Edited version of private advice

Authorisation Number: 1051810932318

Date of advice: 2 March 2021

Ruling

Subject: Income - assessable

Question

Is the compensation payment of $XXX assessable as income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question

Is the compensation payment of $XXX assessable as a capital gain?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commenced on:

1 July 2019

Relevant facts and circumstances

You left work on or about Month 20XX following a workplace injury. You initially received workers compensation and you then applied for a Total Permanent Disability (TPD) payment through your superannuation fund.

The Trustee accepted that you qualified for a TPD payment. You believed that you were entitled to a TPD payment, if accepted, of $YYY. However, due to a series of errors by the superannuation administration, your superannuation fund had only insured you for $ZZZ.

You received a TPD payment of $ZZZ.

In late 2019 you received a compensation payment of $XXX in respect of the TPD payment you believed you were entitled to receive.

You are unlikely to be able to work in future.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 118-37

Reasons for decision

Ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) refers to ordinary income as income 'according to ordinary concepts'. This phrase is not defined under the legislation, but a large body of case law has developed to identify the factors that indicate if an amount is income according to ordinary concepts.

Typical examples of ordinary income include salaries, wages, and proceeds of carrying on a business, rent, interest and dividends. Typical examples of items which are not generally ordinary income include lottery prizes, proceeds from a hobby, loans and gifts.

A lump sum payment can be classed as ordinary income if it has been paid in compensation or settlement for lost salary or wages.

The Commissioner's view on the taxation treatment of a lump sum settlement payment is clarified in Taxation Determination: TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? (TR93/58).

TD 93/58 states that if a payment is compensation for loss of income only, including interest, then it is assessable income.

This payment was not ordinary income because it is not income under ordinary concepts that is, it was not expected or earned, not related to an income producing activity and was in relation to recovery of a private expense.

Accordingly, the lump sum payment is therefore not assessable under section 6-5 of the ITAA 1997.

Capital gains tax

Payments that are capital in nature may be assessable as statutory income under the capital gains tax (CGT) provisions. Your assessable income includes any net capital gains for an income year.

In Taxation Ruling TR 95/35: Income tax: capital gains: treatment of compensation receipts (TR 95/35), the Commissioner states that whether a lump sum or other compensation payment is assessable in the hands of the recipient depends on whether it is a receipt of a capital or income nature. This in turn depends upon consideration of all the circumstances surrounding the payment. It is the character of the receipt in the hands of the recipient that must be determined.

Paragraph 118-37(1)(a) of the ITAA 1997 disregards payments or receipts for the purposes of the CGT provisions where the amount relates to compensation or damages you received for any wrong, injury or illness suffered in your occupation.

Application to your circumstances

The issue to be determined is the character of the lump sum payment in your hands and whether the exemption contained in section 118-37 of the ITAA 1997 applies.

•   You left employment on or about 20XX due to ill health.

•   You lodged an application for TPD based on your belief that you were entitled to a TPD payment of $XXX.

•   Due to errors by the superannuation administrator, you received only a TPD payment of $YYY.

•   The Trustee of the superannuation fund agreed to pay a compensation payment, the difference between the amount you believed you were entitled to receive and the previous payment.

•   You accepted an offer of $ZZZ as full settlement of your claim. This was formalised as a Settlement Deed.

The payment is not assessable as ordinary income as it is not a product of any employment, services or business carried on by you and it does not have the characteristics normally associated with ordinary income, rather, we consider this payment to be a result of your claim for the insurance benefit, interest and costs.

Such a payment is classified as capital. It is not considered to be assessable as income.

Section 118-37 ITAA 1997

The compensation you received was related to an injury you suffered in your occupation. This follows the reasoning contained in Taxation Determination TD 92/130 Income tax: does subsection 160ZB(1) exclude from the operation of Part IIIA compensation or damages obtained by a taxpayer for defamation, the loss of support following the (wrongful) death of the taxpayer's spouse or parent or the professional negligence of a solicitor failing to institute a personal injuries action? (withdrawn). In that Determination, it stated that where a taxpayer takes legal action against a solicitor for the solicitor's negligent failure to institute a personal injuries action on the taxpayer's behalf, the amounts received are by way of compensation for the personal injury.

The lump sum payment was paid to you as compensation for your injury. In effect it was a form of TPD payment as it was to compensate you for the TPD payment you expected to receive.

The compensation amount of relates to a wrong, injury or illness you suffered. Paragraph 118-37(1)(a) of the ITAA 1997 will therefore apply to the compensation amount so that any capital gain or capital loss will be disregarded.

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