Edited version of private ruling

Authorisation Number: 1011778315528

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Ruling

Subject: Lump sum in arrears tax offset

Questions and answers:

1. Are you entitled to a tax offset for the full lump sum payment in arrears you received?

No.

2. Are you entitled to a tax offset for part of the lump sum payment in arrears you received?

Yes.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commenced on:

1 July 2009

Relevant facts:

You were paid workers compensation as a result of an incapacity to work.

It was paid in a lump sum in the income year.

The lump sum was paid to cover wages in arrears.

The lump sum included wages accrued in previous income years and the current income year.

The wages in arrears that accrued from a date to a later date one year prior to the day the lump sum was paid amounted to $X.

Your taxable income for the income year was $Y.

Your taxable income for the income year was composed only of normal salary and wages from employment. It did not contain any abnormal income, net capital gains, eligible termination payments or lump sum payments on termination of employment.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-5.
Income Tax Assessment Act 1936 Section 159ZRA.

Reasons for decision

Lump sum payment in arrears

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.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; (1952) 10 ATD 82).  Compensation payments that substitute for income have been held by the courts to be income under ordinary concepts (FC of T v. Inkster (1989) 24 FCR 53; 89 ATC 5142, (1989) 20 ATR 1516). The payment retains the characteristics of ordinary income even though it is paid as a lump sum. 

Subsection 6-5(4) of the ITAA 1997 states that in working out whether you have derived an amount of ordinary income, and when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

In your case, the lump sum workers compensation amount you received is a payment for wages in arrears and so is fully assessable as ordinary income. It is assessable in the income year because the payment was received in that income year. This is the case even though part of the payment relates to earlier income years.

Lump sum in arrears tax offset

Individual taxpayers, who receive certain assessable lump sum payments containing an amount that accrued in earlier income years, may be entitled to a lump sum in arrears tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936).

The following income is eligible for the tax offset:

(a) a)salary or wages to the extent to which they accrued during a period ending more than 12 months before the date on which they are paid

(b) b)salary or wages paid to a person after re-instatement to duty following a period of suspension of the person from duty, to the extent to which the salary or wages accrued during the period of suspension

(c) c)superannuation income streams or annuities paid to individuals covered by section 12-80 or 12-120 in Schedule 1 to the Taxation Administration Act 1953

(d) d)a Commonwealth education or training payment

(e) e)income by way of compensation or sickness or accident pay in respect of an incapacity for work which is covered by ITAA 1997 Division 52, 53 or 55 but that is not exempt from income tax under those Divisions

(f) f)a payment under a law of a foreign country.

In your case, paragraphs (b), (c), (d) and (f) are not applicable because they do not relate to workers compensation payments. Paragraph (e) is also not applicable because Divisions 52, 53 and 55 relate to pensions, benefits and allowances under the Social Security Act 1991 or the Veterans' Entitlements Act 1986 and your payment does not fall under any of these Divisions. Therefore, in your case, only paragraph (a) is applicable. Income that is eligible for the tax offset is the salary or wages which accrued during a period ending more than 12 months before the date on which they were paid.

Therefore, in your case, the income accrued during the period from an earlier income year to a date one year prior to the day the lump sum payment was received is the income eligible for the tax offset. This amount was stated to be $X.

To be eligible for the tax offset, the amount of the eligible lump sum must also not be less than 10% of the taxable income of the year of receipt after deducting the amount of the eligible lump sum that accrued in earlier years and other income. Other income includes abnormal income, net capital gains, employer termination payments (ETPs) and lump sum payments on termination of employment in lieu of annual leave or long service leave.

In your case, the eligible lump sum payment you received was $X. Your taxable income for the income year ending 30 June 2010 was $Y and did not contain any other income that required exclusion. Therefore, the eligible lump sum was more than 10% of the taxable income of the year of receipt after deducting the amount of the eligible lump sum that accrued in earlier income years. Therefore, you are entitled to a tax offset for the eligible lump sum of $X.

In conclusion, you are eligible for the lump sum in arrears tax offset for the $X eligible income that accrued between the periods of a date and a later date one year prior to the day of lump sum payment.

Example of calculation

During the 2010/11 income year, a taxpayer received a lump sum payment of $10,000 representing a back payment of workers compensation. The lump sum accrued as follows:

The taxpayer's taxable incomes were $20,000 in 2008/09, $26,000 in 2009/10 and $65,000 (including the lump sum of $10,000) in 2010/11. Assume that the taxpayer is not entitled to any other offsets for those years.

The offset is equal to the amount calculated as:

tax on arrears less notional tax on arrears.

The steps for calculating the offset are as follows:

Step 1: Calculate the tax on arrears

Step 2: Calculate notional tax for recent accrual years

Step 3: Calculation of offset amount