Edited version of your written advice

Authorisation Number: 1013075630399

Date of advice: 22 August 2016

Ruling

Subject: Other income - compensation payment

Question 1

Is the lump sum settlement payment assessable as ordinary income?

Answer

No.

Question 2

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

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You are employed and your employer has an insurance policy which provides insurance benefits including Total Disability benefits.

You became unable to work due to a health condition.

You completed an Initial Claim Form Group Insurance.

You were paid benefits with respect to your condition.

The Insurer then determined, after obtaining further medical evidence, that you no longer satisfied the definition of Total Disability and ceased payments.

Your employer commenced proceedings through the Supreme Court of the relevant state, against the insurer for breach of the insurance policy.

In order to settle the matter without ongoing disputes and expenses, the insurer offered a lump sum settlement payment in return for which you and your employer agree to release the insurer from any further liability under the stated insurance policy, essentially giving up your right to sue for future damages.

You have accepted and received the lump sum payment offer.

There is no specific calculation or breakdown of each component of the settlement offer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-5(2)

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 118-37 (1)

Reasons for decision

Summary

Your lump sum payment is not regarded as assessable ordinary income. We consider it to be a capital payment assessable under the capital gains tax provisions. Therefore the lump sum payment you have received is subject to tax.

Detailed reasoning

Ordinary Income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources 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.

Taxation Determination TD 93/58 outlines the circumstances under which the receipt of a lump sum compensation/settlement payment is assessable as ordinary 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).

The lump sum payment has not been paid to you as compensation for lost salary and wages. Therefore, the lump sum payment is not ordinary income and is not assessable under subsection 6-5(2) of the ITAA 1997.

Capital gains

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.

Part 3-1 of the ITAA 1997 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.

You have entered into an agreement to accept a lump sum payment for agreeing not to seek further compensation. Thus, your right to seek compensation has ended. It is considered the lump sum amount you will receive is a payment for the ending of this right. Therefore, CGT event C2 has occurred and a capital gain may arise.

If the capital proceeds from the CGT event (that is, the lump sum payment) is more than the costs associated with that event, you will make a capital gain and this included in your assessable income.

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 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 employee 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 employee for the loss of entitlements, rather than to compensate the person for their injury or illness as such.

Your lump sum payment has been received for entering into a contract to end your rights to compensation from the insurer. Whilst your rights to seek compensation arose from your injury, the payment is considered to be a payment for the ending of your claim for compensation with the insurer. As stated above, this gives rise to CGT event C2. Your payment cannot be said to be a single defined payment for an injury.

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.