Edited version of private ruling

Authorisation Number: 1011668874501

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Ruling

Subject: Compensation payment - will it be subject to income tax and capital gains tax

Question 1

Will amount A received under the Agreement be subject to income tax?

Answer: Yes

Question 2

Will amount B received under the Agreement be subject to income tax?

Answer: No

Question 3

Will the sum of amount A and amount B, or any part of it received under the Agreement, be subject to capital gains tax?

Answer: No

This ruling applies for the following period

1 July 2010 to 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

The taxpayer is an Australian resident for taxation purposes and was injured at work several times.

The taxpayer has during the period of employment with the employer suffered disabilities arising out of or in the course of their employment with the employer as set out in the table below.

The tax payer acknowledges that he has not suffered any compensable disability arising from his employment with the employer resulting in total or partial incapacity other than those specified.

The employer has an undischarged liability to the worker to:

· make weekly payments of income maintenance pursuant to Division IV of the Act, and

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

The taxpayer and the employer have entered into negotiations and are proposing to enter into an agreement for the redemption of the undischarged liability pursuant to section 42 of the workers rehabilitation and compensation Act 1986.

The tax payer is not currently in receipt of weekly payments of income maintenance. Nevertheless, the employer wishes to redeem its undischarged liability arising out of the compensable disabilities specified.

It is the intention of the employer and the tax payer that this redemption agreement is part of an overall settlement of the worker's incapacity resulting from the compensable disabilities.

It is the intention of the employer and the worker that this redemption agreement is part of an overall settlement of the tax payer's entitlement to compensation resulting form the compensable disabilities and that the employer's liability will be fully and finally extinguished as a consequence of the amounts paid to the worker pursuant to the settlement (including the redemption made pursuant to this agreement).

Redemption of Weekly payments

The undischarged liability to make weekly payments of income maintenance pursuant to Division IV of the Act be redeemed by a lump sum capital payment.

The tax payer's entitlement to Centrelink (Social Security) benefits may be limited or excluded by reason of the said capital payment and the worker assumes that risk and Centrelink may claim a charge for payments made.

That the tax payer, assumes the risk of any taxation consequences, arising from receipt of the said capital payment.

Redemption of Section 32 medical and other expenses

The undischarged liability to pay compensation for medical and other expenses of the kind referred to in section 32 of the Act be redeemed by a capital payment.

That on receipt of the said capital payment the employer would be wholly discharged from any further liability to pay compensation for medical or other expenses of the kind referred to in section 32 of the Act.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 118 paragraph 20

Income Tax Assessment Act 1997 Section 118 paragraph 37(1)(a)

Income Tax Assessment Act 1997 Section 6 - 5

Reasons for decision

Question 1

Summary

The lump sum payment is assessable income as it represents income maintenance payments.

Detailed Reasons

Payment received in connection with salary and wages have the characteristics of assessable income under the concept of "ordinary income" under section 6-5 of the Income Tax Assessment Act 1997.

Worker's compensation payments which represent lost income due to injury are assessable in the same manner as salary and wages as they are received in connection with employment. This is so, irrespective of whether the payments are made periodically or in a lump sum.

The question of whether a lump sum payment received in redemption of weekly compensation payments is income or a capital payment has been considered by a number of AAT and Court cases, notably FCT v Inkster 89 ATC 5142 and case Y47 91 ATC 433.

In both these cases the lump sum payment was held to be assessable income. This situation is also addressed in Taxation Determination TD93/3.

On the other hand, any payments which represent compensation for injury or damages are regarded as capital and not assessable.

Where a lump sum payment contains both income and capital amounts and where the components can be identified, the income components are assessable and the capital amounts are not. On the other hand, where the payment is not dissected by the insurance company, in accordance with the court decisions 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.

The copy of the agreement provided shows that your payment of the lump sum amount consisted of a redemption liability for future weekly payments and medical expenses under the relevant clauses of the Workers Compensation and Rehabilitation Act.

Consequently, the lump sum amount is assessable as there is a direct link with your income. The fact that the weekly payment was commuted into a lump sum does not alter the character of the payment as assessable income. It has only replaced a periodic payment with a lump sum which still represents the weekly payments.

Question 2

Summary

This sum received under medical expenses Agreement is not assessable.

Detailed Reasons

The medical expenses sum is not assessable income as it relates to medical and other expenses which are capital in nature.

Question 3

Summary

The amount is excluded from capital gains tax by the operation of Section 118-20 and Section 118-37(1)(a).

Detailed Reasons

Taxation Ruling TR 95/35 deals quite extensively with the treatment of compensation receipts. TR 95/35 states that we use a 'look through approach' or 'underlying asset approach' to determine the most relevant asset to which a compensation receipt applies.

In the case of personal injury caused by an employer's negligence a number of claims may be sought namely:

1. Loss of past earnings

2. Loss of future earning capacity

3. Medical expenses

4. Personal injury.

A lump sum compensation payment may be dissectible into the different claims. The tax treatment depends upon the claim to which the payment relates. Items 1 and 2 would be assessable under the ordinary income provisions of section 6-5 of the Income Tax Assessment Act 1997. As a result these amounts would be excluded from capital gains tax by the operation of Section 118 - 20 of the ITAA1997.

Items 3 and 4 would have no capital gains tax implications, as the capitol gain is disregarded due to the operation of paragraph 118-37(1)(a) of the ITAA 1997, if it is in respect of a personal injury or damages for a wrong or injury suffered in the taxpayers occupation.

As amount A is covered by item 2 above it is excluded from capital gains tax by the operation of Section 118 - 20 of the ITAA1997.

Amount B is covered by item 3 and therefore, is exempt from capital gains tax by the operation of Section 118-37(1)(a) of the ITAA 1997 because it was paid in respect of a wrong or injury suffered in your occupation.