Edited version of private advice

Authorisation Number: 1051890547226

Date of advice: 27 August 2021

Ruling

Subject: Income or capital

Question 1

Will receipt of the lump sum payment under the Deed of Extension and Release be classified as ordinary income?

Answer

No

Question 2

Is the lump sum payment received under the Deed of Extension and Release capital in nature?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

26 February 20XX

Relevant facts and circumstances

You were engaged to provide services to the Authority from XXXX.

Several contract extensions were executed between you and the Authority over the past XX years.

A Deed of Extension and Release was executed between you and the authority. Under this deed the Authority agreed to pay a lump sum $XXXX (to be sent as payments of $XX and $XX).

Both payments have been received.

The deed signifies the parties agreeing not to sue and allowing a plea in bar to both entities for any proposed claims.

After the payments and end of relationship with Authority, you have completed small levels of work for a separate entity.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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

Income Tax Assessment Act 1997 division 102

Income Tax Assessment Act 1997 section 104-25

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

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 such as commission income, incentive payments, dividends, gratuities, lease payments and hire charges.

Subsection 6-5(2) of the 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.

The payment you received from the Authority was not intended to represent loss of ordinary earnings. The payment does not fit within the general three categories listed above.

We consider that the payment was in its nature compensation received for the parties agreeing that no claims will arise. Payments received as compensation for the right to seek compensation is capital in nature.

The lump sum payment received has caused the business to lose a substantial part to be lost. Where the cancellation or variation affects the framework of the business or causes a substantial part of the business to be lost then the amount received will be of a capital nature (Californian Oil Products Ltd (in liq) v. Federal Commissioner of Taxation (1934) 52 CLR 28).

The right to seek compensation is a particular asset for the purposes of CGT event C2. The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35).

In determining which is the most relevant asset, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt. In your situation, the amount of compensation received as a lump sum constitutes payment in exchange for releasing your right to pursue further action.

The Deed was executed on XXXX and the lump sum was received by you. The Authority did not provide you with any details as to how this amount was calculated. Under the Deed you agreed to release the Authority from any action or claim.

Your circumstances are similar to that seen in example 8 of TR 95/35 and represent that the right to seek compensation is the relevant asset that has been disposed of.