Edited version of private ruling

Authorisation Number: 1011424463099

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Ruling

Subject: Compensation - lump sum

Question 1

Is the relevant amount of foreign currency received from the foreign entity included in your assessable income in Australia?

Answer:

Yes.

Question 2

Is the amount of foreign currency received from the foreign entity included in your assessable income in Australia?

Answer:

No.

This ruling applies for the following period

Year ended 30 June 2009

The scheme commenced on

1 July 2008

Relevant facts

You are a resident of Australia.

You received a one off payment from the foreign entity as a result of your parent's accidental death.

You were eligible for weekly compensation of an amount of foreign currency from the relevant year of income. An arrears amount of foreign currency gross for another period from the relevant year of income and an amount of foreign currency for the year of income to be paid.

These amounts were based on your parent's weekly earnings.

You were also entitled to a survivors grant of foreign currency.

No foreign tax was taken out of your entitlements.

The total amount of relevant foreign income was credited to your account in the relevant year of income.

You included an amount in you tax return.

An assessment for the year issued.

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 paragraph 118-37(1)(b)

Income Tax Assessment Act 1997 section 995-1

International Tax Agreements Act 1953 subsection 4(1)

Reasons for decision

Ordinary income

Subsection 6-5(2) of the ITAA 1997 states that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

You have received the lump sum in the 2008-09 year of income and therefore derived that income at that time for the purposes of section 6-5 of the ITAA 1997 (Taxation Ruling TR 98/1).

Ordinary income is income according to ordinary concepts which is not specifically defined in the legislation.

However, characteristics of ordinary income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.  

Compensation payments

The assessability of a compensation payment depends upon a consideration of all the circumstances surrounding it.

Payment for personal services, whether received in the capacity of an employee or otherwise in connection with employment or other personal services is income according to ordinary concepts. Similarly, any payment (for example compensation) to replace income is also considered to be income according to ordinary concepts.

Payment as a lump sum

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was 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.

Your entitlement to ongoing fortnightly compensation payments was paid as a lump sum amount. The periodic compensation payments were ordinary income and this lump sum payment retains the character of being ordinary income.

In this instance, the lump sum payment has been made to replace an income stream and also for loss of support. As such, it is necessary to consider whether the payment could be dissected into assessable and non-assessable components.

McLaurin v. Federal Commissioner of Taxation (1961) 104 CLR 381; (1961) 12 ATD 273; (1961) 8 AITR 180 and subsequently Allsop v. Federal Commissioner of Taxation (1965) 113 CLR 341; (1965) 14 ATD 62; (1965) 9 AITR 724 raised the proposition that where a lump sum compensation payment can be dissected into its constituent income and capital components, the income components may be assessable. The Commissioner confirmed this view in Taxation Determination TD 93/58 and indicated that any part of a lump sum compensation amount will only be assessable as ordinary income:

· if the payment is compensation for loss of income only...; or

· to the extent that a portion of the lump sum is identifiable and quantifiable as income. This is possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

Survivors grant

The payment does not have the characteristics of ordinary income. It was not earned by you and was not a payment for any personal services provided. Further to this, the payment did not seek to compensate for any loss of earnings which would have otherwise been assessable as ordinary income. It was paid in order to compensate for the suffering as a result of your parent's death. As a one-off payment it had no element of periodicity, recurrence or regularity.

The lump sum survivors grant of foreign currency is therefore not income according to ordinary concepts and therefore not assessable under section 6-5 of the ITAA 1997.

Australian and the foreign country tax treaty (the Agreement)

In determining liability to tax on foreign sourced income received by an Australian resident taxpayer, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (the Agreements Act).

A Schedule to the Agreements Act contains the relevant Agreement. The Agreement operates to avoid the double taxation of income received by Australian and the foreign country's residents.

A Subsection of the Agreements Act provides that the Agreements Act incorporates the ITAA 1997 and those Acts are read as one. The Agreements Act effectively overrides the ITAA 1997 where there are inconsistent provisions (except for some limited situations that are not relevant in the present case).

An Article of the Agreement deals with pensions.

The term 'pension' is not defined in the Agreement. An Article of the Agreement provides that any term not defined in the Agreement shall, unless the context otherwise requires, have the meaning which it has under the law of that State from time of force to time in force relating to the taxes to which the Agreement applies.

In relation to the meaning of the term 'pension', Taxation Determination TD 93/151, this 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.

Your lump sum compensation payment does not fall within the Macquarie dictionary meaning of 'pension' in that they are not periodical payments made in consideration of injury or loss sustained.

The compensation payments made to you from the foreign entity are therefore not a pension for the purposes of the Agreement.

An Article deals with Other Income which means income not expressly covered by any other article of the agreement. This income is assessable in the country of residence of the recipient which is Australia.

Accordingly the lump sum is assessable in Australia.

Capital Gains Tax

Section 6-10 of the ITAA 1997 provides that, amounts that are not ordinary income but may be assessable under another provision are called statutory income. Receipt of a lump sum payment may give rise to a capital gain (a statutory income), as a right to seek compensation is an asset for capital gains tax (CGT) purposes and the cancellation or surrendering of such a right is a CGT event .

However, Taxation Ruling TR 95/35 provides that a capital gain made from a CGT event which relates directly to compensation or damages received for any wrong, injury or illness suffered by a person or a relative of that person is disregarded for CGT purposes, (paragraph 118-37(1)(b) of the ITAA 1997).

'Relative' is defined under section 995-1 of the ITAA 1997 as:

· a person's spouse,

· the parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendent or adopted child of that person or of that person's spouse, or

· spouse of a person referred to in paragraph (b).

In your case, the payment is directly related to the loss of your parent, and as such the payment will be exempt from CGT under paragraph 118-37(1)(b) of the ITAA 1997.

Accordingly, the lump sum payment will not be assessable as a capital gain.

Note: If you choose to rely on this private ruling please inform the office and we will process an amendment to give affect to the ruling decision.