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Edited version of your written advice
Authorisation Number: 1051394062073
Date of advice: 5 July 2018
Ruling
Subject: Assessability of compensation payment
Question 1
Are the compensation payments you received assessable as ordinary income?
Answer
No.
Question 2
Are the compensation payments you received disregarded under the capital gains tax provisions?
Answer
Yes.
This ruling applies for the following period:
Year ended 30 June 2018
The scheme commenced on:
1 July 2017
Relevant facts and circumstances
You commenced legal proceedings against your former employer.
Legal proceedings were discontinued when settlement was reached.
You have provided a copy of the Terms of Settlement which outline the proceedings and the nature of the payments made to you.
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 10-5
Income Tax Assessment Act 1997 paragraph 118-37(1)(a)
Reasons for decision
Summary
The lump sums you received are not assessable as ordinary income, neither are they assessable under the capital gains tax (CGT) provisions.
Detailed reasoning
Ordinary income
The assessable income of an Australian resident includes the ordinary income they derive directly or indirectly from all sources, whether in or out of Australia, during an 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.
For income tax purposes, a lump sum received in compensation generally takes on the nature of that for which it has substituted. For example, amounts paid to compensate for loss of income have been held by the courts to be taxable as income under ordinary concepts.
On the other hand, if an amount is paid for the loss of a capital asset then it will be regarded as a capital receipt and not ordinary income. For example, if a farmer receives a payment from a mining company compensating the farmer for loss of the use of his farm land, such payments will be capital receipts as they relate to the capital asset, being the farmer’s land.
Lump sum compensation payments
The Commissioner refers to Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? to assist in determining when a lump sum compensation/settlement payment is assessable. TD 93/58 states:
● if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or
● to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.
Under clause 2.1 of the Terms of Settlement, your lump sums included amounts:
… as compensation for the Alleged Damage suffered as a result of the Alleged Contraventions claimed in the Proceedings. It is noted that this payment is not in any way compensation for or in consequence of the Termination.
and
…to reimburse the Applicant for the legal fees she has incurred in connection with the Proceedings.
No components of the lump sums were paid as compensation for loss of income and are not assessable as ordinary income.
However, as the amounts were paid in connection with the alleged damage suffered it is necessary to consider the provisions of the income tax law which deal with capital receipts.
Statutory income
Statutory income is not ordinary income, but is made assessable by specific provisions of income tax law.
The Commissioner refers to Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts when considering the capital gains tax (CGT) consequences of compensation payments. The ruling explains that we must look at why the payment was made so that we can determine if a capital asset has been disposed of.
A right to seek compensation is a capital asset for the purposes of the CGT provisions, and a right to seek compensation is:
● acquired at the time of the compensable wrong or injury, and
● disposed of when it is satisfied, surrendered, released or discharged.
CGT exemption
There are conditions within the CGT provisions that allow any capital gain or capital loss to be disregarded where the amount relates to compensation or damages you receive for any wrong, injury or illness you suffer personally.
The Terms of Settlement state that the lump sums were paid as compensation for the alleged damage suffered and by virtue of the CGT provisions, are disregarded.
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