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Ruling

Subject: Lump sum compensation payment

Question

Would any part of the proposed lump sum settlement payment be assessable as ordinary income or as a capital gain?

Answer

No.

This ruling applies for the following periods

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commences on

1 July 2012

Relevant facts and circumstances

You were involved in accident on your way to work.

You made a workers compensation claim which was accepted and you received fortnightly workers compensation payments for a period of time.

You have now returned to work.

You have been assessed by the insurer's medical practitioner as having a permanent disability as a result of the injury you sustained.

You attend quarterly assessments as directed by the insurer, as you are on medication as a result of your injuries.

Earlier this year you were contacted in writing by the insurer with an offer regarding the possible resolution of your claim via a settlement. You have rejected this offer as you have concerns regarding the funding of future surgery.

The offer was for a lump sum payment made up of two components. The first component is in respect of the permanent impairment from the injury and the other amount in respect of future medical expenses.

You are currently in negations in regards to the future medical expenses component of the offer as you have been advised by a legally qualified medical practitioner that you will require further surgical procedures as a result of your injuries.

If your proposal is accepted and duly approved, the lump sum received is taken to be in full and final satisfaction of all present and future claims.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 6-10

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

Income Tax Assessment Act 1997 Section 10-5

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 Income Tax Assessment Act 1997 (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 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 lump sum payment you are negotiating will not be earned as it does not relate to services performed. The payment is also be a one off payment and 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, you have suffered as a result of the injury, rather than from a relationship to personal services.

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. However no component of the lump sum amount you are negotiating will be received to compensate for loss of income. The lump sum relates to the loss of physical abilities and medical expenses you will need to pay for in the future.

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

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)(a) of the ITAA 1997 disregards a capital gain where the amount received relates to compensation or damages received for any 'wrong or injury you suffer in your occupation'.

Accordingly, no part of the lump sum compensation payment is assessable under section 6-10 of the ITAA 1997 as statutory 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. Therefore no part of the settlement amount would need to be included in your assessable income.