Edited version of your written advice

Authorisation Number: 1012753979494

Ruling

Subject: Compensation payment with repayment amounts to WorkCover

Questions and Answers:

1. Was either your balance received or your agreed lump sum settlement sum tax-free?

No.

2. Does your settlement sum represent capital proceeds for a discountable taxable capital gains tax (CGT) event C2 that occurred during the year ended 30 June 20ZZ?

Yes.

3. Is the amount you repaid to Workcover in relation to permanent impairment an exempt capital gain that can reduce your capital proceeds from the settlement?

No.

4. Can your costs and outlays deducted from your settlement sum be included in your CGT cost base?

Yes.

5. Can your income tax assessments for the years ended 30 June 20XX and 20YY be amended to exclude the income repaid to Workcover?

Yes.

6. Can you claim a 20% medical expenses tax offset for relevant amounts repaid to Workcover?

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20YY

Year ended 30 June 20ZZ

The scheme commences on:

Relevant facts and circumstances

In the relevant year, you allegedly sustained a personal injury due to local council property during your break at work. As a result, you lodged a workers compensation claim, from which you received benefits, including a lump sum payment for permanent impairment.

You also lodged a claim against the local council pursuant to the Personal Injuries Proceedings Act 2002 (PIPA).

In 20ZZ, you signed a deed of release for your PIPA claim, for a settlement sum, and for which you agreed to execute the deed without any admission of liability by, or on behalf of, the releasee (the local council).

The deed of release also required you to subtract refundable amounts to WorkerCover. It said:

The releasor warrants that the settlement sum will not become payable until such a time as the releasee receive: (a) Notice of clearance or charge from WorkCover; and (b) A Notice of Charge pursuant to the Health and Other Services (Compensation) Amendment Act 1996…and (c) A Medicare Notice of Settlement executed on behalf of the releasor.

Your lawyer also subtracted costs and outlays from the settlement sum.

Relevant legislative provisions

Income Tax Assessment Act Section 54-10

Income Tax Assessment Act Section 54-15

Income Tax Assessment Act Section 54-20

Income Tax Assessment Act Section 54-45

Income Tax Assessment Act Section 59-30

Income Tax Assessment Act Section 104-25

Income Tax Assessment Act Section 110-25

Income Tax Assessment Act Section 115-25

Income Tax Assessment Act Section 116-20

Income Tax Assessment Act Section 116-50

Income Tax Assessment Act Section 118-37

Income Tax Assessment Act 1936 Section 159P

Reasons for decision

Compensation amount not exempt

Section 118-37 of the Income Tax Assessment Act (ITAA 1997) provides capital gain or capital loss you make from a CGT event is disregarded when it relates directly to compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally.

Division 54 of the ITAA 1997 provides a tax exemption for certain payments made under structured settlements and structured orders. To be a structured settlement or a structured order, paragraph 54-10(1)(e) and paragraph 54-10(1A)(e) provide the following criterion must be met:

…some or all of the compensation or damages is to be used by the defendant (or by a person with whom the defendant has insurance against the liability to which the claim relates) to purchase from one or more life insurance companies or State insurers:

(i) an annuity or annuities to be paid to the injured person, or to a trustee for the benefit of the injured person; or

(ii) such an annuity or annuities, together with one or more lump sums that are also to be paid to the injured person, or to a trustee for the benefit of the injured person.

For the sake of clarity, section 54-15 and section 54-20 of the ITAA 1997 (in combination) provide that a payment of a personal injury annuity made to the injured person is exempt from income tax if the compensation or damages that were used to purchase the annuity would not have been assessable income under section 118-37 of the ITAA 1997 in the event those compensation or damages had instead been paid to the injured person in a single lump sum on the date of the settlement or order.

Section 54-45 provides a payment of a personal injury lump sum that is made to the injured person is exempt from income tax if: (a) there is at least one personal injury annuity (provided under the same structured settlement or structured order) that satisfies the conditions in Subdivision 54-B; and (b) the other conditions in this Subdivision are satisfied.

A 'personal injury lump sum' means a lump sum: (a) that is purchased under the terms of a structured settlement as mentioned in paragraph 54-10(1)(e) or (b) that is purchased under the terms of a structured order as mentioned in paragraph 54-10(1A)(e).

Taxation Ruling TR 95/35 is about capital gains and the treatment of compensation receipts. In having regard to section 104-25 (CGT event C2) and 118-37 (exemption) of the ITAA 1997, paragraphs 3, 18, 19, 20 and 21 of TR 95/35 state:

An undissected lump sum compensation receipt is any amount of compensation received by the taxpayer where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated.

If the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.

Compensation received by an individual for any wrong or injury suffered to his or her person or in his or her profession or vocation is exempt from CGT…

Exemption…is available if the taxpayer receives compensation in an undissected lump sum which relates wholly to the personal wrong or injury suffered by the taxpayer.

However, if compensation is received by a taxpayer in a 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, no part of the compensation can be quantified as relating to the personal injury of the taxpayer. Accordingly, the exemption…does not apply to any part of the compensation.

In the case of Purvis v. FC of T [2013] AATA 58, the AAT considered the tax consequences of a pilot receiving a lump sum insurance payment for the loss of licence. Although the loss of licence came about as a result of illness or injury, the Tribunal found that the payment did not relate directly to compensation or damages within section 118-37. The amount was calculated without regard to the nature of the personal injury suffered, save that the personal injury had to result in the loss of licence.

In your case, your compensation was not received from a 'structured settlement' given it did not include the criterion of an annuity purchased for you by the defendant (the local council). Also, similar to Purvis' case, your compensation amount was calculated without regard to the nature of the personal injury suffered. Instead, your compensation amount was an undissected lump sum in which no part of the compensation can be quantified as relating to personal injury.

It follows your compensation receipt is not exempt under Division 54 or section 118-37 of the ITAA 1997. Instead, your compensation receipt is capital proceeds in relation to the ending of your right to seek compensation, namely, CGT event C2 under section 104-25 of the ITAA 1997.

Your capital gain

Section 104-25 of the ITAA 1997 provides CGT event C2 happens if your ownership of an intangible CGT asset ends when the asset is released, discharged or satisfied.

You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

In general, section 116-20 of the ITAA 1997 provides the capital proceeds from a CGT event is the money you have received, or are entitled to receive, in respect of the event happening.

In general, section 110-25 of the ITAA 1997 provides the five elements of a CGT cost base are:

1. the money paid, or required to pay, in respect of acquiring the asset;

2. incidental costs incurred (such as remuneration for the services of a consultant or legal adviser);

3. various holding costs, such as interest, rates, land tax, maintenance, insurance, etc;

4. capital expenditure incurred to increase or preserve the asset's value; and

5. capital expenditure incurred to preserve your right over the asset.

Divisions 116 and 110 of the ITAA 1997 list certain modifications to the general rules about capital proceeds and the cost base. However, none of these rules apply to your case.

For example, section 116-50 is about the 'repaid rule'. This applies to the repayment of the capital proceeds received, such as when being sued for faulty property sold. It does not apply to the repayment of unrelated debts from capital proceeds.

Section 115-25 of the ITAA 1997 provides, to be a discount capital gain, the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event. The discount percentage is 50%.

In your case, your capital proceeds were the settlement sum. Your cost base was your incidental costs for legal fees. The amounts you had to repay to WorkCover, etc, did not fall into any cost base under section 110-25; nor were they capital proceeds received and repaid. Instead, the amounts you repaid were required so you would not be compensated twice. As you held your right to seek compensation (asset) for over 12 months before its ending, you qualify for the 50% CGT discount on your gain.

Permanent impairment amount

You were originally paid an amount for permanent impairment by WorkCover, which was originally an exempt capital gain under section 118-37 of the ITAA 1997.

However, your repayment of this amount did not fall into any cost base under section 110-25 or fall into the repaid rule in section 116-50.

The fact that you repaid an exempt amount does not make any part of your settlement sum exempt.

Also, the fact that you lost your exempt amount, does not create a capital loss, since, under section 118-37 of the ITAA 1997, both capital gains and capital losses are disregarded.

Amended assessments

Section 59-30 of the ITAA 1997 provides an amount you receive is not assessable income and is not exempt income for an income year if: (a) you must repay it; and (b) you repay it in a later income year; and (c) you cannot deduct the repayment for any income year. It does not matter if: (a) you received the amount as part of a larger amount; or (b) the obligation to repay existed when you received the amount or it came into existence later.

Subsection 59-30(3) states this section does not apply to an amount you must repay because you received a lump sum as compensation for a wrong or injury you suffered in your occupation.

In your case, section 59-30 of the ITAA 1997 provides the income amounts you had to repay to Work Cover are not assessable income. Therefore, your relevant income tax returns must be amended.

Subsection 59-30(3) does not apply because your lump sum payment was not explicitly received for wrong or injury you suffered in your occupation.

Medical expenses tax offset

Subsection 159P(1) of the Income Tax Assessment Act 1936 (ITAA 1936) states:

An amount paid by the taxpayer in the year of income as medical expenses in respect of himself or herself, or in respect of a dependant who is a resident, less any amount paid to the taxpayer or any other person, and any amount which the taxpayer or any other person is entitled to be paid, in respect of those medical expenses by a government or public authority or by a society, association or fund (whether incorporated or not) is a rebatable medical expense amount in respect of that year of income.

The meaning of the words 'paid by the taxpayer' was considered in Case U223 87 ATC 1231; Tribunal Case 144 (1987) 18 ATR 4055. In that case a taxpayer was injured in an accident and was awarded damages. The insurer of the other party to the action paid the taxpayer's medical expenses and was entitled to a credit for that amount when the damages were awarded. The taxpayer claimed the medical expenses tax offset under section 159P of the ITAA 1936 in respect of the medical expenses paid by the insurer. The Administrative Appeals Tribunal held that the taxpayer was not entitled to the tax offset because the taxpayer did not 'pay' the medical expenses as required by subsection 159P(1) of the ITAA 1936.

In your case, your medical expenses were paid by your employer's insurer (WorkCover) and not by you. Your lump sum compensation payment was reduced by the amount of these payments so you would not be compensated twice. Since you had not 'paid' the medical expenses as required under subsection 159P(1) of the ITAA 1936, you are therefore not entitled to a medical expenses tax offset under section 159P of the ITAA 1936.

The Commissioner has published this view in ATO Interpretative Decision ATO ID 2001/654.