Edited version of your private ruling

Authorisation Number: 1012443026746

Ruling

Subject: Lump sum compensation payment

Question

Is any part of the lump sum compensation payment assessable as ordinary income or as a capital gain?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

You sustained injuries in a motor vehicle accident.

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

In an Australian state, a motor accident commission (MAC) is the Compulsory Third Party (CTP) insurer. An insurance company is the claims manager and it is responsible for processing claims and handling enquiries.

You received a payment and signed a deed of release.

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

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 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

· have an element of periodicity, recurrence or regularity.

The compensation amount you have accepted is 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. 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.

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 will receive is received to compensate for loss of income.

Medical expenses are a private expense. Therefore, reimbursement of this amount does not give rise to assessable income.

Accordingly, no part of the lump sum compensation payment will be 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 will receive to compensate you for the injuries you received in your motor vehicle accident.