Edited version of your written advice

Authorisation Number: 1012757761310

Ruling

Subject: Compensation payment

Question 1

Is the compensation payment for defective administration regarded as assessable income?

Answer

Yes.

Question 2

Do you need to pay tax on the compensation payment if your taxable income is below the tax free threshold of $18,200?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2015

The scheme commenced on

1 July 2014

Relevant facts

In 20XX, enquiries were made about your eligibility for a benefit.

You were advised that you were not eligible.

You are now in receipt of the benefit, paid from 20YY.

Claims for this benefit were made in 20YY after further enquires were made.

The evidence presented for your claim shows that you could have met the eligibility criteria for the benefit from 20XX.

As you were reliant on the department to provide accurate information and had suffered a loss, it was considered appropriate to pay compensation equal to 75% of your overall loss in accordance with the Compensation for Detriment caused by defective administration scheme.

You received compensation in the relevant financial year.

You have no other assessable income.

Your total assessable income is below the tax free threshold.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5

Income Tax Assessment Act 1997 subsection 6-10

Reasons for decision

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.

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.

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).

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? 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.

You received your compensation payment as a result of lodging a claim for defective administration. The payment was based on your lost benefits. Although 100% of your loss was not received, it remains that the payment helped compensate you for the loss of income you suffered.

Although the payment was not earned by you as it does not relate to services performed and is a one-off payment, the payment can be said to be relied upon. Your compensation payment does not lose its character as an income receipt, even though it was paid as a lump sum.

As the purpose of the payment was a substitute for the income which would otherwise have been received, the amount received is regarded as income in nature.

Therefore, your compensation is assessable as ordinary income under section 6-5 of the ITAA 1997.

An amount of ordinary income is exempt income if it is made exempt from income tax by a provision of the ITAA 1997 or another Commonwealth law (section 6-20 of the ITAA 1997).

Divisions 51, 52, 53 and 54 of the ITAA 1997 provide that certain amounts of income are exempt from income tax.

Certain pensions, benefits and allowances are exempt from income tax under Division 52 of the ITAA 1997.

Although your compensation payment related to lost exempt payments, this does not mean that the subsequent compensation payment is exempt.

The compensation payment for Detriment caused by Defective Administration scheme is not an exempt payment paid under the Social Security Act 1991.

Your payment is not exempted by any provision of either the Income Tax Assessment Act 1936 or the ITAA 1997. 

However, as you have no other income and your total assessable income for the relevant financial year is less than the tax free threshold of $18,200, no tax is payable. You therefore do not need to lodge a tax return.