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Edited version of your written advice
Authorisation Number: 1012753801555
Ruling
Subject: Assessability of compensation payment
Questions
1. Is the compensation payment your client received representing weekly earnings assessable income?
Answer:
Yes.
2. Is the pre judgment interest assessable income?
Answer:
No.
This ruling applies for the following period:
Year ended 30 June 2013
The scheme commenced on:
1 July 2012
Relevant facts and circumstances
During the 2012-13 income year your client received a compensation payment of $X.
The compensation payment represented weekly payments for Y weeks.
The compensation payment included an amount of $Z which represented pre judgment interest.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5.
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)(b).
Reasons for decision
Summary
The portion of the compensation payment received by your client that represents weekly payments is assessable income. The portion which represents the pre judgement interest is not assessable income and is also not subject to the capital gains provisions.
Detailed reasoning
Subsection 6-5(2) 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, and
• have an element of periodicity, recurrence or regularity.
Payments of salary and wages are examples of ordinary income.
Receipts that are not salary or wages, but are paid as a substitute for salary or wages that would normally have been earned, expected and relied upon by a taxpayer, are also assessable as ordinary income.
The general principle is that such payments take on the character of the salary or wages they replace. That is, if the substituted amount was an amount of ordinary income, the amount paid to compensate for the loss of that amount will also be ordinary income.
In this case, your client received a compensation payment which represented Y weeks of income and pre judgement interest. The portion of the compensation payment relating to the Y weeks is ordinary income and therefore assessable income.
The portion of the compensation payment which represents the pre judgement interest is not ordinary income and therefore not assessable under section 6-5 of the ITAA 1997.
It has been decided by the Full Federal Court in Whitaker v FC of T 98 ATC 4285 (Whitaker's case) that pre-judgement interest, being interest calculated up to the date of judgement, awarded as part of a lump sum compensation payment for personal injury is capital in nature and not assessable income. In Whitaker's case the taxpayer received a compensation payment, including pre-judgement interest, due to personal injury suffered as a result of unsuccessful surgery.
Lockhard J stated at 4295 that the pre-judgement interest, in relation to personal injury: -is to be included in the sum for which judgement is given. It is one of the components which together make up the global sum constituting the amount of the award.
Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income. Capital gains are one form of statutory income.
Taxation Ruling TR 93/35 deals with the capital gains treatment of compensation receipts. The ruling provides that an insured's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation.
The disposal of an asset gives rise to a CGT event. However, paragraph 118-37(1)(b) of the ITAA 1997 disregards the payments or receipts where the amount relates to compensation or damages received for any wrong, injury or illness suffered by the recipient.
The pre judgement interest payment your client received in relation to their illness is not assessable under subsection 6-5(2) of the ITAA 1997 as it is not ordinary income. The pre judgement interest amount is also disregarded from CGT by the operation of paragraph 118-37(1)(b) of the ITAA 1997. Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income.
Accordingly, the portion of the compensation payment which represents X weekly payments is assessable income and the portion which represents the pre judgement interest is not assessable income and is not subject to the capital gains provisions.