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Ruling

Subject: Compensation payments

Question 1

Is the payment that you received for non-economic loss included in your assessable income?

Answer

No.

Question 2

Is your lump sum compensation settlement payment included in your assessable income?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

In a previous income year you sustained an injury in the course of your employment.

You received workcover payments following your injury.

You received a specified payment from the agent authorised to provide claims management services for the relevant workcover authority.

The specified payment was made pursuant to legislation, which pays compensation for non-economic loss.

Your solicitor subsequently served an application for serious injury certification on the relevant workcover authority.

The workcover authority granted you a serious injury certificate. As your injury was found to be serious, you had the right to sue your employer for damages.

You sued your employer for common law damages with regards to your injury. You claimed that your employer was negligent (that is, that they breached a duty of care to you).

Court proceedings for damages did not commence. Your claim for common law damages was settled after a statutory offer was made and your statutory counter-offer was accepted.

The lump sum settlement sum was in full and final settlement of your claim for both pecuniary loss and pain and suffering damages.

From the lump sum compensation settlement amount, your solicitors' fees and a repayment to Centrelink were deducted. The net amount was then deposited into your bank account.

Your solicitor advised that you received the lump sum settlement for both pain and suffering and for pecuniary loss, but that no specific amount was allocated to each type of damage (that is, there was no breakdown). The settlement was an undissected lump sum compensation payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 4-10

Income Tax Assessment Act 1997 Section 4-15

Income Tax Assessment Act 1997 Subsection 6-1(1)

Income Tax Assessment Act 1997 Subsection 6-15(1)

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Subsection 118-37(1)

Reasons for decision

Summary

The compensation payments that you received (that is, the specified payment for non-economic loss and the lump sum settlement payment) are not ordinary income and are not statutory income. Consequently, the payments are not assessable income so you do not have to pay income tax on them.

Detailed reasoning

Taxable income

Under section 4-10 of the Income Tax Assessment Act 1997 (ITAA 1997), income tax is worked out by reference to your taxable income for the income year. Taxable income is calculated by subtracting the deductions from the assessable income for the income year (section 4-15 of the ITAA 1997).

Assessable income

Subsection 6-1(1) of the ITAA 1997 states that assessable income consists of:

o ordinary income

o statutory income.

If an amount is not ordinary income and is not statutory income it is not assessable income, so you do not have to pay income tax on it (subsection 6-15(1) of the ITAA 1997).

Ordinary income

Ordinary income is income according to ordinary concepts (section 6-5 of the ITAA 1997).

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

The courts have identified a number of factors which indicate whether an amount has the character of income according to ordinary concepts.

A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity (FCT v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82).

One or more of the following characteristics will combine with periodicity to give an amount an income nature:

o it is made in substitution of income

o it is made to provide financial support, for example, as an income supplement

o it is received in circumstances where the recipient has an expectation of receiving the payment on a regular basis so that the recipient is able to depend upon the payment for his or her regular expenditure.

In your case, you received a specified payment as compensation for non-economic loss and a lump sum payment to settle your claim for common law damages. These compensation payments were made as a result of your injury. They are not payments for rendering personal services, income from property or income from carrying on a business. The payments were also one-off payments and therefore do not have an element of periodicity or regularity.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments which substitute income, or which are paid to replace lost earnings, have been held by the courts to be ordinary income. 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.

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:

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

o 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.

In your case, you received the specified payment as compensation for non-economic loss rather than for loss of an income nature. You received the lump sum settlement for both pain and suffering and for pecuniary loss, but no specific amount was allocated to each type of damage (that is, there was no breakdown). The settlement payment was an undissected lump sum, so none of the lump sum is identifiable and quantifiable as relating to loss of an income nature.

Therefore, neither the specified payment for non-economic loss nor the lump sum settlement payment is assessable as ordinary income.

However, it is also necessary to consider whether the above compensation payments are statutory income.

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.

Section 102-5 of the ITAA 1997 provides that assessable income includes any net capital gain (the total of capital gains for the income year, reduced by certain capital losses).

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:

o acquired at the time of the compensable wrong or injury

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

However, subsection 118-37(1) of the ITAA 1997 disregards any capital gain or capital loss made where the amount relates to compensation or damages you receive for:

o any wrong or injury you suffer in your occupation

o any wrong, injury or illness you or your relative suffers personally.

In your case, subsection 118-37(1) of the ITAA 1997 applies. This means that the compensation payments (the specified payment for non-economic loss and the lump sum settlement) that you received as a result of the injury you sustained in the course of your employment are not included in your assessable income by virtue of the CGT provisions. Therefore, these compensation payments are not statutory income.

Conclusion

The compensation payments that you received (that is, the specified payment for non-economic loss and the lump sum settlement) are not ordinary income and are not statutory income. Consequently, they are not assessable income so you do not have to pay income tax on them (subsection 6-15(1) of the ITAA 1997).