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Edited version of your private ruling
Authorisation Number: 1012594007444
Subject: Compensation payments - other
Question:
Is your receipt of a settlement sum exempt from capital gains tax (CGT) under Section 118-37 of the Income Tax Assessment Act 1997 (ITAA 97)
Answer:
No.
This ruling applies for the following period:
Year ended 30 June 2013
The scheme commenced on:
1 July 2012
Relevant facts:
You purchased an investment product (X) after 19 September 1985 for an amount.
X isn't an asset; rather it is a cash account that tracks all purchases, income, expenses and disposals.
The underlying assets are subject to CGT.
You financed the investment through various loans; one of the providers of these loans was (Y).
The income and interest deductions were included in your income tax returns.
You also included capital gains and capital losses.
A part withdrawal from X occurred in the 2008 income year.
The proceeds were used to pay a margin call.
X was cashed out in the 2011 income year for an amount.
The proceeds were used to pay down the remaining balance of the margin call.
You had a remaining loan in relation to X which had a balance of an amount.
You commenced legal proceedings in the 2012 income year.
You settled your claim after a period of time.
You received the proceeds (settlement sum) in the 2013 income year.
The amount you received was an undissected lump sum.
You have provided a copy of the following document which forms part of this private ruling:
• Deed of settlement
You lodged a complaint with Y in the 2012 income year.
The amount you received was an undissected lump sum.
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 104-10
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 taxpayer includes income according to ordinary concepts (ordinary income).
Ordinary income has generally been held to include 3 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 is also a one off payment and thus it does not have an element of recurrence or regularity.
A 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.
Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The whole of the settlement amount is thus treated as capital proceeds from a CGT event happening to your right to seek compensation.
Your settlement is a result of legal action. It is not a lump sum payment which substitutes for an income stream but rather for entering into a Deed of settlement. The settlement sum 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 are called statutory income.
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.
Applying paragraph 118-37(1)(b) to your circumstances, the lump sum payment referred to as a settlement sum is an undissected amount with a series of conditions. The release payment is made without any admission of liability; the payment requires you to discontinue the legal proceedings, releases the other party from all past, present or future claims.
The whole of the settlement amount is treated as capital proceeds from a capital gains tax (CGT) event (CGT event C2) happening to your right to seek compensation.
However, paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any 'wrong, injury or illness you suffer personally'.
As the amount of the settlement sum is an undissected sum and no part relates to any personal injury suffered by you, accordingly, the whole amount and its basis of acceptance represents consideration for the disposal of the right to seek compensation, therefore no part of the settlement sum will be exempt.