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Edited version of your written advice

Authorisation Number: 1051430403467

Date of advice: 18 September 2018

Ruling

Subject: Assessable income - Compensation payments.

Question 1

Is the portion of a compensation payment you received relating to loss of income considered to be part of your assessable income?

Answer

Yes

Question 2

Is the portion of a compensation payment you received relating to pain, suffering and provision of care considered to be part of your assessable income?

Answer

No

Question 3

Should the compensation payment you received relating to loss of income be included as assessable income in the 2017/18 income year?

Answer

Yes

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Your partner passed away on XXXX of an illness.

The Executors to your partner’s estate contacted your solicitor stating that the court case was drawing to a close and they were shortly expecting a payout. They requested confirmation that in the event of any tax liability that you would bear the liability rather than the Estate.

Later the Solicitor in the Country A sent an email to you stating that he had received the settlement funds and was forwarding the entire amount to the Estate that same day.

Having not received the payout, you contacted the Solicitor and realised that a letter needed to be written as per the Executors previous request.

You contacted your accountant to requests assistance to draft a letter to the Executors accepting any possible tax liability.

In response, the Executors of the Estate wrote a letter, enclosing a cheque for the amount of compensation.

The letter was received at you tax agent’s address whilst she was overseas.

The letter, dated in the 2017/18 year, stated that the compensation sum was apportioned into two amounts:

A cheque for the sum was enclosed.

On XX/XX/20XX the cheque was given to you and banked shortly afterwards.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(2)

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

Compensation payment relating to loss of income

Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provide 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:

Payments of salary and wages are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997.

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 under ordinary concepts (FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

Taxation Determination TD 93/58 outlines the circumstances under which the receipt of a lump sum compensation/settlement payment is assessable as ordinary income. The determination states that where the compensation payment is for loss of income, the amount is assessable as ordinary income. Where a portion of a lump sum payment is identifiable and quantifiable as income, that portion of the payment will be assessable.

In your case, you received a compensation payment. The compensation included an amount paid for loss of earnings. The amount paid to compensate for loss of earnings is assessable as ordinary income under subsection 6-5(2) of the ITAA 1997 in the income year it was received.

Compensation payment relating to pain, suffering and provision of care

You also received a lump sum payment for pain and suffering, and provision of care. 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, suffering and care provided as a result of your partner’s illness and death, rather than from a relationship to personal services performed.

Accordingly, the lump sum payment you received relating to pain, suffering and provision of care is not ordinary income and is therefore, not assessable under section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income and are also included in assessable income.

Amounts received in respect of personal injury which is 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.

However, paragraph 118-37(1)(a) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any wrong, injury or illness you suffer in your occupation. As part of the compensation payment you received is for alleged pain and suffering, it is disregarded under paragraph 118-37(1)(a) of the ITAA 1997. Consequently this payment is not statutory income.

Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income.

As the lump sum payment for pain, suffering and provision of care is neither ordinary income nor statutory income, it does not form part of your assessable income and is not subject to tax.

Which year was the income derived?

Taxation Ruling TR 98/1 considers the appropriate method of determining when income is derived under subsection 6-5(2) of the ITAA 1997 where income is earned in one tax year but received in another. Paragraph 42 of TR 98/1 states that salary and wages or other employment remuneration is assessable on a receipts basis. This is irrespective of whether that income relates to a past or future income period.

The amount paid to compensate for loss of earnings is assessable as ordinary income, and is considered to be derived in the year of receipt, which in your case is the year ended 30 June 20XX.

As a result, the compensation amount of $X is assessable when you received it, in the year ended 30 June 20XX.

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