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Edited version of your written advice
Authorisation Number: 1012910724922
Date of advice: 18 November 2015
Ruling
Subject: Lump Sum payment
Question 1
Is the lump sum payment you received assessable as ordinary income?
Answer
No.
Question 2
Is the lump sum payment you received assessable as a capital gain?
Answer
Yes.
This ruling applies for the following periods:
Financial year ended 30 June 2016.
The scheme commences on:
1 July 2015
Relevant facts and circumstances
You have received a lump sum compensation payment from a Deed of Settlement and Release. The break-up of the payment was not disclosed. It was paid on a General protection claim and for an Underpayment claim for wages.
The Respondent denies both claims but agreed to settle in the terms of the deed. The amount was paid by the Respondent minus any applicable taxation.
You have provided a signed copy of your Statement of Claim.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 6-5
Income Tax Assessment Act 1997 section 118-37
Reasons for decision
Ordinary income
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 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.
Capital gain
CGT Exemption
Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. If an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.
Where such compensation is received for the ending of such a right, and that right arose only in relation to either a wrong or injury suffered in your occupation or any wrong, injury or illness you or your relative suffers personally, any capital gain arising under CGT event C2 will be disregarded under section 118-37.
If the compensation is received in relation to multiple heads of claim, TR 95/35 allows a reasonable apportionment of that payment. For example, if a payment is both for personal injury and related damage to a CGT asset, the payment may be apportioned between the two heads of claim. The part of the payment that can reasonably be attributed to personal injury will be treated as capital proceeds for the ending of the right to seek compensation, and any capital gain arising will be disregarded under section 118-37.
The part of the payment that can reasonably be attributed to damage to the asset will be applied to reduce the cost base of the underlying asset. Any additional amount that cannot be attributed to the underlying asset will be capital proceeds for the ending of the right to seek compensation.
Un-dissected lump sum
However, if the payment is truly an un-dissected lump sum - that is, no reasonable apportionment can be made between the multiple heads of claim- it can only be capital proceeds for the ending of the right to seek compensation and the exemption in section 118-37 does not apply. No concessional treatment can be applied unless you are able to prove that the amount received was solely for personal injury.
This approach was confirmed in Dibb v Commissioner of Taxation [2004] FCAFC 126 which found that no part of a genuinely un-dissected lump sum could be said to be paid in relation to personal injury. The exemption in section 118-37 cannot apply if the compensation amount is received as a lump sum (and that lump sum is truly un-dissected) but there were rights to income type payments as well as rights relating to personal injury that are extinguished in the settlement.
Application to your circumstances
In your case, you have received an un-dissected lump sum payment from a Deed of Settlement. The payment relates to multiple heads of claim; your General protection claim and your Underpayment claim. However based on the information you have provided there is no reasonable basis on which the payment you received could be apportioned between the two heads of claim. Therefore, in accordance with TR 95/35 although your claims related to both income (underpayment of wages) and capital (compensation for dismissal) components, the undissected lump sum you ultimately received can only be considered to be proceeds from the ending of your right to seek compensation.
Accordingly, the lump sum payment is not ordinary income and is therefore, not assessable under section 6-5 of the ITAA 1997
However, you will be subject to capital gains tax in respect of the amount you will receive to compensate you from the Deed of Settlement as exemption in section 118-37 does not apply to your capital gain.