Edited version of your written advice

Authorisation Number: 1012999080778

Date of advice: 15 April 2016

Ruling

Subject: Un-dissected lump sum payment

Question 1

Is the lump sum settlement payment regarded as ordinary assessable income?

Answer

No.

Question 2

Is the lump sum paid to the Taxpayer in accordance with a settlement deed an employment termination payment (ETP) as defined in section 82-130 of the Income Tax Assessment Act (ITAA 1997)?

Answer

No.

Question 3

Is the lump sum settlement payment assessable under the capital gains tax provisions?

Answer

Yes.

This ruling applies for the following period(s)

Year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You sustained an injury in the course of your employment.

In 20XX you commenced your active work with your employer.

Certain issues arose that interfered with your ability to do your work were:

• Insufficient equipment to fulfil your duties

• Longer than usual travel times between clients

• Lack of sympathy from managers

• Lack of assistance with technical issues

• Insufficient training in the coded language used

• Lack of work/life balance

During this time you fell in to a depressive state.

In 20XX you travelled to a large distance for work purposes. When you got back to the office you advised your manager you couldn't complete your work. You received an unsympathetic response to this issue.

In 20XX you went to work and immediately felt so depressed you couldn't focus on your work. You called your manager and told him/her that you would be seeking immediate medical attention for this issue. You also advised their superior.

On the afternoon in 20XX you advised your manager that your doctor had told you to take sick leave for several weeks.

Over the next few weeks you kept your manager updated with your medical condition. You also received several calls, text messages and emails from him/her regarding this issue. You had a medical certificate for all of the time you were away from work sick.

In 20XX you called your manager to advise him/her of an additional medical appointment.

In 20XX at your doctor's appointment you received a letter from your doctor to your employer requesting co-operation with progressive return to work. You informed your manager of this and he/she advised you that he/she would talk to HR about it.

In 20XX you received notification of termination from your employer.

In 20XX you applied for workers compensation with your employer's insurer.

In 20XX you received acknowledgement of your workers compensation claim and were informed that your employer had to continue paying you until the matter was decided.

From 20XX to 20XX you were paid a fortnightly income from your employer while your worker's compensation claim was being assessed.

In 20XX you received notification that your workers compensation claim was being denied.

In 20XX you received notification for mediation with your employer and their insurer.

This mediation was unsuccessful and led litigation through which you received an un-dissected lump sum payment of $XX,000 from the insurer. Your employer and their insurer still denied liability for the injury you received.

You have been paid this amount so that you will not maintain your claim for worker's compensation.

You believe that due to the issues you've had with your employer you will be unable to pursue future employment for some time and you will have no opportunity to work in that profession within your state again.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Subsection 82-130(1)

Income Tax Assessment Act 1997 Paragraph 82-130(1)(a)

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 118-37

Reasons for decision

Summary

Your un-dissected lump sum is not regarded as ordinary assessable income nor an employment termination payment but is capital in nature. No exemption applies and the capital payment is assessable under the capital gains tax provisions.

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 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.

Payments of salary and wages are income according to ordinary concepts and are included in your assessable income.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443;10 ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

Lump sum payments

Taxation Determination TD 93/58 outlines the circumstances under which the receipt of a lump sum compensation/settlement payment is assessable as ordinary income. The determination states that where the compensation payment is for loss of income, the amount is assessable as ordinary income. Where a portion of a lump sum payment is identifiable and quantifiable as income, that portion of the payment will be assessable.

This view was subsequently confirmed in Sommer v FC of T 2002 ATC 4815; 51 ATR 102 (Sommer's case). The case involved a medical practitioner who had taken out an income protection policy. Following the rejection of the taxpayer's claim for income replacement payments of $4,000 per month, the matter was settled out of court with the taxpayer receiving a lump sum. The taxpayer argued that the amount was a payment of capital as it was paid in the consideration of the cancellation of the policy, and the surrender of his rights under it or that the payment was capital as it was an un-dissected aggregation of both income and capital.

In dismissing the taxpayer's appeal it was held that the payment was in settlement of income claims of the taxpayer in circumstances where the purpose of the insurance policy was to fill the place of a revenue receipt. As a result, the payment was clearly on a revenue account. The fact that the payment was received in one lump sum did not change its revenue character.

In your case you were making a claim for workers' compensation. You have now been offered a lump sum payment to give up your claim for workers compensation with the employer and their insurer.

The lump sum settlement you have received does not relate to personal services, property, or the carrying on of a business. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from the performance of personal services. In your circumstances, the lump sum payment is not ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

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, and are also included in assessable income.

Amounts received as a lump sum are generally capital in nature and are potentially taxable as statutory income under the capital gains tax (CGT) provisions of the ITAA 1997. However, before considering CGT provisions we must determine if the lump sum payment is an employment termination payment.

Employment Termination Payment

According to subsection 82-130(1) of the ITAA 1997, a payment is an employment termination payment (ETP) if:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

(ii) after another person's death, in consequence of the termination of the other person's employment; and

(b) it is received no later than 12 months after that termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

To determine if a payment is an ETP, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of the conditions under subsection 82-130(1) will result in the payment not being considered an ETP.

Payment made 'in consequence of the termination' of employment

For a payment to be treated as an ETP, the first condition that must be met is that the payment is made in 'consequence of' the termination of employment.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views on the meaning of this phrase, the Commissioner's view on the meaning and application of the 'in consequence of' test are set out in Taxation Ruling TR 2003/13 Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of' (TR 2003/13).

While TR 2003/13 considered the meaning of the phrase 'in consequence of' in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner.

In paragraph 5 of TR 2003/13 the Commissioner states:

...the Commissioner considers that a payment is made in respect of a taxpayer in consequence of the termination of the employment of the taxpayer if the payment 'follows as an effect or result of' the termination. In other words, but for the termination of employment, the payment would not have been made to the taxpayer.

In your case, the payment under the deed received by you is not a payment that 'follows as an effect or result of the termination.' Rather, the payment is one that follows as an effect or result of your injury since it is the injury, and not the termination, that gave cause to the claim under the Return to Work Act and the subsequent payment under the deed.

Even if you had not been terminated, you still would have been able to submit a claim for compensation and be paid an amount under a settlement deed.

Accordingly, it cannot be said that the payment would not have been made to you 'but for' the termination of employment.

In view of the above, the payment does not satisfy the condition under paragraph 82-130(1)(a) of the ITAA 1997. As one of the conditions in subsection 82-130(1) of the ITAA 1997 has not been satisfied, the payment received by you cannot be an ETP.

Capital gains

Part 3-1 contains the capital gains and capital loss provisions commonly referred to as the CGT provisions. You make a capital gain or capital loss if a CGT event happens in respect of a CGT asset.

Section 104-25 provides that CGT event C2 happens on the ending of the right to seek compensation, that is, the right to take legal action. The lump sum amount you will receive will be capital proceeds for this CGT event and a capital gain will usually arise.

The net capital gain you make is then included in your assessable income under section 102-5.

CGT Exemption

Paragraph 118-37(1)(a) of the ITAA 1997 allows a capital gain to be disregarded if it is compensation or damages you receive for any wrong or injury you suffer in your occupation.

Paragraph 118-37(1)(b) of the ITA 1997 allows a capital gain to be disregarded if it is compensation or damages you receive for any wrong, injury or illness you suffer personally.

These provisions would have clear and direct application in relation to an insurance policy against a specific injury or illness. For example, trauma insurance that pays a lump sum if the person loses a limb or suffers a heart attack. Such a payment would be disregarded for CGT purposes under section 118-37 of the ITAA 1997.

However, the application of section 118-37 of the ITAA 1997 in relation to settling a workers' compensation claim may be more problematic.

In the case of Purvis v. FC of T [2013] AATA 58 (Purvis' case), the Administrative Appeal Tribunal 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 paragraph 118-37(1)(b) of the ITAA 1997. 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 cases where a dispute between the insurer and the insured is settled by way of the former making a lump sum payment to the latter; it would presumably be the case that the payment is intended to compensate the policy holder for the loss of entitlements under the policy, rather than to compensate the person for their injury or illness as such.

Where compensation is intended to remedy damage to an asset, taxing of that compensation may prevent the remedy occurring. For example, if you incur $1,000 damage to your car and receive $1,000 in compensation, paying tax on that amount would frustrate the purpose of the compensation. For this reason, it is sometimes necessary to identify the damaged underlying asset that the compensation was intended to remedy, and to consider the capital gains tax consequences of the compensation in relation to that asset.

Taxing the compensation for the giving up of an income stream does not create this issue, as the income stream would have itself been taxable. Taxing compensation intended to cover medical benefits, however, may frustrate the purpose of the compensation. In these circumstances it may be appropriate to take a concessional approach and concede that compensation for the payment of medical costs are sufficiently related to personal illness or injury to be exempt from capital gains under paragraph 118-37(1)(b) of the ITAA 1997.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts outlines when it may be relevant to consider the compensation in the context of an underlying asset.

Primarily the settlement of a dispute involving a workers' compensation claim would amount to the disposal of a right to seek compensation. However, underlying this is the forfeiture of your rights under the RTWA - in most cases, this would predominantly involve forfeiting the right to receive an income stream; but in some cases, there may also be subsidiary benefits at issue.

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 intended to replace both an income stream and other potential benefit entitlements, the payment may be apportioned between the two heads of claim on a reasonable basis. 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 - no exemption 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 paragraph 118-37(1)(b) of the ITAA 1997 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

Your lump sum settlement is more than a straight income replacement and includes potential capital benefits such as incapacity, medical and rehabilitation payments. It is therefore accepted that the payment is an un-dissected settlement amount and that the lump sum payment is not assessable under section 6-5 of the ITAA 1997.

Acceptance of the lump sum is considered to be a payment for the ending of your claim for workers compensation with your employer. This gives rise to CGT event C2. Your payment cannot be said to be for a single defined payment for an injury.

As was the case in Sommer's case and Purvis' case, although your compensation may have been triggered by a personal injury, the actual lump sum payment is not a personal injury payment. The payment covers a loss of various rights and entitlements, including a loss of income. Therefore the lump sum payment is assessable as a capital gain and the exemption contained in section 118-37 of the ITAA 1997 cannot apply.