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Ruling

Subject: Compensation payment

Question

Is any part of your lump sum compensation payment assessable income?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You sustained injuries in a vehicle accident.

You lodged a claim for damages in respect of the injuries.

You have provided a breakdown of your settlement from your insurer.

You received a lump sum settlement to finalise the claim from the insurance company that is responsible for compulsory third party insurance in your State.

You have provided a breakdown of your settlement from your insurer.

You received a lump sum settlement to finalise the claim from the insurance company that is responsible for compulsory third party insurance in your State.

The legislation in your State governing compulsory third party insurance provides for payment of 'damages for loss of earning capacity'. The legislation does not provide for compensation for actual loss of income.

Relevant legislative provisions

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 and

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

Reasons for decision

Summary

No part of the lump sum payment you received to compensate you for the injuries you sustained in a motor cycle accident is assessable and the amount will not be subject to capital gains tax.

Detailed reasoning

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 three 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 compensation you received was not income from rendering personal services, income from property or income from carrying on a business.

The payment is also a one off payment and thus it does not have an element of recurrence or regularity.

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. However no component of the amount you received was received to compensate for loss of income. The portion relating to past or future economic loss is compensation for loss of earning capacity (a capital asset) rather than for actual loss of income.

Accordingly, no part of the lump sum compensation payment is assessable under section 6-5 of the ITAA 1997.

Capital gains tax arising from the compensation payment

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Section 10-5 of the ITAA 1997 lists those provisions. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains.

Amounts received in respect of personal injuries which are not for reimbursements 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.

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.

The disposal of a taxpayer's right to seek compensation triggers the capital gains tax provisions and the settlement amount is treated as capital proceeds.

However, paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain where the amount relates to compensation or damages received for any 'wrong, injury or illness you suffer personally'.

In your case, you will not be subject to capital gains tax in respect of the amount you received to compensate you for the injuries you received in your vehicle accident.