Disclaimer
This edited version has been archived due to the length of time since original publication.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: 1013117350685

Date of advice: 2 November 2016

Ruling

Subject: Compensation payment

Question 1

Is the lump sum payment regarded as ordinary assessable income?

Answer

Yes.

Question 2

Is the lump sum settlement payment assessable under the capital gains tax provisions?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

You suffered an injury at work. The injury limited your mobility.

You and your employer were in dispute as to the quantum of compensation.

You signed a letter saying that you hereby resign from your employment upon the condition that you are paid all proper entitlements arising out of the termination of your employment.

You and your employer reached agreement which pursuant to section 294 of the Workplace Injury Management and Workers Compensation Act 1998 and rule 15.9(1) of the Workers Compensation Commission Rules 2011 was ratified by the Relevant Commissioner.

The Commissioner issued a determination stating that the dispute was resolved under section 40 of the Workers' Compensation Act 1987.

Your claim was closed off. Under the Consent Orders, your previous employer was to pay you weekly compensation at a specified rate for a specified period.

Your solicitor advised you that the payment was for personal injury.

You received a payment.

You later received a payment summary from your employer showing a gross payment amount.

You contacted the employer to state the payment was for personal injury and not wages. The employer stated that they would not cancel and could not adjust the payment summary.

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

Detailed reasoning

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 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 form 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:

Payments of salary and wages are income according to ordinary concepts and are included in your assessable income.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443;10 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).

Therefore periodic payments received during a period of total or partial disability are included in your assessable income on the same principle as salary and wages.

Lump sum payments

Whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability as ordinary income was considered in Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138. In that case Mathews J found that payments made to replace income take on the character of the payment they replace and that the method of payment does not alter the character of the payment. Mathews J held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing a redemption of those future weekly payments was also income.

This view was subsequently confirmed in Sommer v FC of T 2002 ATC 4815; 51 ATR 102 (Sommer's case). The case involved a medical practitioner who had taken out an income protection policy. Following the rejection of the taxpayer's claim for income replacement payments of $4,000 per month, the matter was settled out of court with the taxpayer receiving a lump sum. The taxpayer argued that the amount was a payment of capital as it was paid in the consideration of the cancellation of the policy, and the surrender of his rights under it or that the payment was capital as it was an un-dissected aggregation of both income and capital.

In dismissing the taxpayer's appeal it was held that the payment was in settlement of income claims of the taxpayer in circumstances where the purpose of the insurance policy was to fill the place of a revenue receipt. As a result, the payment was clearly on a revenue account. The fact that the payment was received in one lump sum did not change its revenue character.

In your case you were injured at work and sought compensation. You were offered a lump sum payment for weekly compensation. The payment represents a payment for lost salary and wages while you were injured.

It is acknowledged that your injury triggered the compensation claim, however the payment is not a payment for your injury. Rather it is a payment for your loss of income while you were injured. There is no documentation to show that the compensation is for your injury or loss of earning capacity. The payment was made under section 40 of the Workers' Compensation Act 1987 which relates to weekly compensation entitlements. The payment was not calculated based on your injury suffered or medical expenses incurred.

The fact that you agreed to resign does not change the nature of the payment.

Furthermore the fact that your employer did not deduct any PAYG withholdings from the payment does not mean that the payment is capital in nature. Where a person earns a lower weekly income, there is generally no need to withhold tax.

In your circumstances, the payment is compensation for lost salary after your injury and is regarded as ordinary assessable income under subsection 6-5(2) of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).