Edited version of private advice

Authorisation Number: 1052230121829

Date of advice: 10 April 2024

Ruling

Subject: Foreign sourced compensation payment

Question 1

Is the backdated weekly compensation amount you received as a lump sum from the Foreign Worker's Compensation Entity (the Entity) assessable in Australia under Article X.1 of the Double Taxation Agreement between Australia and Country A(the DTA)?

Answer

Yes.

Question 2

Is the ongoing weekly compensation you receive from the Entity assessable in Australia under Article X.1 of the DTA?

Answer

Yes.

Question 3

Will the backdated weekly compensation amount you received as a lump sum from Worker's Compensation Entity in Country A be eligible for the lump sum payment in arrears tax offset provided for in section 159KZRA of the Income Tax Assessment Act 1936?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You are a citizen of Country A.

You have been a resident of Australia for less than ten years.

Shortly after you arrived in Australia you began cohabiting with your de facto partner who is an Australian resident, both for taxation purposes and within the meaning of the Social Security Act 1991.

You sustained an injury in Country A approximately 15 years ago that left you unable to work.

For approximately five years from the time you sustained your injury you received weekly compensation payments for your injury from the Worker's Compensation Entity (the Entity) in Country A.

After about 5 years of payments the Entity stopped paying your weekly compensation.

You instituted court proceedings in Country A to challenge the Entity's decision to stop paying you weekly compensation payments.

Some years later, a decision by a Country A court (the Court) held that the Entity's decision to stop paying you weekly compensation payments was unlawful.

After the court case had been finalised, at which time you were already a resident of Australia for taxation purposes, the Entity paid you a lump sum as a back payment for weekly compensation you were entitled to over a period of time you were a resident of Country A for some years, then subsequently resident of Australia.

You have paid tax on the back payment in Country A.

Your weekly compensation payments from the Entity which are taxed in Country A have been reinstated since the Court's ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

International Tax Agreements Act 1953

Reasons for decision

Questions 1 and 2 - compensation payments

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Salary and wages, as well as interest earned on bank accounts, are examples of ordinary income that would generally be included in a resident Australian taxpayer's assessable income.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

As such, compensation payments will be ordinary income and assessable under section 6-5 of the ITAA 1997 unless overridden by some other statutory provisions. For foreign sources of income, this may include the application of relevant tax treaty provisions.

Section 4 of the International Tax Agreements Act 1953 (Agreements Act) incorporates that Act with the ITAA 1936 and the ITAA 1997 so that all three Acts are read as one. The Agreements Act overrides both the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Section 5 of the Agreements Act states that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 has the force of law. The Double Taxation Agreement between Australia and Country A(the DTA) is listed in section 5 of the Agreements Act.

Article X of the DTA reads as follows:

Pensions

1. Pensions (including government pensions) and other similar periodic remuneration paid to a resident of a Contracting State shall be taxable only in that State. However, such income arising in the other Contracting State ... shall not be taxed in the first-mentioned State to the extent that such income would not be subject to tax in the other State if the recipient were a resident of that other State.

2. Lump sums arising in a Contracting State and paid to a resident of the other Contracting State under a retirement benefit scheme, or in consequence of retirement, invalidity, disability or death, or by way of compensation for injuries, shall be taxable only in the first-mentioned State.

A relevant ATO Interpretative Decision (The ATO ID) confirms that weekly compensation payments made by the Country A Worker's Compensation Entity (The Entity) to a resident of Australia for taxation purposes will be taxable only in Australia in accordance with Article X.1 of the Convention:

In relation to the meaning of the term 'pension', Taxation Determination TD 93/151, which deals with how periodic workers' compensation payments made by Comcare are characterised for the purposes of Australia's tax treaties, states at paragraph 1:

A pension is defined in the Macquarie Dictionary as '1. A fixed periodical payment made in consideration of past services, injury or loss sustained, merit, poverty etc. 2. An allowance or annuity.' The meaning of the term 'pension' was considered by Hill J. in the Federal Court in Tubemakers of Australia Ltd v FCT (1993) 25 ATR 183. His Honour concluded that the essential characteristic of a pension is that there be periodical payments.

Subsection 60(1) of the [relevant Country A Legislation] provides that an earner who suffers personal injury by accident and does not completely recover from incapacity due to the accident will be paid earnings related compensation. Subsection 60(1) also stipulates how the amount of the compensation is calculated based on the assessment made by the [Entity].

The payments fall within the Macquarie dictionary meaning of 'pension' in that they are a fixed periodical payments made in consideration of injury or loss sustained. Furthermore, the payments have the essential characteristic of a pension as per Hill J in the Tubemakers Case in that they are periodical payments made weekly.

The compensation payments made to the taxpayer from the Entity are therefore a pension for the purposes of the [DTA].

As the workers' compensation payments are related to earnings, they are ordinary income and are included in the assessable income of the taxpayer under subsection 6-5(2) of the ITAA 1997.

Taxation Determination TD 93/3 Income tax: is a payment, being a partial commutation of weekly compensation payments, assessable income? considers that where a lump sum payment is made in lieu of weekly compensation for loss of income, the amount continues to be assessable income. Paragraph 4 of TD 93/3 states:

The weekly payments are assessable income because they are paid as compensation for loss of income or salary, or because of their regular receipt and their nature as a supplement to income, etc (FC of T v. Inkster 89 ATC 5142; 20 ATR 1516). We consider that a lump sum payment, which is a partial commutation of weekly payments, does not change its character of compensation for loss of income. Effectively, the payment is an advance of future weekly payments. Consequently, it continues to be assessable...

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects its character was also considered in Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138. In that case, Mathews J found that payments made to replace income take on the character of the payment they replace and that the method of payment does not alter the character of the payment. Mathews J held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing redemption of those future weekly payments was also income.

Application to your circumstances

Question 1

The ATO view illustrated in TD 93/3 confirms that the amount you received as a back payment for weekly compensation paid in arrears does not change its character as earnings related compensation, as it is merely the method of payment which has changed; rather than the nature of the payment itself. Therefore, the amount retains its character as weekly compensation payments paid in arrears by the Entity to you as a resident of Australia; which the ATO ID confirms are pension payments for the purposes of the DTA.

As such, Article X.2 of the Convention will not apply to the back payment of weekly compensation, and the amount will be assessable in Australia under Article X.1 of the Agreement in the income year in which the payment was received. This is the case even though the payment relates to earlier income years.

Question 2

The ATO ID confirms that weekly payments made to Australian residents by the Entity are taxable only in Australia under Article X.1 of the Convention.

Therefore, ongoing weekly compensation payments you receive from the Entity will be taxable only in Australia under Article X.1 of the Convention.

Question 3 - lump sum payment in arrears tax offset

Income in the nature of employment income and pension income is generally derived only when received. Accordingly, back payments of income that relate to an earlier income year or years will be assessable in the year of receipt.

Section 159ZRA of the ITAA 1936 allows an income tax offset in relation to certain lump sum payments that accrued in a prior year or years.

The lump sum payment in arrears tax offset is designed to alleviate the problem of more tax being payable in the year in which the lump sum payment is received than would have been payable if the lump sum payment had been taxed in the years in which it accrued.

The offset is available in the year an 'eligible lump sum' is included in a taxpayer's assessable income and the total arrears amount is not less than 10% of the amount remaining after deducting that total arrears amount from the normal taxable income of the current year (subsection 159ZRA(1) of the ITAA 1936).

Eligible lump sum payments include those relating to back payments of compensation, sickness or accident pay for incapacity to work (subsection 159ZR(1) of the ITAA 1936).

Application to your circumstances

The back payment for weekly compensation you received from the Entity meets the criteria for eligibility contained in subsection 159ZR(1) of the ITAA 1936.

As the amount you received meets the criteria for eligibility, you can apply the lump sum payment in arrears tax offset to the lump sum in the income year in which the amount was received in accordance with section 159ZRA of the ITAA 1936.

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