Edited version of your written advice

Authorisation Number: 1051471965966

Date of advice: 16 January 2019

Ruling

Subject: Lump sum payments

Question 1

Is the lump sum payment paid to you as a redemption of liability to make future weekly payments regarded as ordinary assessable income?

Answer

Yes

Question 2

Is the lump sum payment of paid to you for future medical expenses regarded as ordinary assessable income?

Answer

No.

Question 3

Is the lump sum payment of paid to you for compensation for your permanent impairment from the injury regarded as ordinary assessable income?

Answer

No.

Question 4

Will any capital gains arising from the compensation payment be disregarded?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You were injured at work, which resulted in permanent total incapacity.

You have reached a settlement and received compensation under the relevant worker’s compensation legislation made up of payments for the following:

● redemption of liability to make future weekly payments

● reimbursement of expenses

● compensation for your permanent impairment from the injury.

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 15-30

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 118-37

Reasons for decision

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; and

● Have an element of periodicity, recurrence or regularity.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (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).

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.

It is well established that, in general, insurance moneys are received on revenue account where the purpose of the insurance was to fill the place of the revenue receipt which the event insured against has prevented from arising (Carapark Holdings Ltd v. Federal Commissioner of Taxation (1967) 115 CLR at 633).

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was considered by the Commissioner in Taxation Determination TD 93/3. As outlined in paragraph 4 of TD 93/3, such a commutation would result in the lump sum remaining assessable, as its effect is simply to pay in advance the future periodic payments.

This view has also been confirmed in Sommer v. FC of T 2002 ATC 4815; 51 ATR 102 (Sommer’s case). The case involved a medical practitioner who had taken out an income protection policy. Following the rejection of the taxpayer’s claim for income replacement payments of $4,000 per month, the matter was settled out of court with the taxpayer receiving a lump sum.

The taxpayer argued that the amount was a payment of capital as it was paid as consideration for the cancellation of the policy, and the surrender of his rights under it or that the payment was capital as it was an undissected aggregation of both income and capital.

In dismissing the taxpayer’s appeal it was held that the payment was in settlement of income claims of the taxpayer in circumstances where the purpose of the insurance policy was to fill the place of a revenue receipt. As a result, the payment was clearly on revenue account. The fact that the payment was received in one lump sum did not change its revenue character.

It is acknowledged that in accepting the lump sum you will give up your rights in relation to compensation. However, it is considered that your case is similar to Sommer’s case and the lump sum represents a redemption of the right to receive income and is also regarded as income in nature.

The fact that the income will be made in one lump sum does not change the revenue character of the receipt as it will essentially be designed to compensate you in respect of your income claims, or as a payment in substitution of those claims.

Consequently, the lump sum payment which relieves the obligation to make future payments to you retains its character of ordinary income and is assessable under section 6-5 of the ITAA 1997 in the year that you receive it.

Compensation for injury

Amounts received in respect of personal injury, which are not a 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. Accordingly, the lump sum amount of $X represents 18.33% permanent impairment from your injury 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 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.

The lump sum payment paid to you for your personal injury meets this description. Therefore, section 118-37 of the ITAA 1997 applies to the lump sum amount so that any capital gain you make will be disregarded.

Expenses

Although the payment can be said to be expected, and perhaps relied upon in order to pay your medical bills, this expectation arises from the medical treatment required resulting from the injury, rather than from a relationship to personal services performed.

Accordingly, the payment is not ordinary income and is therefore, not assessable under section 6-5 of the ITAA 1997.

Section 15-30 of the ITAA 1997 operates to include in your assessable income any amount received by way of insurance or indemnity for the loss of an amount if:

(a)The loss amount would have been included in your assessable income; and

(b)The amount you receive is not assessable as ordinary income under section 6-5.

The lump sum amount paid to you for future medical expenses does not meet this description as it was not paid for loss of earnings but in satisfaction of the giving up of capital rights.

Section 15-30 of the ITAA 1997 does not apply to the lump sum amount.

Section 118-37 of the ITAA 1997 states that you may disregard any capital gain or capital loss from any capital gains tax event relating directly to compensation or damages you receive for any wrong or injury you suffer in your occupation.

The lump sum amount paid meets this description. Therefore, section 118-37 of the ITAA 1997 applies to the lump sum amount so that any capital gain you make will be disregarded.