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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1013051483712

Date of advice: 1 August 2016

Ruling

Subject: Assessability of compensation payment

Question 1

Will the lump sum payment, in relation to compensation for a wrong, injury, illness and personal suffering arising from personal injury, be assessable income?

Answer

No.

Question 2

Will any capital gain arising from the compensation payment for the personal injury claim be disregarded?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

You were employed for a period of time until your resignation.

You made a compensation claim in respect of various heads of damage.

In a deed of release between yourself and your employer (the deed) the claim was settled with amounts agreed to be paid for unpaid commission and compensation for the personal injury claim.

The deed states that your employer has agreed to settle the claims without admission of liability.

The deed specifies that a component of the agreed payment is in consideration of the personal injury claim.

The commission component will be taxed appropriately.

You will be paid the personal injury component within the specified period.

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 102-5

Income Tax Assessment Act 1997 paragraph 118-37(1)(a)

Reasons for decision

Question 1

Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes ordinary and statutory income derived directly and 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:

Part of your compensation payment amount is in relation to your personal injury claim.

The amount is not income from rendering personal services, income from property or income from carrying on a business. The payment was not earned by you as it does not relate to services performed. 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 pain and suffering resulting from the injury, rather than from a relationship to personal services performed.

A compensation amount generally bears the character of that which it is designed to replace. 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.

Amounts received in respect of personal injury, which are not for reimbursement of medical expenses or direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax provisions of the ITAA 1997.

The personal injury component of your settlement is not a lump sum payment which substitutes for an income stream or a reimbursement of medical expenses. Accordingly, the lump sum amount for the personal injury claim is a capital receipt and is not ordinary income. Therefore the amount will not be assessable under section 6-5 of the ITAA 1997.

Question 2

Receipt of a lump sum payment may give rise to a capital gain (statutory income). The net capital gain you make is then included in your assessable income under section 102-5 of the ITAA 1997 unless an exemption applies.

Taxation Ruling TR 95/35 indicates that settlement of a personal injuries claim represents the disposal of an asset, as you have disposed of the right to seek compensation for the losses arising from the injury suffered. 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 you of the right to seek compensation.

As the amount you are to receive is not in respect of any underlying asset, the whole of the settlement amount is treated as capital proceeds from a CGT event (CGT event C2) happening to your right to seek compensation.

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

Therefore the lump sum amount for the personal injury is considered to be exempt from CGT.

Conclusion

As the amount from the personal injury compensation is not assessable as either ordinary income or as a capital gain it will not be assessable income. Therefore the lump sum amount for the personal injury claim amount will not be required to be included in your income tax return.

Other relevant comments

Your settlement was a result of legal action, which was settled in private negotiations, where you sought damages in respect of various heads of damage. We have addressed the assessability of the pending personal injury claim payment.

In assessing the payment we have considered the decision in Sommer v FC of T 2002 ATC 4815; 51 ATR 102 (Sommer case) which involved a medical practitioner who had taken out a professional income replacement insurance policy. Following rejection of the taxpayer's claim for income replacement payments of $4,000 per month, the matter was settled out of court with the payment of an undissected lump sum to him. The terms of the agreement referred to the relevant surrounding circumstances. Accordingly, it was difficult to argue that the surrounding circumstances were not relevant to the characterisation of the settlement amount.

In your case the deed of release specifies the character of the payment and dissects the lump sum payments. The deed does not refer to surrounding circumstances or other agreements. In line with the Sommer's case the decision of this ruling has been based on the facts in the deed of release. The settlement was made as a full and final settlement of any and all claims between yourself and your employer and it released and discharged both parties from all claims.

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