Edited version of private ruling

Authorisation Number: 1011823721449

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Compensation - pain and suffering and loss of income

Question

Is the part of the compensation payment of $X you received for pain and suffering assessable income?

No.

Is the part of the compensation payment you received of $Y for loss of past and future income assessable income?

Yes.

This ruling applies for the following periods

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You received a compensation payment of $ for pain and suffering and loss of income.

The compensation payment was dissected as follows:

$X general - pain and suffering

$W past income

$Z future income

The compensation payment was dispersed as follows:

$A solicitors fees

$B solicitors fees

$C repayment of Centrelink income

$D you received

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5(2)
Income Tax Assessment Act 1997 subsection 6-15(1)
Income Tax Assessment Act 1997 section 6-20
Income Tax Assessment Act 1997 section 102-5
Income Tax Assessment Act 1997 paragraph 118-37(1)(a)

Reasons for decision

Subsection 6-5(2) of the 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 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 lump sum payment is not earned as it does not directly relate to services performed. Rather the lump sum relates to the loss of physical abilities. 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 investment in insurance, rather than from a relationship with personal services performed. Thus, the lump sum payment is not ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

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.

Amounts received in respect of personal injury which is not for reimbursement of medical expenses, or direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax provisions of the ITAA 1997.

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 ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; (1952) 10 ATD 82).

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. As such, the amount received to compensate for loss of income will be subject to tax under the ordinary income provisions of section 6-5 of the ITAA 1997.

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 the taxpayer 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 the taxpayer's right to seek compensation.

However, paragraph 118-37(1)(a) 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 ... suffer in your occupation'. Therefore, any capital gain made from the CGT event happening to a taxpayer's right to seek compensation is disregarded under paragraph 118-37(1)(a) of the ITAA 1997. It is thus not statutory income.

You were awarded a settlement amount of $ which was dispersed as follows:

$A solicitors fees

$B solicitors fees

$C repayment of Centrelink income

$D you received

The settlement amount of $ was received in respect of:

$X general - pain and suffering

$W past income

$Z future 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 the amount received for pain and suffering is neither ordinary or statutory income and is not included in assessable income. However the amount received for past income and the amount received for future income are considered to be ordinary income as they are paid to replace income. As such, these amounts are assessable income.

You repaid Centrelink an amount of $C, as this amount was assessable income when you received it, it can be excluded from the assessable portion of the payment.

A deduction is available for solicitor's fees you paid that relate to obtaining the assessable part of the settlement as it is an expense incurred in earning assessable income. For example if the lawyer's time and chargeable costs related equally to obtaining both the assessable part and the capital part of the settlement then 50% would be an allowable deduction.