Edited version of your private ruling

Authorisation Number: 1012537905725

Ruling

Subject: taxation of compensation settlement

Question

Is the lump sum compensation payment you received included as assessable income?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

When you worked for X you suffered an injury to your back. You received weekly workers compensation payments and associated expenses were paid.

You commenced legal action for payment for further compensation due the ongoing injury to your back.

On the dd/mm you reached a negotiated settlement with X in relation to your legal proceedings. You agreed to accept payment of $X to finalise your legal action.

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 Paragraph 118-37(1)(a)

Reasons for decision

Income

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

· have an element of periodicity, recurrence or regularity.

The lump sum payment you accepted is not income from rendering personal services, income from property or income from carrying on a business.

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

The 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.

It is not a lump sum payment which substitutes for an income stream but rather for entering into a Memorandum of Agreement with your employer for the purpose of surrendering your rights under the Workers' Compensation And Injury Management Act 1981.

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 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 surrendered your rights, not only to recover any such benefits in the action, but also to claim any further benefits.

As the claim relates to your incapacity, any capital gain or loss arising from the surrender of your rights under your policy will be disregarded.

Applying paragraph 118-37(1)(b) of the ITAA1997 to your circumstances, the lump sum payment would not be considered as an assessable capital gain.