Edited version of your written advice

Authorisation Number: 1051302424841

Date of advice: 1 December 2017

Ruling

Question 1

Is any part of the lump sum payment you have been offered assessable as ordinary income?

Answer

No

Question 2

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

Answer

Yes

This ruling applies for the following period

Year ending 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

You were employed by a company.

You submitted a claim for an injury sustained at work, and a further claim for a later injury.

The insurer for your employer accepted liability for the claims.

Liquidators were appointed to the company after previously being appointed administrators.

You commenced court proceedings against the company and insurer with regards to the worker’s compensation claim.

However your employer denied that you suffered the injuries, loss or damage.

The three parties resolved to end the dispute as set out in the Agreement in full and final satisfaction of any further claims in relation to the dispute and any other injuries that may have been sustained throughout his term of employment.

You became entitled to lump sum proceeds as a result of entering into the agreement, and the proceeds included an amount to reimburse you for an amount for legal costs.

You signed a memorandum of agreement to accept a lump sum payment pursuant to your states workplace legislation, with a writ of summons to be filed in the your states district court.

Before the settlement, you were receiving some medical costs and some regular income stream, mainly medical.

The lump sum payment extinguishes all rights.

In accepting the compensation payment your workers’ compensation claim is now finalised and you have surrendered your entitlement to any further compensation in relation to your injuries under the Act as well as forfeiting any chance to recover civil damages from the employer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 102-5

Reasons for decision

Ordinary Income

Section 6-5 of the 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

● have an element of periodicity, recurrence or regularity.

The lump sum payment you have been offered is not income from rendering personal services, income from property or income from carrying on a business.

The payment is a one off payment and thus it does not have an element of recurrence or regularity.

The nature of a lump sum payment generally bears the character of that which it is designed to replace. If the lump sum payment is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Your payment is not a lump sum payment which substitutes for an income stream but rather for entering into an agreement with the employer for payments for incapacity resulting from an injury and for surrendering your rights under the Worker’s Compensation and Injury Act 1981.

The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but may be assessable under another provision called statutory income.

Capital gains

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.

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 seek compensation. (section 104-25 of the ITAA 1997)

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 of the ITAA 1997.

CGT Exemption

Paragraph 118-37(1)(a) (i) 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)(a)(ii) 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)(a) 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.

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 – 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)(a) 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 includes potential capital benefits such as incapacity, medical and rehabilitation payments, as well as an income component. 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. This gives rise to CGT event C2. Your payment cannot be said to be for a single defined payment for an injury.

While we acknowledge that you believe that some of the $X lump sum is to go toward future medical expenses, there is no documentation in the agreement to support this.

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.

Please note legal costs form part of the cost base and as it has been 12 months or more since the compensable incident occurred, then you may be able to reduce the capital gain by 50%.