Edited version of your written advice

Authorisation Number: 1051305468210

Date of advice: 5 December 2017

Ruling

Subject: Workers compensation

Question 1

Is the amount paid to you pursuant to your states Workers Compensation and Injury Management Act 1981, ordinary assessable income?

Answer

No

Question 2

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

Answer

Yes

Question 3

Is any part of the payment disregarded under the capital gains tax provisions?

Answer

No

This ruling applies for the following period

30 June 2017

The scheme commences on

1 July 2016

Relevant facts and circumstances

You sustained an injury at work.

Since claiming workers compensation, you have been receiving weekly payments under your states workers compensation act.

Your claim for incapacity due to stress/depression was disputed by your employer.

You have agreed to an early settlement agreement with your employer through your legal representatives.

You signed a settlement which entitles you to a lump sum payment.

The insurer will notify Medicare and forward 10% of the lump sum to Medicare.

The lump sum payment extinguishes all rights, and under the agreement:

You will have no further entitlement to compensation for, or claims for weekly payments arising from the disability, and

You will forfeit any entitlement you may have to pursue common law damages in respect of the injury referred to in the agreement.

Your medical entitlements will also cease.

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.

You have had legal costs associated with the agreement, which will be paid from the lump sum you receive.

Settlement payment was received.

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

Further issues for you to consider

Reasons for decision

Issue

Workers Compensation payment

Reasoning

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).

The courts have identified a number of factors which indicate whether an amount has the character of income according to ordinary concepts.

A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity (FCT v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82).

One or more of the following characteristics will combine with periodicity to give an amount an income nature:

● it is made in substitution of income;

● it is made to provide financial support, for example, as an income supplement; or

● it is received in circumstances where the recipient has an expectation of receiving the payment on a regular basis so that the recipient is able to depend upon the payment for his or her regular expenditure.

Payments for rendering personal services, such as salary or wages, are ordinary income and are included in assessable income under section 6-5 of the ITAA 1997.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments, such as workers compensation, which substitute income, have been held by the courts to be income under ordinary concepts (FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142).

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.

Under the agreement:

You will have no further entitlement to compensation for, or claims for weekly payments arising from the disability, and

You will forfeit any entitlement you may have to pursue common law damages in respect of the injury referred to in the agreement.

Your payment is not a lump sum payment which substitutes solely 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 Management 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.

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.