Edited version of private advice

Authorisation Number: 1051874912909

Date of advice: 06 August 2021

Ruling

Subject: Lump sum compensation payment - redemption settlement

Question 1

Will the lump sum amount of the redemption settlement to extinguish your ongoing benefits for future income compensation entitlements be included in your assessable income?

Answer

Yes.

Question 2

Will the lump sum amount of the redemption settlement to extinguish your ongoing benefits for future medical expenses entitlements be included in your assessable income?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2021

Year ending 30 June 2022

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

You are a currently employed.

You have a current accepted claim for benefits under your current employment award in receipt of weekly income compensation and medical expenses.

Those benefits currently extend until age 67 for income compensation and for life for medical expenses.

You have accepted an offer from your employer to receive a lump sum to extinguish those ongoing benefits in the amount of $X - being $X for future income compensation entitlements and $X for future medical expenses entitlements.

You will also resign from your employment as part of the agreed settlement.

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

In your case, you have accepted an offer from your employer to receive a lump sum to extinguish your ongoing benefits in the amount of $X - being $X for future income compensation entitlements and $X for future medical expenses entitlements, with the payment being pursuant to the award you employment is covered by.

Therefore, in order to determine the taxation treatment of your lump sum payment the nature of the individual components must be examined.

Lump sum to extinguish your ongoing benefits for future income compensation entitlements

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 (for example, capital gains) 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.

A lump sum payment representing redemption of future weekly payment is also regarded as assessable income. The fact that the payment is received in one lump sum does not change its revenue character. This is consistent with the approach taken by the Commissioner in Taxation Determination TD 93/3 Income tax: is a payment, being a partial commutation of weekly compensation payments, assessable income? As outlined in paragraph 4 of TD 93/3, such a commutation would result in the lump sum remaining assessable, as its effect was simply to pay in advance the future weekly payments.

Taxation Determination TD 2016/18 Income tax: is a redemption payment received by a worker under the Return to Work Act 2014 (SA) assessable income of the worker, states that a payment made under section 53 of the Return to Work Act 2014 (SA) (RWA) is ordinary income of the worker and is therefore assessable under section 6-5 of the ITAA 1997 in the income year in which it is received.

Paragraph 23 of TD 2016/18 provides that these redemption payments are also considered to be income according to ordinary concepts, since they represent a recoupment, replacement or compensation for income that would otherwise be derived in the form of weekly payments.

Paragraph 24 of TD 2016/18 also provides that the character of a redemption payment of this kind was considered in Brackenreg V Federal Commissioner of Taxation [2003] AATA 824; 2003 ATC 2196; (2003) 53 ATR 1116 (Brackenreg). There the taxpayer received weekly compensation payments from Comcare, which took into account her normal weekly earnings. Comcare's liability to make these payments was subsequently redeemed for a lump sum. The AAT found that the taxpayer's weekly compensation was income, since it was in substitution for and was paid for loss of earnings; and the character of that compensation did not change upon being redeemed by the payment of a lump sum.

However, paragraph 3 of TD 2016/18 provides that in a series of private rulings, issued over several years, the Commissioner has accepted that amounts substantially similar to those covered by this Determination are not assessable for income tax purposes.

As such, paragraph 4 of TD 2016/18 provides that this determination only applies to redemption payments made under agreements entered into on or after 10 August 2016.

In your case, your redemption settlement agreement for all components to be received will be entered into after 10 August 2016.

You will be receiving a lump sum to extinguish your ongoing benefits being $X for future income compensation entitlements with the payment being pursuant to your current employment award. Despite the fact that this type of payment is not specifically covered by TD 2016/18, the sections in your current employment award reflect the relevant sections in the RWA and TD 2016/18.

As such, the principles outlined in TD 2016/18 (and TD 93/3) will apply to your circumstances, and the expected lump sum amount you will receive to extinguish your ongoing benefits being $X for future income compensation entitlements will be assessable under section 6-5 of the ITAA 1997 in the income year in which it is received.

Lump sum to extinguish your ongoing benefits for future medical expenses entitlements

You will be receiving lump sum redemption amount to extinguish your ongoing benefits being $X for future medical expenses entitlements pursuant to your current employment award.

These are rights of a capital nature and the money you will be receiving is to compensate you for the relinquishment of these rights will similarly be of a capital nature.

Therefore, the payment 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 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.

In your case, the lump sum payment under your current employment award be received as compensation for a 'wrong or injury you have suffered in your occupation', being the loss of body functionality in respect of your workplace injury.

Therefore, any capital gain or capital loss arising from the CGT event will be disregarded under subparagraph 118-37(1)(a)(i) of the ITAA 1997 and the payments will not be assessable as statutory income.

As the expected lump sum payment of $X pursuant to your current employment award is not assessable as either ordinary or statutory income, you are not required to include this amount in your assessable income.

Additionally, as the criteria in subsection 82-135(i) of the ITAA 1997 is satisfied this $X payment is excluded from being an Eligible Termination Payment.