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Edited version of your private ruling
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Ruling
Subject: Taxation of settlement amount
Question 1
Will any part of your settlement amount constitute assessable income?
Answer 1
No.
Question 2
Will any part of your settlement amount be assessable under the capital gains tax (CGT) provisions?
Answer 2
No.
This ruling applies for the following period
Year ended 30 June 2012.
The scheme commences on
01 July 2011
Relevant facts and circumstances
You suffered a work related injury. You attempted to claim compensation for your injury and your employer disputed their liability in relation to your injury. They assessed that you were not entitled to a benefit and declined to accept your claim and payments were denied.
A dispute arose about your entitlement to the compensation benefits and you commenced legal proceeding against your employer.
Your employer has negotiated an out of court settlement with you and their settlement offer is to settle your court proceedings and your entitlement to benefits under the Workers' compensation legislation.
You have recently signed the Deed of Agreement to settle for an un-dissected capital payment.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 6-10
Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)
Reasons for decision
Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).
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
§ have an element of periodicity, recurrence or regularity.
The lump sum payment you will be accepting is not income from rendering personal services, income from property or income from carrying on a business.
The payment will be a one off payment and thus it does not have an element of recurrence or regularity.
A nature of the payment described in the scheme generally bears the character of that which it is designed to replace. If the lump sum payment 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 settlement is a result of legal action where entitlement to receive income from your employer's workers' compensation policy was in dispute. It is not a lump sum payment which substitutes for an income stream but rather for entering into a Deed of Release with your employer for the purpose of surrendering your rights under the workers' compensation policy. The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.
Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but may be assessable under another provision are called statutory income.
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 ITAA 1997.
Receipt of a lump sum payment may give rise to a capital gain (statutory income). However, paragraph 118-37(1)(b) of the ITAA 1997 disregards payment or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness.
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.
When settling with a lump sum payment you would be surrendering your rights, not only to recover any such benefits in the action, but also to claim any further benefits to which you might now or in the future have an entitlement under your workers' compensation entitlements. As each of these claims relate to your injury, any capital gain or loss arising from the surrender of your rights under your employer's workers' compensation policy will be disregarded.
Applying paragraph 118-37(1)(b) to your circumstances, the lump sum payment would not be considered as an assessable capital gain.