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This edited version has been archived due to the length of time since original publication.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

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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:

Under clause 2.1 of the Terms of Settlement, your lump sums included amounts:

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:

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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