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Authorisation Number: 1051301503525

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Date of advice: 30 October 2017

Ruling

Subject: Compensation – undissected amount

Question 1

Is the settlement sum assessable as ordinary income?

Answer

No.

Question 2

Is the settlement sum assessable under the capital gains tax (CGT) provisions?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2018

The scheme commences on

1 July 2017

Relevant facts and circumstances

You made a claim for compensation after you sustained a work related injury.

The compensating authority accepted your claim and you were paid weekly incapacity payments together with the payment of reasonably incurred medical expenses.

You continued to receive weekly payment for designated periods of time.

Your injuries resulted in you being assessed as suffering a degree of permanent impairment.

The employer provided you with suitable employment and duties pursuant to a number of rehabilitation plans over an extended period of time.

Your rehabilitation ended on the grounds that you had returned to work, but had permanent restrictions that were ongoing.

There was a change to the states workers compensation legislation and a new Act was introduced.

Your entitlement to weekly payments in respect of your compensable injury ceased with the introduction of the new Act.

Your entitlement to medical costs in respect of your compensable injury ceased a year later.

The employer advised you that their statutory obligation to provide you with suitable duties under the Act had ceased, and that they would no longer be allocated. You were given notice of your last day of employment.

You engaged legal representation. The legal firm sent a letter to the employer disputing that your entitlement to be provided with suitable employment under the Act had ceased. They advised that you were ready, willing and able to return to suitable employment and listed the duties that you were capable of performing.

A month later the legal firm lodged an application on your behalf. You sought to invoke a particular section of the Act and demand the employer provide ‘suitable employment’ by way of an order from the employment tribunal.

This matter was not considered by the tribunal and is being settled by way of a Deed of Release and Settlement (the deed).

Under this deed you agree to release the employer from all obligations relating to the application in return for an undissected lump sum.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 paragraph 108-5(1)(b)

Reasons for decision

A payment or other benefit received by a taxpayer is assessable income if it is:

a) income in the ordinary sense of the word (ordinary income); or

b) an amount or benefit that through the operation of the provisions of the tax law is included in assessable income (statutory income).

Ordinary income

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). The legislation does not provide specific guidance on the meaning of income according to ordinary concepts, however, a substantial body of case law exists which identifies likely characteristics.

Characteristics of ordinary income that have evolved from case law include receipts that:

a) are periodical, regular or recurrent

b) are relied upon by the recipient for their regular expenditure and paid to them for that purpose and

c) are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

In your case, you have been in dispute with your pre-injury employer in relation to their statutory obligation to provide you with suitable duties. Under the Act, a worker who had an existing incapacity as 1 July XXXX has a right to seek an order from the employment tribunal that the employer re-employs them in suitable alternate duties. Through your legal representative, you have made an application.

The dispute is being settled by way of a Deed of Release and Discharge and you have been offered an undissected lump sum payment. You have agreed to settle all issues arising out of the application or related to the matters referred to in the Recitals on the terms set out in the Deed.

The payment is not assessable as ordinary income in your hands as it is not a product in a real sense of any employment, services or business carried on by you and it does not have the characteristics normally associated with ordinary income such as periodicity and reliance on the payments to meet regular expenditure.

The settlement sum is considered to be capital in nature and does not constitute ordinary income under subsection 6-5(1) of the ITAA 1997

Statutory income – capital gains

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes a net capital gain. A capital gain or loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

A CGT asset is defined in paragraph 108-5(1)(b) of the ITAA 1997 as including a legal or equitable right that is not property. Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation.

Paragraph 70 of TR 95/35 provides that in determining the most relevant asset for which the compensation has been received, it is often appropriate to adopt a ‘look-through’ approach to the transaction which generates the payment.

The ‘look-through’ approach is defined in paragraph 3 of TR 95/35 to be the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related.

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. A C2 event can apply where there is a release or discharge of a right to sue on the settlement of a legal dispute (See Re Coshott and FCT [2014] AATA 622).

In this case we consider that the settlement sum relates to the disposal of your statutory rights to seek an order from the employment tribunal. As the settlement amount is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of your rights.

CGT event C2 happens when you accept the settlement sum.