Edited version of your written advice

Authorisation Number: 1051309326660

Date of advice: 27 November 2017

Ruling

Subject: Compensation payment

Question 1

Is the payment assessable only under the capital gains tax (CGT) provisions?

Answer

Yes.

Question 2

Is any part of the settlement payment disregarded under the CGT provisions?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2017

The scheme commenced on

1 July 2016

Relevant facts and circumstances

You were employed by entity A for many years.

You became aware that your employer had not been complying with the relevant awards that covered your employment, including that you had been paid at a lower than the minimum rate prescribed by the awards and that you had not received penalty rates to which you were entitled.

You complained to your employer about the non-compliance with the relevant awards. You then received responses.

These matters caused you considerable distress and hurt.

You ceased working for this employer and from that time received workers compensation payments but remained employed by entity A.

You later commenced an application seeking:

1. Compensation for underpayment of wages;

2. Compensation for loss in the form of hurt, humiliation, distress and loss of professional reputation associated with the contraventions by entity A and another party of their obligations to you;

3. Orders for recalculation of your annual leave entitlements; and

4. That civil penalties imposed on entity A for its breaches of the Fair Work Act 2009 to be paid to you.

The proceedings allege various contraventions of the relevant Award applicable to your employment and the Fair Work Act 2009.

Your employer paid you an amount in acknowledgement of your claim for underpayment of wages. This amount was not the full value of your claim which included back pay, interest and superannuation contributions.

In 20XX a Deed of Release was entered into by you, entity A and another party under which your employer agreed to pay you an amount for you to abandon the rest of the claims made in the proceedings, including the claims for civil penalties for the admitted contraventions (noting entity A and the other party do not admit all the alleged contraventions and underpayments) and abandoning any other claim against entity A and the hurt, humiliation and distress caused to you by the contraventions, including damage to your reputation, and you executing this Deed which includes your resignation; and

Under the Deed you were obliged to resign your employment within 31 days of the execution of the Deed.

The settlement sum was paid.

You resigned from your employment with entity A.

The Deed was executed by the parties in full and final settlement of the proceedings and any claim arising out of the employment (with identified exceptions) in accordance with the terms outlined.

‘Claim’ or ‘claims’ means any present and future claim in relation to or arising out of the proceedings or the employment (including the termination of the employment) and includes any action, application, arbitration, cause of action, charge, cost, debt due or demand. The term does not include any claim arising from or contemplated by workers compensation legislation (including any work injury damages claim arising out of the employment).

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

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

Reasons for decision

Ordinary assessable income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes 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 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.

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.

In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

The settlement payment received was not earned by you as it does not relate to services performed. Although the settlement payment relates to your previous employment, the payment is not a revenue receipt directly related to your employment duties. The payment is not considered to be a payment solely for lost income. The payment is also a one-off payment and thus 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 alleged breach of conditions under the Award applicable to your employment and the Fair Work Act 2009.

Considering the full circumstances, the payment is not regarded as ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

Statutory income

Amounts that are not ordinary income, but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997).

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list are capital gains, section 102-5 of the ITAA 1997.

Capital gains tax provisions

Your assessable income includes your net capital gain for the income year (section 102-5 of the ITAA 1997). Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens.

Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the capital gains tax implications for compensation receipts.

Why the payment was made is an important factor in determining whether an asset has been disposed of for capital gains tax purposes.

TR 95/35 discusses the various scenarios, including:

● disposal of the underlying asset,

● compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and

● disposal of the right to seek compensation.

The transaction which generated your compensation receipt is the actions of your previous employer. The relevant CGT asset in your case is the right to seek compensation. The payment received was in full settlement of the claims made.

Your right to seek compensation is an intangible CGT asset and your ownership of that asset ended when you accepted the settlement sum. At that time CGT event C2 happened. CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being released or cancelled (subsection 104-25(1) of the ITAA 1997). In your case, the settlement sum payment represents capital proceeds for your CGT C2 event.

CGT exemption

Under paragraph 118-37(1)(a) of the ITAA 1997 a capital gain is disregarded if it is compensation or damages you receive for:

(i) any wrong or injury you suffer in your occupation; or

(ii) any wrong, injury or illness you or your relative suffers personally.

These provisions would have clear and direct application in relation to an insurance policy against a specific injury or illness. For example, trauma insurance that pays a lump sum if the person loses a limb or suffers a heart attack. Such a payment would be disregarded for CGT purposes under section 118-37 of the ITAA 1997.

However, the application of section 118-37 of the ITAA 1997 in relation to settling an employment dispute claim may be more problematic.

In the case of Purvis v. FC of T [2013] AATA 58 (Purvis’ case), the Administrative Appeal Tribunal considered the tax consequences of a pilot receiving a lump sum insurance payment for the loss of licence. Although the loss of licence came about as a result of illness or injury, the Tribunal found that the payment did not relate directly to compensation or damages within paragraph 118-37(1)(a) of the ITAA 1997. The amount was calculated without regard to the nature of the personal injury suffered, save that the personal injury had to result in the loss of licence.

In cases where a dispute between an employer and an employee is settled by way of the former making a lump sum payment to the latter; it would presumably be the case that the payment is intended to compensate the employee for the loss of entitlements under the Employment or Enterprise Agreement, rather than to compensate the person for their injury or illness or wrong suffered as such.

The settlement of a dispute between an employer and employee amounts to the disposal of a right to seek compensation. However, underlying this is the forfeiture of your rights under the relevant employment agreement.

If the compensation is received in relation to multiple heads of claim, TR 95/35 allows a reasonable apportionment of that payment. For example, if a payment is intended to replace both an income stream and other potential benefit entitlements, the payment may be apportioned between the two heads of claim on a reasonable basis. However, if the payment is truly an un-dissected lump sum – that is, no reasonable apportionment can be made between the multiple heads of claim – no exemption can be applied unless you are able to prove that the amount received was solely for personal injury or wrong suffered.

This approach was confirmed in Dibb v Commissioner of Taxation [2004] FCAFC 126 which found that no part of a genuinely un-dissected lump sum could be said to be paid in relation to personal injury. The exemption in paragraph 118-37(1)(a) of the ITAA 1997 cannot apply if the compensation amount is received as a lump sum (and that lump sum is truly un-dissected) but there were rights to income type payments as well as rights relating to personal injury that are extinguished in the settlement.

Application to your circumstances

Your lump sum settlement is not regarded as solely being an income replacement. The payment includes capital components. It is therefore accepted that the payment is an un-dissected settlement amount and that the lump sum payment is not assessable under section 6-5 of the ITAA 1997.

Your payment cannot be said to be for a single defined payment for an injury or wrong. In fact the payment is for you to abandon the rest of your claims.

As was the case in Purvis’ case, although your compensation may have been triggered by a wrong, the actual lump sum payment is not a payment for a wrong or injury you suffered. There is no evidence to show that the amount was calculated based on a wrong, injury or illness suffered.

The payment covers a loss of various rights and entitlements. Therefore the lump sum payment is assessable as a capital gain and the exemption contained in paragraph 118-37(1)(a) of the ITAA 1997 cannot apply.

As you acquired the right to seek compensation more than 12 months before the CGT event, you may be able to apply the 50% general discount.

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