Edited version of your written advice

Authorisation Number: 1051415522212

Date of advice: 14 August 2018

Ruling

Subject: Lump sum payment – compensation for personal injury

Question 1

Is the amount received as a lump sum compensation for personal injury exempt for income tax purposes?

Answer

Yes

This ruling applies for the following period:

Period ending 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You are more than 50 years old.

You have a Life Insurance policy

In 200A you suffered various injuries as a result of a motor vehicle accident.

In mid 200B you made a claim for income protection benefits under your policy.

In 201C you were medically determined as totally and permanently disabled as a result of your injuries.

In late 201D you lodged a complaint with the Financial Ombudsman Service in relation to your claim.

This dispute was resolved in late 201D in your favour.

In determining the Lump sum compensation payment the insurance company considered your age and likely future earning capacity based on available medical material.

In early 201E you received a letter and Deed of Release as a final settlement of any future entitlements under the policy.

Relevant legislative provisions

Income Tax Assessment Act 1997 (ITAA 1997) section 6-5

Income Tax Assessment Act 1997 (ITAA 1997) section 6-10

Income Tax Assessment Act 1997 (ITAA 1997) section 102-5

Income Tax Assessment Act 1997 (ITAA 1997) section 118-37 paragraph (1) (a)

Reasons for decision

Summary

The lump sum amount for the personal injury claim is a capital receipt and is not ordinary income. As the lump sum amount was received due to personal injury that you suffered it is exempt from taxation under paragraph 118-37(1) (a) of the ITAA 1997.

Detailed reasoning

Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes ordinary and statutory income derived directly and 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

● have an element of periodicity, recurrence or regularity.

Your compensation payment amount is in relation to your personal injury claim.

The amount is not income from rendering personal services, income from property or income from carrying on a business. The payment was not earned by you as it does not relate to services performed. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the pain and suffering resulting from the injury, rather than from a relationship to personal services performed.

A compensation amount generally bears the character of that which it is designed to replace. 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 ordinary income.

Amounts received in respect of personal injury, which are not for reimbursement of medical expenses or direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax provisions of the ITAA 1997.

The personal injury component of your settlement is not a lump sum payment which substitutes for an income stream or a reimbursement of medical expenses. Accordingly, the lump sum amount for the personal injury claim is a capital receipt and is not ordinary income. Therefore the amount will not be assessable under section 6-5 of the ITAA 1997.

Receipt of a lump sum payment may give rise to a capital gain (statutory income). The net capital gain you make is then included in your assessable income under section 102-5 of the ITAA 1997 unless an exemption applies.

Taxation Ruling TR 95/35 - Income tax: capital gains: treatment of compensation receipts indicates that settlement of a personal injuries claim represents the disposal of an asset, as you have disposed of the right to seek compensation for the losses arising from the injury suffered. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by you of the right to seek compensation.

As the amount you have received is not in respect of any underlying asset, the whole of the settlement amount is treated as capital proceeds from a CGT event (CGT event C2) happening to your right to seek compensation.

However paragraph 118-37(1)(a) of the ITAA 1997 disregards a capital gain where the amount relates to compensation or damages received for any wrong or injury you suffer in your occupation or any wrong, injury or illness you or your relative suffers personally.

Therefore the lump sum amount for personal injury will be exempt from CGT.

Conclusion

As the amount from the personal injury compensation is not assessable as either ordinary income or as a capital gain it will not be assessable income. Therefore the lump sum amount for the personal injury claim amount will not be required to be included in your income tax return.