Edited version of private ruling

Authorisation Number: 1011651057296

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Ruling

Subject: Compensation income

1. Is the lump sum compensation you received for loss of income assessable?

Yes.

2. Is the lump sum compensation you received for injury assessable?

No.

3. Will any capital gain arising from the injury component amount be disregarded?

Yes.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commenced on:

1 July 2009

Relevant facts and circumstances

You received a workers compensation payment in the 2009-10 financial year.

This injury was acquired while you were working for your employer.

The payment dates back to previous income years.

Your compensation payment was for the injury and for loss of weekly income for a period of over one year.

The lump sum is dissected into payment for weekly compensation, expenses and compensation for impairment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 15-30.

Income Tax Assessment Act 1997 Paragraph 118-37(1)(b).

Income Tax Assessment Act 1997 Section 102-5.

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

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:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Lump sum for loss of income

In order to determine the taxation treatment of a compensation payment, the nature of the compensation payment must be examined, as 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) 5 ATR 443; (1952) 10 ATD 82).

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. Therefore, the payment you received for loss of income is ordinary income and is assessable under section 6-5 of the ITAA 1997.

Lump sum for injury

The lump sum you received for injury 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 injury, rather than from a relationship to personal services performed.

Accordingly, the payment for injury 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 a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Section 10-5 of the ITAA 1997 lists those provisions. Included in this list are section 15-30 of the ITAA 1997 which deals with insurance recoveries and section 102-5 of the ITAA 1997 which deals with capital gains.

Section 15-30 of the ITAA 1997 operates to include in a taxpayer's assessable income any amount received by way of insurance or indemnity for the loss of an amount if the lost amount would have been included in the taxpayer's assessable income but was not assessable under section 6-5 of the ITAA 1997.

The compensation amount paid to you for injury would not have been included in your assessable income and therefore section 15-30 of the ITAA 1997 will have no application.

Amounts received in respect of personal injury, which are 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)(b) 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 personally'.

Accordingly, the lump sum payment you received for injury is not assessable under either section 6-5 or section 102-5 of the ITAA 1997.

You are required to declare the amount for loss of earnings in your tax return and will be taxed at your marginal tax rate.

Additional Note

Please note that you may be entitled to a lump sum in arrears offset. Whether an offset applies in your situation cannot be determined until you lodge your income tax return.

To be eligible for the lump sum in arrears tax offset a taxpayer must satisfy the following conditions:

1. The taxpayer must have received a lump sum payment of eligible income that accrued, in whole or in part, in an earlier year or years of income. Eligible income is defined in subsection 159ZR(1) of the Income Tax Assessment Act 1936 (ITAA 1936) to include income by way of compensation or sickness or accident pay that is:

§ in respect of an incapacity for work;

§ calculated at a weekly or other periodical rate; and

§ not made under a policy of insurance to the owner of the policy; and

2. the amount of the lump sum which accrued before the year of receipt must not be less than 10% of the taxpayer's normal taxable income of the year of receipt. Normal taxable income is defined in subsection 159ZR(1) of the ITAA 1936 to be taxable income less:

§ the amount of the eligible lump sum that accrued in earlier years;

§ abnormal income (generally income of certain professionals, such as artists or sportspeople, that is subject to averaging);

§ net capital gains;

§ eligible termination payments; and

§ lump sum payments on termination of employment in lieu of annual leave or long service leave.

The amount of the lump sum in arrears tax offset to which a taxpayer may be entitled is calculated in accordance with sections 159ZRB to 159ZRD of the ITAA 1936. The tax offset amount is effectively the difference between the tax payable on the lump sum in the year of receipt, and the tax that would have been paid had it been taxed as it accrued.