Edited version of private advice

Authorisation Number: 1051843152377

Date of advice: 21 June 2021

Ruling

Subject: Lump sum compensation payment

Question

Is the lump sum compensation payment or any portion thereof paid to you assessable as either ordinary income or as a capital gain?

Answer

No.

This ruling applies for the following period:

For the income year beginning 1 July 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You made a claim under your State workers compensation legislation in relation to an injury you sustained whilst undertaking your employment duties.

You received benefits under the scheme for reasonable medical expenses.

You also pursued a claim for additional injuries however these claims were rejected by a Tribunal who reviewed the case as non-compensable conditions.

You elected to undergo an assessment of whole person impairment by an accredited medical practitioner in accordance with the Impairment Assessment Guidelines, to establish your entitlement to economic and non-economic loss pursuant to the workers compensation legislation.

The doctors reported findings were rejected by the Respondent, so you instituted dispute proceedings in the State Employment Tribunal to seek to resolve the matter.

You and the other party have agreed, without admission of liability, that within seven days of receiving an executed copy of the Deed, the Respondent will pay you a lump sum compensation payment in consideration for entering into the Deed of Release and Discharge known as the Settlement Sum.

The Settlement Sum is in full/final satisfaction of your employment, claims and proceedings.

The Settlement Sum is not said to be paid as a replacement for loss of income but is in recognition of permanent impairment you have suffered as a result of your injuries.

You were awarded a contribution towards your legal and representation costs.

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 104-25

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

Reasons for decision

Ordinary income

Section 6-5 and section 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 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.

Compensation paid due to the surrendered right to seek compensation relating to a personal wrong, injury or illness which you have suffered personally is an isolated transaction. Whether a profit from an isolated transaction is ordinary assessable income according to ordinary concepts depends on the circumstances of the case.

The ATO view on this matter is contained in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income. Profit from an isolated transaction is generally ordinary income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain, and

(b) the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 of Taxation Ruling TR 92/3).

In your case, the lump sum compensation payment therefore does not give rise to income according to ordinary concepts or to a profit arising from a profit-making undertaking or plan pursuant to section 6-5 of the ITAA 1997.

Therefore, the lump sum compensation amount or any portion is considered capital in nature and will not be assessable as ordinary income.

Statutory income

The receipt of a lump sum compensation amount may give rise to a capital gain (statutory income) under Capital Gains Tax (CGT) event C2 (section 104-25 of the ITAA 1997) which relates to cancellation, surrender or similar endings. However, a capital gain or loss made upon the ending of a CGT asset acquired on or after 20 September 1985 is disregarded under subparagraph 118-37(1)(a)(i) of the ITAA 1997, if the CGT event is in relation to compensation or damages received for any wrong or injury you suffer in your occupation.

The Commissioner's view as to the CGT consequences of receiving a compensation payment is published in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts. TR 95/35 states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity. In this instance the compensation relates to a personal wrong, injury or illness which you have suffered personally and CGT may therefore be disregarded under subparagraph 118-37(1)(a)(i) of the ITAA 1997.

Therefore, in your case a capital gain arising from the CGT event will be disregarded under subparagraph 118-37(1)(a)(i) of the ITAA 1997 and the lump sum compensation payment will not be assessable as statutory income.

In summary, as the lump sum compensation payment or any portion thereof is not assessable as either ordinary or statutory income, you are not required to include the total amount in your assessable income on your tax return.