Edited version of private advice

Authorisation Number: 1051949800865

Date of advice: 7 March 2022

Ruling

Subject: Compensation

Question 1

Is the initial lump sum payment from Foreign Country Support Scheme (the Support Scheme) assessable as ordinary income under the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the second lump sum payment from the Support Scheme assessable as ordinary income under the ITAA 1997?

Answer

No.

Question 3

Is the capital gain or loss from above two lump sum payments from the Support Scheme disregarded under the capital gains tax (CGT) provisions?

Answer

Yes.

Question 4

Is the backdated Stage 1 payment from the Support Scheme assessable as ordinary income under the ITAA 1997?

Answer

Yes.

Question 5

Will the ongoing monthly payments from the Support Scheme be assessable as ordinary income under the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are an Australian resident for tax purposes.

You were ill at a young age while living in foreign country A.

During the late 19XXs, because of your condition, you had a treatment at hospitals in foreign country A.

You were subsequently diagnosed with another illness as a result of the treatment.

Foreign country A established the Support Scheme.

The Support Scheme is to provide you with ex-gratia financial and non-financial support.

Your application did not (and was not required to, nor requested) disclose any information in respect of your income capacity.

You received a letter from the Support Scheme confirming your eligibility to receive compensation payments.

The details of your compensation are:

•         a lump sum payment (the Initial Payment),

•         a second lump sum payment (the Second Lump Sum Payment),

•         a backdated Stage 1 payment,

•         ongoing monthly payments for the remainder of your life thereafter (the Ongoing Payments).

All payments received under the Support Scheme are not subject to taxation in that country.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Subsection 6-10(4)

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)

International Tax Agreements Act 1953

Reasons for decision

Ordinary Income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia, 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 expected,

•         are relied upon, and

•         have an element of periodicity, recurrence or regularity.

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).

In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

The Initial Payment and the Second Lump Sum Payment

The Initial Payment and the Second Lump Sum Payment were not earned by you as it did not relate to services performed. The payments were not a revenue receipt directly related to your employment duties. The payments were not considered to be a payment for lost income. The payments were also one-off payments and thus do not have an element of recurrence or regularity. Although the payments can be said to be expected, and perhaps relied upon, this expectation arises from the illness you suffer.

Considering the full circumstances, the Initial Payment and the Second Lump Sum Payment will not be as ordinary income and are therefore not assessable under subsection 6-5(2) of the ITAA 1997.

The backdated Stage 1 payment and the Ongoing Payments

The payments under the Support Scheme are being made to you because: the illness is expected to cause you to have resulting substantial and long-term difficulties when carrying out routine daily activities; and individuals living with those conditions face extra costs.

Your application did not (and was not required to, nor requested) disclose any information in respect of your income capacity.

There is nothing in the documentation related to the Support Scheme which suggests that these payments are being made to you to compensate you for any loss of income, rather it stipulates that the purpose of the Support Scheme payments is to provide financial compensation.

The backdated Stage 1 payments and the Ongoing Payments are paid to meet current expenses not a payment of compensation for the illness.

It is clearly that you expect these payments to meet the regular extra expenses; while the payments are not to replace income, it is intended to cover the extra ongoing expenses you will incur. This points to the payments being regular and relied upon to meet expenses and hence in the nature of income not capital.

Therefore, the backdated Stage 1 payment and the Ongoing Payments are assessable as ordinary income under subsection 6-5(2) of the ITAA 1997.

Statutory income

Subsection 6-10(4) of the ITAA 1997 provides that your assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

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

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens.

Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Taxation ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts.

Why the payment was made is an important factor in determining whether an asset has been disposed of for CGT purposes.

TR 95/35 discusses the various scenarios, including:

•         disposal of the underlying asset,

•         compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and

•         disposal of the right to seek compensation.

The relevant CGT asset in your case is your right to a capital amount payable under the Support Scheme.

However, paragraph 118-37(1)(b) of the ITAA 1997 disregards any capital gain or capital loss made where the amount relates to compensation or damages you receive for any wrong, injury or illness you suffer personally.

In your case, paragraph 118-37(1)(b) of the ITAA 1997 applies. This means that the lump sum payments you received are not included in your assessable income under the CGT provisions.

Double tax agreement between Australia and the Foreign Country A

In determining your liability to pay tax in Australia it is necessary to consider not only the domestic income tax laws but also any applicable double tax agreements.

The foreign country A agreement is located on the Austlii website (www.austlii.edu.au) in the Australian Treaties Series database. The agreement operates to avoid the double taxation of income received by residents of Australia and foreign country A.

Article 20 (Other income) of the agreement sets out rules for incomes not dealt with in the other Articles of the agreement.

Article 20(1) of the agreement states that:

•         Items of income beneficially owned by a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.

Article 20(3) of the agreement states that:

•         Notwithstanding the provisions of paragraphs 1 and 2 of this Article, items of income of a resident of a Contracting State not dealt with in the foregoing Articles of this Convention from sources in the other Contracting State may also be taxed in the other Contracting State.

In your case, both Australia and foreign country A have taxing rights for the payments from the Support Scheme, however, all payments received under the Support Scheme are not subject to taxation in that country. As a resident of Australia for taxation purposes, you are required to include the assessable amount from the Support Scheme in your tax return.

Lump sum payments in arrears tax offsets

Lump sum payments in arrears (LSPIA) are taxable in the year you receive payment. You may be eligible for a tax offset to reduce your tax payable.

A lump sum payment in arrears amount, is a payment that relates to earlier income years.

You may be eligible for a tax offset on a LSPIA amount in certain conditions. Eligible payments usually relate to employment, compensation or welfare payments.

For more information, please go to ATO website and search QC 63791.