Edited version of private ruling

Authorisation Number: 1011699843196

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Ruling

Subject: motor vehicle accident payment

Question 1

Is any part of the lump sum compensation amount you received for damages and costs resulting from a motor vehicle accident, assessable income?

Answer

No.

Question 2

Are you entitled to a deduction for the costs relating to your motor vehicle accident claim and hearing?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling,

· letters from your solicitor, and

· compensation assessment and calculation details.

You are a sole trader.

You were injured in a motor vehicle accident.

You lodged a motor vehicle accident claim under your compulsory third party insurance policy.

Your claim was settled.

You were awarded an amount for economic losses plus regulated costs under the motor accident compensation legislation in your State.

Your settlement payment was for

· Past loss of earnings

· Future economic loss

· Past treatment

· Future treatment

· Past commercial care

· Future commercial care

· Legal costs

· Medical costs

The amount of compensation for past or future economic loss was calculated in part by reference to your estimated business income that you would have earned had you not been injured. It also refers to deprivation and impairment of earning capacity.

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 6-15.

Income Tax Assessment Act 1997 Section 10-5

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

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

No part of your compensation payment meets the ordinary definition of income or is included as assessable income by a specific statutory provision. Therefore, no part of your compensation payment is regarded as assessable income. A deduction is not allowed for your costs associated with obtaining the compensation payment as the costs were not incurred in earning or gaining assessable income.

Detailed reasoning

Ordinary income

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

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.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. Damages awarded for past or future loss or impairment of earning capacity is not ordinary income (Groves v. United Pacific Transport Pty Ltd [1965] Qd R 62).

Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income:

· if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or

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

You received your compensation payment as a result of lodging a motor vehicle personal injury claim, in respect of injuries you sustained in a motor vehicle accident.

Taxation Ruling IT 2193 deals with the issue of compensation for loss of earning capacity received as a result of a motor vehicle accident. IT 2193 discusses the decision in FCT v. Slaven 84 ATC 4077; 15 ATR 242 (Slaven's case), and makes it clear that compensation for loss of earning capacity will not lose it's character as a capital receipt simply because the amount of compensation is calculated by reference to the amount of income the taxpayer would have earned.

In Slaven's case, the taxpayer was injured in a motor vehicle accident which left her unable to work for a period of nine months. She received compensation for the deprivation or impairment of her earning capacity from the Motor Accidents Board, under the Motor Accidents Act (Vic) 1973. The Board, in determining an adequate amount of compensation to be paid to an injured person, had to have regard to the loss of earnings actually suffered and to the likely loss of future earnings. The Federal Court held that the essential character of the compensation was compensation for loss or impairment of earning capacity, a capital asset, and that it was not liable to income tax.

IT 2193 states that the decision in Slaven's case will extend to payments made by other compensation boards where the payments made are in the nature of compensation for deprivation or impairment of earning capacity.

In your case, the compensation lump sum included an amount for past loss of earnings and future economic loss.

The payment was not earned by you as it does not relate to services performed or income from carrying on your business. 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 personal injury resulting from the accident, rather than from a relationship to personal services performed.

The payment made under the motor accident compensation legislation in relation to a compulsory third party insurance policy was paid to compensate you for diminished capacity to earn income rather than the actual loss of income. The capacity to earn income is a capital asset and compensation for the loss of a capital asset is a capital receipt. In accordance with IT 2193 and Slaven's case, your compensation payment does not lose it's character as a capital receipt merely because it was calculated in part by reference to the income that you would have earned had you not been injured.

You also received a payment in relation to your past and future medical treatment and care. Medical expenses are private expenditure and the associated payment is not regarded as ordinary income. Similarly, a payment for your legal and other costs are also not considered to be ordinary income. Therefore, these payments do not give rise to assessable ordinary income.

It is considered that no component of the amount you received was received to compensate you for loss of income. Therefore, your compensation is not assessable as ordinary income under section 6-5 of the ITAA 1997.

However, as the compensation for past and future loss of earning capacity is a capital receipt, it is also necessary to consider the provisions of the income tax law which deal with capital receipts.

Statutory income

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997. The list includes capital gains, which are included in assessable income by virtue of the capital gains tax (CGT) provisions.

Taxation Ruling TR 95/35 considers the CGT consequences for a person who receives an amount as compensation. The ruling states that a right to seek compensation is an asset for the purposes of the CGT provisions, and that a right to seek compensation is:

· acquired at the time of the compensable wrong or injury, and

· disposed of when it is satisfied, surrendered, released or discharged.

TR 95/35 states that compensation received under a policy of insurance relates to a right to seek compensation.

However, paragraph 118-37(1)(b) of the ITAA 1997 disregards any capital gain or capital loss made where the amount relates to compensation or damages you receive for any wrong, injury or illness you suffer personally.

In your case, paragraph 118-37(1)(b) of the ITAA 1997 applies. This means that the compensation you received for personal injury from a motor vehicle accident is not included in your assessable income by virtue of the CGT provisions.

Your payment is not assessable under any other taxation provision.

The compensation payments you received is not ordinary income and is not statutory income. Consequently, it is not assessable income (subsection 6-15(1) of the ITAA 1997).

Expenses

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

For legal expenses to be deductible, they must have a relevant connection to the production of assessable income.

You incurred legal expenses in pursuing your personal injury claim. The compensation that you received is not assessable income, so your legal expenses do not have a relevant connection to the production of your assessable income.

Medical expenses are regarded as private in nature and therefore no deduction is allowed under section 8-1 of the ITAA 1997.

Accordingly, a deduction is not allowable for the expenses that you incurred in relation to your personal injury claim.