Edited version of private advice

Authorisation Number: 1051520775712

Date of advice: 6 June 2019

Ruling

Subject: Lump sum compensation payment.

Question

Will the lump sum compensation payment or any portion thereof be assessable as either ordinary income or as a capital gain?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

·        Whilst working on a commercial building site you suffered a work injury.

·        You have been assessed as suffering a degree of permanent impairment as a result of the injury.

·        You have been in receipt of compensation benefits in respect of the injury.

·        You lodged a civil damages claim against two parties for damages in respect of your injury.

·        The heads of claim being pursued were pain and suffering, past economic loss, loss of future earning capacity, gratuitous assistance/care, loss of amenities of life, past and future medical expenses (surgery, medical treatment, therapeutic treatment and ongoing pharmaceuticals) and private expenses.

·        A third party also issued proceedings against the same two parties in respect of compensation paid and payable to you.

·        The two parties denied the claims made.

·        All partied attended a mediation and agreed to settle the matter as an out of court settlement.

·        You have been offered a lump sum payment (Settlement Sum) to settle any and all issues, claims or disputes arising directly or indirectly from the incident, the injuries, the claim and the recovery claim.

·        The Settlement Sum is inclusive of interest, costs, disbursements, expenses and any statutory charges.

·        The third party is entitled to recover the amount of compensation paid or payable to you from the two parties or yourself.

·        You are entitled to retain the balance of the damages after the deduction of the amount recoverable.

Relevant legislative provisions

Income Tax Assessment Act section 6-5

Income Tax Assessment Act section 6-10

Income Tax Assessment Act section 10-5

Income Tax Assessment Act section 59-30

Income Tax Assessment Act subsection 59-30(3)

Income Tax Assessment Act section 104-25

Income Tax Assessment Act paragraph 104-25(1)(b)

Income Tax Assessment Act subsection 104-25(2)

Income Tax Assessment Act paragraph 104-25(2)(a)

Income Tax Assessment Act paragraph 104-25(2)(b)

Income Tax Assessment Act paragraph 108-5(1)(b)

Income Tax Assessment Act subparagraph 118-37(1)(a)(ii)

Reasons for decision

Sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary and statutory income (for example, capital gains) derived directly and indirectly from all sources, whether in or out of Australia during the income year.

The ITAA 1997 does not provide specific guidance on the meaning of ordinary income. However, a substantial body of case law exists which identifies its likely characteristics. Amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income, as are amounts that are the product of any employment of, or services rendered by, the recipient. Further, amounts which compensate for lost income or serve as a substitute for other income are themselves income according to ordinary concepts.

A compensation amount generally bears the character of that which it is designed to replace (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82; (1952) 5 AITR 443; (1952) 10 ATD 82). 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 assessable as ordinary income.

Generally, payments that are income (such as lost wages) will be assessable under the ordinary income provisions of section 6-5 of the ITAA 1997. Amounts identifiable as reimbursement for private expenses (such as medical expenses) of which are otherwise capital in nature (such as compensation for pain and suffering) are not assessable as ordinary income.

In your case, you sustained an injury whilst performing your work duties and have been in receipt of benefits under the WRCA and/or the RWA. You have recently taken legal action against an entity other than your employer for damages in relation to the same injury and have been offered a lump sum settlement payment.

There are two identifiable components to your settlement, one is an amount that represents the total benefits (weekly income payments/medical expenses) that the Corporation has paid in relation to your injury claim and the other is a lump sum damages payment.

Portion of the lump sum to be paid to the Corporation

Where a taxpayer is required to repay an amount in an income year after its receipt and is not entitled to a deduction for the repayment, section 59-30 of the ITAA 1997 treats the amount as non-assessable non-exempt income in the year of receipt.

However, this provision will not apply where the taxpayer has received instalments of worker's compensation or sickness allowance that have to be repaid on receipt of a lump sum payment for compensation for damages for a wrong or injury suffered in their occupation (subsection 59-30(3) of the ITAA 1997).

This follows the basic principles under worker's compensation law that a person cannot be compensated more than once for the same injury.

You have received and included the weekly compensation payments which are assessable as ordinary income under section 6-5 of the ITAA of 1997, in the correct income tax periods of receipt. There will be no taxation consequences for you in relation to the lump sum amount that is being paid to the Corporation.

In the RWA the Corporation has the right to intervene to protect the Corporations interest. Under the terms of the Deed of Release the Corporation will receive the full amount of compensation they have paid.

Balance of the damages payment

The remainder of the lump sum is not assessable as ordinary income as it lacks any element of periodicity, recurrence or regularity, nor is it paid to compensate for loss of income. This amount is considered to be capital in nature.

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision of the tax law.

Section 10-5 of the ITAA 1997 lists those other provisions and included in the list are:

·        amounts received by way of insurance or indemnity payments in respect of a lost amount, and

·        capital gains.

Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset. A taxpayer's right to seek compensation is therefore classified as an intangible CGT asset.

Section 104-25 of the ITAA 1997 discusses CGT event C2 which refers to cancellation, surrender and similar endings. Paragraph 104-25(1)(b) of the ITAA 1997 states, in part, that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied.

Subsection 104-25(2) of the ITAA 1997 states that the time of the event is:

·        when you enter into the contract which results in the asset ending; or

·        if there is no contract when the asset ends.

Paragraph 3 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts, confirms that the right to seek compensation is a CGT asset and is taken to be acquired at the time of the compensable wrong or injury, and includes all the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged.

However, under subparagraph 118-37(1)(a)(ii) of the ITAA 1997 a capital gain or capital loss for a CGT event is disregarded when the CGT event relates directly to compensation or damages received for any wrong, injury or illness you personally suffer.

In your case, the balance of the damages payment relates wholly to the right to seek compensation for the personal injury you suffered and as such, the payment will be exempt for CGT.

Accordingly, the lump sum payment you will receive is not assessable as either ordinary or statutory income and you will not be required to include the amount in your assessable income.

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