Edited version of your written advice

Authorisation Number: 1051442830607

Date of advice: 24 October 2018

Ruling

Subject: Compensation – past loss of earning capacity

Question

Is the amount of compensation you received for past loss of earning capacity included in your assessable income?

Answer

No.

This ruling applies for the following period

Financial year ended 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You were injured in a motor vehicle accident.

You lodged a motor vehicle accident claim with the insurer.

You agreed to settle the claim and received a compensation payment.

The breakup of the compensation received included an amount for past loss of earning capacity.

The amount of compensation paid for loss of sick leave credits and loss of annual leave entitlements was calculated based on your full time salary and your regular working week.

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 6-15

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 subsection 102-5(1)

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subparagraph 118-37(1)(a)(ii)

Reasons for decision

Ordinary income

Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)).

Ordinary income has generally been held to include 3 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, and

● have an element of periodicity, recurrence or regularity.

Salary and wages (including payments for sick leave and annual leave) are ordinary income.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, 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. Damages awarded for past or future loss or impairment of earning capacity is not ordinary income (Groves v. United Pacific Transport Pty Ltd [1965] Qd R 62). The capacity to earn income is a capital asset and compensation for the loss of a capital asset is a capital receipt and is not ordinary income.

Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income:

● if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or

● to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

In your case, the motor vehicle third party insurance legislation under which your claim was made provides for compensation for loss of earning capacity, not loss of income. Taxation Ruling IT 2193 makes it clear that compensation for loss of earning capacity will not lose its character as a capital receipt simply because the amount of compensation is calculated by reference to amounts of income lost.

No component of your lump sum related to loss of income. Rather it related to damages, future treatment, travel and the loss of your earning capacity.

In reaching the agreed settlement amount the breakdown in the payment in relation to your personal injury claim listed an amount which, while calculated based on your average weekly earnings, was clearly identified as being for a loss of past earning capacity.

Therefore it is considered that the portion of the compensation payment received which is clearly identified and calculated as an amount for the loss of past earning capacity is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Statutory income

Amounts that are not ordinary income, but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997).

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list is section 102-5 (capital gains).

Your assessable income includes your net capital gain for the income year (subsection 102-5(1) of the ITAA 1997). You make a capital gain (or loss) as a result of a CGT event happening (section 102-20).

CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being redeemed, released, discharged or surrendered (subsection 104-25(1) of the ITAA 1997). The time of the event is when you enter into the contract that results in the asset ending, or if there is no contract, when the asset ends (subsection 104-25(2)).

A CGT asset is any kind of property or a legal or equitable right that is not property (section 108-5 of the ITAA 1997).

In your case, your right to seek compensation was an intangible CGT asset and your ownership of that asset ended when you entered into the agreement with the insurer to accept the settlement amount. At that time CGT event C2 happened and you made a capital gain.

However, subparagraph 118-37(1)(a)(ii) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any 'wrong, injury or illness you or your relative suffers personally'.

Therefore, the capital gain you made from the CGT event happening to your right to seek compensation is disregarded under subparagraph 118-37(1)(a)(ii) of the ITAA 1997. As such, it is not statutory income.

Subsection 6-15(1) of the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income. Consequently no part of the compensation you received for past loss of earning capacity is included in your assessable income.