Edited version of your written advice

Authorisation Number: 1051435646006

Date of advice: 2 November 2018

Ruling

Subject: Settlement payment

Question 1

Is the gross sum payment assessable as ordinary income?

Answer

Yes

Question 2

Is the gross sum payment assessable as a capital gain?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You began employment with Employer A in 19XX

On early 20XX you lodged a workers compensation claim for loss of income and medical expenses

The claims agent for Employer A rejected the claim in mid 20XX

You lodged an Application for Review with the Employment Tribunal to dispute the determination.

An agreement, with denial of liability, was reached to resolve all matters in full between yourself and the employer

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(2)

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

An amount paid to compensate for loss generally acquires the same nature of what it is substituting (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82). Compensation payments 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; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

Ordinary income has 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 received as a product of any employment, services rendered, or any business;

● are earned;

● are received regularly or periodically;

● are expected; and

● are relied upon.

It is not necessary for all of these characteristics to be present for an amount to be considered ordinary income. A lump sum payment is generally classified as ordinary income if it is simply a lump sum made up of periodic income payments but paid in arrears to cover a certain period.

This view has been subsequently confirmed in Sommer v. FC of T 2002 ATC 4815; (2002) 51 ATR 102 (Sommer’s case) where a lump sum paid to a doctor in settlement of his claim under an income protection policy was assessable on the basis that it was in substitution for his original claim under the policy for lost income. The taxpayer argued that the amount comprised an undissected aggregation of both income and capital and, therefore should be treated as capital.

The taxpayer’s case was dismissed in the Federal Court and it was held that the commercial reality of the payment was that it was a full and final settlement of all the taxpayer’s income claims. The fact that it was a lump sum did not change its revenue nature.

The Sommer decision was followed in Gorton v. FC of T 2008 ATC 10-018, where a lump sum payment received by a former medical practitioner from his insurer in settlement of his professional income replacement claims was held to be assessable income.

Your situation is similar to the above cases as the lump sum you will receive will be a payout to settle and finalise your original claim for loss of wages and medical expenses.

Capital gain

Payments that are capital in nature may be assessable as statutory income under the capital gains tax (CGT) provisions.

In Taxation Ruling TR 95/35: Income tax: capital gains: treatment of compensation receipts, the Commissioner states that whether a lump sum or other compensation payment is assessable in the hands of the recipient depends on whether it is a receipt of a capital or income nature. This in turn depends upon consideration of all the circumstances surrounding the payment. It is the character of the receipt in the hands of the recipient that must be determined.

In TR 95/35 the Commissioner adopts a ‘look-through’ or ‘underlying asset’ approach to determine the nature of the asset. The ‘look-through’ approach is 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.

Having no documentation which identifies the nature of the settlement payment, the ‘look-through’ approach leads us to the conclusion that the payment you received was to compensate you for lost income which is the most relevant aspect of your original claim for lost wages and medical expenses.

The lump sum is a receipt of income only, that is, there is no capital component in the payment and therefore the payment is assessable as ordinary income under section 6-5 of the ITAA 1997 in the year it is received.

Conclusion

The capital gains tax (CGT) provisions do not apply to the lump sum finalisation payment as it is otherwise included in your assessable income, as ordinary income.