Edited version of private ruling

Authorisation Number: 1011769215951

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Ruling

Subject: Compensation payment - personal injury

· Is the compensation payment you received for pain and suffering, medical expenses, loss of chance, past economic loss, travel expenses, voluntary services, loss of consortium, future care, interest and payments to Medicare Australia assessable income?

No

· If not, will this amount of the compensation payment be subject to Capital Gains Tax (CGT)?

No

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commenced on:

1 July 2010

The scheme that is the subject of the ruling

You are in receipt of a compensation award for personal injuries.

You were involved in a motor vehicle accident.

You received an undissected amount.

It was made of the following payments:

· Pain & suffering

· Past Economic Loss and Loss of Chance

· Future Medical Expenses

· Travel Expenses

· Voluntary Services (Past)

· Future Care

· Loss of Consortium

· Special Damages - Police Report

· Interest

· Medicare Australia

· Legal Costs

Relevant legislative provisions:

Income Tax Assessment Act 1997 Subsection 6-5(2).
Income Tax Assessment Act 1997 Paragraph 118-37(1)(b).
Income Tax Assessment Act 1997 Section 6-5.
Income Tax Assessment Act 1997 Section 51-57

Explanation (This does not form part of the ruling)

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

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of ordinary 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.

The compensation offered to you is not income from rendering personal services, income from property or income from carrying on a business.

The payment is also a one off payment and thus it does not have an element of recurrence or regularity.

A compensation amount generally bears the character of that which it is designed to replace. 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.

Your compensation claim was to replace lost income, reimburse previous and future medical expenses and contained a capital receipt, being the pain and suffering component of your claim. As such, it is necessary to consider whether the payment could be dissected into assessable and non-assessable components.

McLaurin v. Federal Commissioner of Taxation (1961) 104 CLR 381; (1961) 12 ATD 273; (1961) 8 AITR 180 and subsequently Allsop v. Federal Commissioner of Taxation (1965) 113 CLR 341; (1965) 14 ATD 62; (1965) 9 AITR 724 raised the proposition that where a lump sum compensation payment can be dissected into its constituent income and capital components, the income components may be assessable. The Commissioner confirmed this view in Taxation Determination TD 93/58 and indicated that any part of a lump sum compensation amount will only be assessable as ordinary income:

a) if the payment is compensation for loss of income only...; or

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

Consequently, where you receive an undissected lump sum which includes assessable and non-assessable components that cannot be identified or quantified, the whole of the lump sum amount is treated as a non-assessable receipt.

As the lump sum payment to you would comprise compensation for a mixture of income and capital items and the payment cannot be dissected into its constituent parts, the whole amount would be deemed to be of a capital nature. Therefore, the lump sum amount is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Amounts that are not ordinary income (such as capital gains) may be included in assessable income by specific provisions in the tax legislation. These amounts are called statutory income.

Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

As the amount received by you is not in respect of any underlying asset, the whole of the settlement amount is treated as capital proceeds from a CGT event (CGT event C2) happening to your right to seek compensation.

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 or your relative suffers personally'. Therefore, any capital gain made from the CGT event happening to your right to seek compensation is disregarded under paragraph 118-37(1)(b) of the ITAA 1997. It is thus not statutory income.

Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income. Consequently no part of the amount received is included in your assessable income.