Edited version of your private ruling

Authorisation Number: 1012591031560

Ruling

Subject: Compensation

Question 1

Is the lump sum compensation payment assessable income?

Answer

No.

Question 2

Is the payment for large medical equipment assessable income?

Answer

No.

Question 3

Is the payment for ongoing future expenses including care costs, medical expenses and medication assessable income?

Answer

No.

Question 4

Would a lump sum settlement that included all of the above payments be assessable income?

Answer

Decline to rule - refer to reasons for decision.

This ruling applies for the following period

Year ending 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling, and

· the further information provided.

The individual was seriously injured in an accident.

As a result, the individual was left with severe disabilities.

The individual has received, and will in the future, require ongoing 24 hour care.

The individual has already received an amount from the statutory insurer to cover medical care and other necessary expenses.

The settlement proposes a lump sum payment to be paid for non-pecuniary damages.

The settlement also proposes that large items of expense regarding the replacement of medical and other expensive equipment in the future should be identified by the agreement. The insurer will in the future fund the replacement of equipment as and when this becomes necessary.

Finally, the agreement proposes that the insurer will agree to pay the individual's other on-going future and reasonable necessary expenses for the rest of their life.

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 paragraph 118-37(1)(b)

Reasons for decision

Question 1

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).

Lump sum compensation

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 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.

Taxation Ruling IT 2193 deals with the issue of compensation for loss of earning capacity received as a result of a motor vehicle accident. IT 2193 discusses the decision in FCT v. Slaven 84 ATC 4077; 15 ATR 242 (Slaven's case), and makes it clear that compensation for loss of earning capacity will not lose its character as a capital receipt simply because the amount of compensation is calculated by reference to the amount of income the taxpayer would have earned.

In Slaven's case, the taxpayer was injured in a motor vehicle accident which left her unable to work for a period of nine months. She received compensation for the deprivation or impairment of her earning capacity from the Motor Accidents Board, under the Motor Accidents Act (Vic) 1973. The Board, in determining an adequate amount of compensation to be paid to an injured person, had to have regard to the loss of earnings actually suffered and to the likely loss of future earnings. The Federal Court held that the essential character of the compensation was compensation for loss or impairment of earning capacity, a capital asset, and that it was not liable to income tax.

IT 2193 states that the decision in Slaven's case will extend to payments made by other compensation boards where the payments made are in the nature of compensation for deprivation or impairment of earning capacity.

In this case, the compensation lump sum included amounts for pain and suffering, loss of enjoyment of life, permanent disability and other items.

We consider the payment was paid to compensate the individual for diminished capacity to earn income rather than the actual loss of income. The capacity to earn income is a capital asset and compensation for the loss of a capital asset is a capital receipt.

It is considered that no component of the amount received was received as compensation for loss of income. Therefore, the compensation is not assessable as ordinary income under section 6-5 of the ITAA 1997.

However, as the compensation for past and future loss of earning capacity is a capital receipt, it is also necessary to consider the provisions of the income tax law which deal with capital receipts.

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 capital gains tax (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.

CGT exemption

However, 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.

In this case, paragraph 118-37(1)(b) of the ITAA 1997 will apply. Therefore, the compensation received is not assessable income by virtue of the CGT provisions.

Question 2

The amount that is paid to the trustee for large items, such as medical equipment, is private in nature and not included as assessable income.

Question 3

The amount that is paid to the trustee for medical expenses, is private in nature and not included as assessable income.

Question 4

Paragraph 357-110(1)(a) of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) states the Commissioner may decline to make a ruling if he considers that the correctness of a private ruling would depend on which assumptions were made about a future event or other matter.