Edited version of your written advice

Authorisation Number: 1051322416630

Date of advice: 20 December 2017

Ruling

Subject: Compensation – Lump Sum

Question

Will the lump sum compensation payment you are to receive or any portion thereof be assessable as either ordinary income or as a capital gain?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Whilst you were conducting your work duties you sustained an injury for which you have been in receipt of workers compensation benefits (weekly income payments/medical expenses).

You chose to exercise your right of action against a person other than your employer for damages in respect of your injury and lodged civil damages claim.

You are to receive damages from a third party pursuant to rights arising from the same trauma as gave rise to the rights to compensation under your states worker’s compensation legislation (the Act).

Under the Act, the Authority is entitled to recover the amount of compensation paid or payable to you under the Act from the wrongdoer/third party or yourself, subject to the certain qualifications.

You have entered into a Deed of Release with the Authority pursuant to the section of the Act that deals with rights of action and recovery against third parties. The purpose of the Deed is to acknowledge the amount recoverable by the Authority.

The Deed also confirms your entitlement to retain the balance of the damages payable.

By signing the Deed, you release the Authority and employer from any past, present or future action, suit, claim or demand arising out of or in any way connected with the injury.

Relevant legislative provisions

Income Tax Assessment Act section 6-5

Income Tax Assessment Act section 6-10

Income Tax Assessment Act section 10-5

Income Tax Assessment Act section 59-30

Income Tax Assessment Act subsection 59-30(3)

Income Tax Assessment Act section 104-25

Income Tax Assessment Act paragraph 104-25(1)(b)

Income Tax Assessment Act subsection 104-25(2)

Income Tax Assessment Act paragraph 104-25(2)(a)

Income Tax Assessment Act paragraph 104-25(2)(b)

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

Income Tax Assessment Act subparagraph 118-37(1)(a)(ii)

Reasons for decision

Sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary and statutory income (for example, capital gains) derived directly and indirectly from all sources, whether in or out of Australia during the income year.

The ITAA 1997 does not provide specific guidance on the meaning of ordinary income. However, a substantial body of case law exists which identifies its likely characteristics. Amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income, as are amounts that are the product of any employment of, or services rendered by, the recipient. Further, amounts which compensate for lost income or serve as a substitute for other income are themselves income according to ordinary concepts.

A compensation amount generally bears the character of that which it is designed to replace (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82; (1952) 5 AITR 443; (1952) 10 ATD 82). If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not assessable as ordinary income.

Generally, payments that are income (such as lost wages) will be assessable under the ordinary income provisions of section 6-5 of the ITAA 1997. Amounts identifiable as reimbursement for private expenses (such as medical expenses) of which are otherwise capital in nature (such as compensation for pain and suffering) are not assessable as ordinary income.

In your case, you sustained an injury whilst performing your work duties and have been in receipt of benefits under worker’s compensation legislation. You have recently taken legal action against a third party for damages in relation to the same injury and have been offered a lump sum settlement payment.

There are two identifiable components to your settlement, one is an amount that represents the total benefits (weekly income payments/medical expenses) that the Authority has paid in relation to your injury claim and the other is a lump sum damages payment.

Portion of the lump sum to be paid to the Corporation

Where a taxpayer is required to repay an amount in an income year after its receipt and is not entitled to a deduction for the repayment, section 59-30 of the ITAA 1997 treats the amount as non-assessable non-exempt income in the year of receipt.

However, this provision will not apply where the taxpayer has received instalments of worker’s compensation or sickness allowance that have to be repaid on receipt of a lump sum payment for compensation for damages for a wrong or injury suffered in their occupation (subsection 59-30(3) of the ITAA 1997).

This follows the basic principles under worker’s compensation law that a person cannot be compensated more than once for the same injury.

The weekly compensation payments you have received are assessable as ordinary income under section 6-5 of the ITAA of 1997 in the financial years of receipt. There will be no taxation consequences for you in relation to the lump sum amount that is being paid to the Corporation.

In the Act the Authority has the right to intervene to protect the Authorities interest. Under the terms of the Deed of Release the Authority will receive the full amount of compensation they have paid.

Balance of the damages payment

The remainder of the lump sum is not assessable as ordinary income as it lacks any element of periodicity, recurrence or regularity, nor is it paid to compensate for loss of income. This amount is considered to be capital in nature.

Section 6-10 of the ITAA 1997 provides that a taxpayer’s assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision of the tax law.

Section 10-5 of the ITAA 1997 lists those other provisions and included in the list are:

● amounts received by way of insurance or indemnity payments in respect of a lost amount, and

● capital gains.

Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset. A taxpayer’s right to seek compensation is therefore classified as an intangible CGT asset.

Section 104-25 of the ITAA 1997 discusses CGT event C2 which refers to cancellation, surrender and similar endings. Paragraph 104-25(1)(b) of the ITAA 1997 states, in part, that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied.

Subsection 104-25(2) of the ITAA 1997 states that the time of the event is:

(a) when you enter into the contract which results in the asset ending; or

(b) if there is no contract when the asset ends.

Paragraph 3 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts, confirms that the right to seek compensation is a CGT asset and is taken to be acquired at the time of the compensable wrong or injury, and includes all the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged.

However, under subparagraph 118-37(1)(a)(ii) of the ITAA 1997 a capital gain or capital loss for a CGT event is disregarded when the CGT event relates directly to compensation or damages received for any wrong, injury or illness you personally suffer.

In your case, the balance of the damages payment ($$$$) relates wholly to the right to seek compensation for the personal injury you suffered and as such, the payment will be exempt for CGT.

Accordingly, the lump sum payment you will receive is not assessable as either ordinary or statutory income and you will not be required to include the amount in your assessable income.