Edited version of your private ruling

Authorisation Number: 1012590452156

Ruling

Subject: Compensation payment

Question 1

Is the compensation payment assessable as ordinary income?

Answer

No

Question 2

Is the compensation payment assessable under the capital gains tax (CGT) provisions?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts and circumstances

Your relative died as a result of a motor vehicle accident.

Following their death you lodged a personal injury claim against the compulsory third party insurer.

You were unable to work for a period of time following the accident due to your distress.

You have since obtained new employment.

A psychiatric assessment prepared in relation to your claim determined that you had developed an illness as a result of the grief you experienced following the accident. The assessment also determined that you would require ongoing medical treatment and that while you were capable of full time work, you were only capable of work involving less responsibility and independence of action.

After several months of negotiations the insurer agreed to pay you a settlement for personal injury and loss of income.

Your solicitors advised you that they had received your settlement payment. Your solicitors deducted their fees and forwarded the remaining amount to you.

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 Section 104-25

Income Tax Assessment Act 1997 Section 115-10

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

Reasons for decision

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, 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.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. Damages awarded for past or future loss or impairment of earning capacity is not ordinary income (Groves v. United Pacific Transport Pty Ltd [1965] Qd R 62).

Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable as ordinary income:

· if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or

· to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

Statutory income

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997. The list includes capital gains, which are included in assessable income by virtue of the CGT provisions.

Taxation Ruling TR 95/35 considers the CGT consequences for a person who receives an amount as compensation. The ruling states that a right to seek compensation is an asset for the purposes of the CGT provisions, and that a right to seek compensation is:

· acquired at the time of the compensable wrong or injury, and

· disposed of when it is satisfied, surrendered, released or discharged.

TR 95/35 states that compensation received under a policy of insurance relates to a right to seek compensation. Additionally, if the amount of compensation received is an undissected lump sum, the whole amount is treated as being received for the disposal of the right to seek compensation.

Where an intangible asset, such as a legal or equitable right is disposed of, CGT event C2 occurs under subsection 104-25(1) of the ITAA 1997.

Paragraph 118-37(1)(b) of the ITAA 1997 disregards any capital gain or capital loss made where the amount relates to compensation or damages you receive for any wrong, injury or illness you suffer personally.

However, if compensation is received by a taxpayer in an undissected lump sum paid in settlement of a number of claims, including a personal injury claim, and its individual components cannot be determined or reasonably estimated, then no part can be quantified as relating to personal injury of the taxpayer. Accordingly, if a compensation payment is paid as an undissected lump sum, the exclusion contained in paragraph 118-37(1)(b) of the ITAA 1997 will not apply unless it can be determined that the amount relates wholly to the personal injury.

Application to your circumstances

From the information provided we consider that the compensation payment you received was in settlement of your claim relating to both your loss of income and personal injury.

In accordance with TR 95/35, as you received an undissected lump sum payment, the whole amount you received will treated as being received for the disposal of your right to seek compensation. CGT event C2 occurred when you received the payment and you will make a capital gain or loss.

Although we accept that part of your claim related to personal injury you suffered, the individual components of your compensation payment cannot be determined or reasonably estimated. Accordingly, no part of the compensation you received can be quantified as relating to your personal injury and the exclusion contained in paragraph 118-37(1)(b) of the ITAA 1997 will not apply to disregard any part of the capital gain or loss.