marty decided to sell the property. On 15 March 1990 Waldo indicated to Marty that he was willing to buy the property for $200,000. On 20 March 1990 Marty engaged his solicitors, Legal Eagles, to act for him in the sale. Legal Eagles had also acted for Marty when he purchased the property. On 10 July 1990 contracts were exchanged with a requirement that the sale be settled one year later on 10 July 1991. The sale was not finalised on 10 July 1991 because of a delay in receiving a clearance from one of the local authorities. Waldo later exercised his right under the contract to repudiate the contract and claimed a refund of his deposit.

284. On 24 October 1991 Marty commenced legal action against Legal Eagles seeking damages for their negligence in not ensuring that the certificate was received by the proposed settlement date. On 20 December 1991 Legal Eagles advised Marty they were willing to negotiate a settlement. On 17 January 1992 Marty accepted and received compensation of $95,000 in settlement of his claim against Legal Eagles. At this date Marty had not sold the property.

Note: no part of the $95,000 represents a repayment of the deposit paid by Waldo.

285.

Relevant asset:	The right to seek compensation. The property is not the relevant asset as it was neither permanently damaged nor was its value permanently reduced by the actions of Legal Eagles.
Acquired:	July 1991 (when Legal Eagle's negligent action became apparent)
Cost base:	Nil acquisition cost plus legal costs
Disposed of:	January 1992
Consideration:	$95,000
CGT consequences:	Marty will be assessed in the 1992 income tax year on the net capital gain

While it is acknowledged that, your particular circumstances differ from those provided in the above example the principles of identifying the underlying asset remain the same.

In your case the compensation payment does not have the characteristics of income described above nor is it for replacement of income. The payment was made to resolve the proceedings and all actions, suits, claims, complaints, demands, costs and other liabilities of any nature.

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

In your situation, you received a lump sum compensation payment. The payment was made without any admission of liability by your employer. The Deed of release did not state that the lump sum payment related to damages received for any wrong, injury or illness your suffered personally. Therefore paragraph 118-37(1) (b) does not apply to your circumstances.

As the payment was made to resolve the proceedings and all actions, suits, claims, complaints, demands, costs and other liabilities of any nature, it is viewed as being consideration received for the disposal of your right to seek compensation.

You disposed of your right to seek compensation when you entered into a Deed of Settlement and Release, this triggered CGT event C2. Accordingly, the lump sum payment that you received is assessable under Section 6-10 of the ITAA 1997.

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