Edited version of private ruling

Authorisation Number: 1011653694642

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Ruling

Subject: Income Tax: Redemption of compensation payments in lump sum payment

Question 1

Is the money paid by the employer by way of redemption of liabilities to pay for the future weekly income assessable as ordinary income?

Answer

No.

Question 2

If not assessable as ordinary income, are you liable for capital gains tax on the redemption amount?

Answer

Yes. However, the capital gains tax is disregarded under section 118-37 of the Income Tax Assessment Act 1997 (ITAA 1997).

This ruling applies for the following period

Income year ending 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You suffered compensable disability arising from employment with a Self Insured Employer.

You sustained several injuries during this time.

The employer has undischarged its liability to you arising from the compensable disabilities and have reached an agreement with you for the redemption of these liabilities:

§ to make weekly payments of income maintenance pursuant to Division 4 of the Workers Rehabilitation and Compensation Act 1986 (SA) (WRCA); and

§ to pay compensation for medical and other expenses of the kind referred to in section 32 of the WRCA.

The employer and you have agreed that the undischarged liability consist of:

§ weekly payments of income maintenance be redeemed by a capital payment; and

§ to pay compensation for medical and other expenses of the kind referred to in section 32 of the WRCA incurred by the taxpayer after the date of the agreement be redeemed by a capital payment.

You acknowledge that the payment less any payments required to Medicare Australia and Centrelink, discharges the employer from any further liability to make a capital payment for loss of future earning capacity/weekly payments and medical and like expenses.

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 15-30

Income Tax Assessment Act 1997 Section 118-37

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

Reasons for decision

Question 1

Ordinary income

Section 6-5 of the ITAA 1997 deals with receipts of ordinary income. It does not operate to include in assessable income amounts of a capital nature.

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

Based on case law, ordinary income generally includes receipts that:

§ are earned

§ are expected

§ are relied upon, and

§ have an element of periodicity, recurrence or regularity.

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.

Whether compensation payments are paid on a weekly basis or in a lump sum fashion, the compensation receipts that substitute for income have been held by the courts to be income under ordinary concepts. As such, the amount received to compensate for loss of income will be subject to tax under the ordinary income provisions of section 6-5 of the ITAA 1997.

However, in your case, you and your employer have agreed to a settlement of the employer's liabilities of weekly income maintenance and medical expenses to be paid as lump sum redemption under sections 32 and 42 of the WRCA. The settlement to be received will be in satisfaction of surrendering your rights to weekly income maintenance payments and medical expenses and any future claim against your employer for injuries suffered in your occupation.

These are rights of a capital nature and the money to be received to compensate you for their relinquishment will similarly be of a capital nature.

Therefore, section 6-5 of the ITAA 1997 will not apply to the lump sum redemption amounts.

Assessable Income

Section 15-30 of the ITAA 1997 operates to include in your assessable income any amount receive by way of insurance or indemnity for the loss of an amount if:

(a) the loss amount would have been included in your assessable income; and

(b) the amount you receive is not assessable as ordinary income under section 6-5.

Where a lump sum payment is made as compensation for loss of salary or wages, such a payment retains the characteristics of ordinary income even though it was paid as a lump sum.

In your case, the lump sum redemption amounts to be paid under sections 32 and 42 of the WRCA do not meet this description, as they are not paid for loss of earnings but in satisfaction of the giving up of capital rights.

Therefore, section 15-30 of the ITAA 1997 will not apply to the lump sum redemption amounts.

Capital gains tax

Paragraph 118-37(1)(a) of the ITAA 1997 states that you may disregard any capital gain or capital loss from any capital gains tax event relating directly to compensation or damages that you receive for any wrong or injury you suffered in your occupation.

The lump sum redemption amounts to be paid under sections 32 and 42 of the WRCA meet this description.

Section 118-37 of the ITAA 1997 will apply to the lump sum redemption amounts so that any capital gain or capital loss you make will be disregarded.