Edited version of private ruling

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Ruling

Subject: Capital Gains Tax concessions - query regarding compensation settlement received overseas

The taxpayer, an Australian resident, met with an accident whilst living in the overseas, for which he lodged a compensation claim.

The taxpayer migrated to Australia and the compensation claim was finally settled more than two years later. A year later the taxpayer received a payment in a foreign currency as full and final settlement of his claim.

The compensation payment was paid directly into his overseas Building Society account by his lawyers. The payment was paid in a lump sum and it was not specified how much of the payment was for pain and suffering and how much was for loss of wages (earning capacity), if any.

At present the money is still in the taxpayer's overseas building society account earning interest annually. The compensation payment is tax free in the overseas country. Although the payment received was not broken down, the taxpayer's lawyer provided a rough estimate of the break down.

Issue 1

Compensation payment received whilst an Australian resident, for an accident which happened in overseas whilst the taxpayer was living overseas. The compensation was deposited into an overseas building society account. This compensation settlement is 100% tax free in the overseas country. Is this payment subject to tax in Australia?

Question 1

Is the lump sum motor vehicle compensation payment received after the taxpayer become an Australian resident, for an accident which happened whilst the taxpayer was living overseas, assessable income in Australia?

Detailed reasoning

A compensation payment may be assessable as ordinary income, as a capital gain or non taxable.

Ordinary Income

Subsection 6-5 of the 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. That section also provides that the assessable income of a non-resident shall include the ordinary income derived from sources in Australia.

The lump sum payment the taxpayer received is not directly related to any personal services. The payment is also a one-off payment and thus 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 pain, suffering and medical treatment required resulting from the injury, rather than from a relationship with personal services performed.

Thus, the lump sum payment for personal injury is not ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

 In the taxpayers situation, as a result of a court settlement, the overseas insurance company did not dissect the payment and therefore in accordance with the court decision in McLaurin v FC of T(1962) 104 CLR 381, 34 ALJR 463;and Allsop v FC of T (1965) 113 CLR 341, the payment is not assessable as ordinary income.

In McLaurin, the taxpayer received the amount of £12,350 from the Commissioner for Railways (NSW) in full settlement of a claim for damages to the taxpayer's grazing property by a fire which commence on land of the Commissioner. The valuer employed by the Commissioner for Railways had computed by reference to the various items an amount of £12,350 which, however, had been offered to and accepted by the taxpayer as a lump sum without his knowing how it had been made up. Of the total amount of £12,350 the Commissioner had included in the taxpayer's income the amount of £10,640.

It was held by Dixon C J, Fullagar and Kitto JJ that the Commissioner of Taxation was not entitled to divide up the amount of £12.350 into the amounts which had formed its components in the valuer's computation and to bring into charge for income tax purposes the amount allowed by the valuer in respect of those items which were of an income nature.

The Court also rejected a submission that the amount was in the nature of compensation to the appellant for "loss of opportunity to use his grazing property to its full capacity, and therefore it should be considered as processing in his hands the same character as the profits would have had which the fire prevented him from making". In this regard, the Court said (104 CLR at p 392):

"But it is impossible to see a basis in fact for the contention that the £12,350

which the appellant accepted in settlement of his claims for every kind of

damage which the fire had caused him was in truth of the nature of compensation for loss of profits. The fire caused him losses of sheep and cattle, and damage to wool on surviving sheep; it put him to expense for the eradication of rabbits to the incursion of which the destruction of fences had exposed the property; it also caused losses of or damage to capital assets such as pastures, fencing and buildings. But the whole of the damage which it did, whether covered by the appellant's list of particulars or not, was compensated for by the one entire sum; and it is simply not true that the sum took the place in the appellant's hands of assessable income.

The compensation the taxpayer received was one entire sum and is capital in nature and therefore not assessable as ordinary income. The fact that the taxpayer's lawyer after the payment was received broke down the payment into various components does not make any part of the compensation assessable as ordinary income.

Capital Gain:

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income and are also included in assessable income.

Taxation Ruling TR 95/35 indicates that settlement of a personal injury claim represents the disposal of an asset, as the taxpayer has disposed of the right to seek compensation for the losses arising from the injury suffered.

The disposal of an asset gives rise to a Capital Gains Tax (CGT) event. However, subsection 118-37(1) of the ITAA 1997 disregards payments or receipts for the purposes of CGT where the amount relates to compensation or damages a taxpayer received for any wrong, injury or illness a taxpayer suffers.

Thus, the lump sum payment the taxpayer received for personal injury is disregarded from CGT by the operation of subsection 118-37(1) of the ITAA 1997.

 Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income.