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Ruling

Subject: taxation of damages settlement

Question 1

Is your lump sum compensation payment received for personal injuries assessable as income?

Answer

No.

Question 2

Will any capital gains arising from the compensation payment be disregarded?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commences on

01 July 2010

Relevant facts and circumstances

In 2010 you suffered a workplace injury to your back.

You received workers' compensation for your personal injury and later commenced a damages action.

Your damages action was settled out of court in 2011. You agreed to a lump sum payment as settlement for your damages action.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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

Reasons for decision

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 included receipts that:

§ are earned

§ are expected

§ are relied upon, and

§ have an element of periodicity, recurrence or regularity

The lump sum you received was not earned by you as it does not relate to services performed. 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 pain, suffering and medical treatment required resulting from the injury, rather than from a relationship to personal services performed.

McLaurin v Federal Commissioner of Taxation (1961) 104 CLR 381; (1961) 12ATD 273; (1961) 8 AITR 180 raised the proposition that where a lump sum compensation payment can be dissected into its constituent income and capital components, the income may be assessable.

However, 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.

The undissected lump sum payment in satisfaction of your claim against your employer for your personal injuries claim is not assessable.

Capital gains tax (CGT)

Amounts received in respect of personal injury which are not direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the CGT provisions of the Income Tax Assessment Act 1997 (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.

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 suffer personally'. Therefore, any capital gain that may arise from the receipt of the lump sum payment for victimisation and unlawful discrimination will be disregarded.