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Edited version of your written advice
Authorisation Number: 1012772591514
Ruling
Subject: Compensation - other
Question
Is the settlement payment received assessable income?
Answer
No
This ruling applies for the following period:
Year ended 30 June 2015
The scheme commences on:
1 July 2014
Relevant facts and circumstances
The deceased was diagnosed with an illness in early 20XX.
After diagnosis, legal action was commenced against Z Pty Ltd in relation to the deceased's exposure to a substance in the course of their employment.
The deceased retired in 19XX. Accordingly, no claim for loss of earnings was or could be advanced. The claim was for general damages to cover pain and suffering and the loss of expectation of life.
The matter proceeded to mediation and the deceased accepted a settlement proposed by Z Pty Ltd by signing a Deed of Settlement.
The deceased died in late 20XX.
In late 20XX the estate received the settlement sum of $XXX,XXX in compensation for pain and suffering, loss of expectation of life, medical expenses and care expenses.
Relevant legislative provisions
Income Tax Assessment Act 1997 subsection 6-5(2)
Income Tax Assessment Act 1997 section 6-10.
Income Tax Assessment Act 1997 paragraph 118-37(1)(b)
Reasons for decision
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.
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).
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).
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 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.
Where an intangible asset, such as a legal or equitable right is disposed of, CGT event C2 occurs under subsection 104-25(1) of the ITAA 1997. Subsection 104-25(2) of the ITAA 1997 provides that the time of the event is when you enter into the contract that results in the asset ending.
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.
Application to your circumstances
The lump sum you received was not earned as it does not relate to services performed by the deceased or the estate. The payment is also a one-off payment and thus it does not have an element of recurrence or regularity.
Accordingly, the lump sum payment is not ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.
CGT event C2 occurred on the date that the deceased entered into the Deed of Settlement as they had disposed of his right to seek compensation. As the compensation received related to an illness or injury suffered by the deceased, any capital gain made from CGT event C2 will be disregarded under paragraph 118-37(1)(b) of the ITAA 1997.
The settlement proceeds represented capital proceeds from CGT event C2 that occurred prior to the deceased's death. Accordingly it is not assessable income for the trustee of the estate. Additionally, as the capital gain is disregarded, there is no amount from the settlement payment to be included in the deceased's final return.