Edited version of private advice

Authorisation Number: 1052005904205

Date of advice: 1 August 2022

Ruling

Subject: Compensation payment - lump sum

Question

Will a capital payment made as a result of an agreement you make with your former employer to redeem their liability to compensate you for medical services be included in your assessable income?

Answer

No.

Question

Will a lump sum contribution towards your retraining expenses made as a result of your agreement with your former employer be included in your assessable income?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 May 20XX

Relevant facts and circumstances

You suffered a work-related injury, namely an injury to the muscle/tendon of your left knee, whilst working as an employee of The Employer between XX September 19XX and XX May 20XX.

The Employer has an undischarged liability to you arising from the injury, to make weekly payments of income maintenance pursuant to a State or Territory workers compensation statute.

The Employer also has an undischarged liability to you, arising from the work related injury, to pay compensation for medical and other expenses.

The Employer and you have reached an agreement for the redemption of the undischarged liability to make weekly payments of income maintenance and to pay compensation for medical and other expenses.

The Employer's undischarged liability to make weekly payments of income maintenance will be redeemed by a capital payment of $XXX. This amount has been arrived at between both parties having regard to the reduced amount which would otherwise have been payable to you by virtue of the requirements of the relevant workers compensation statute and your retained capacity to earn in suitable employment.

You further acknowledge that you are taken to be receiving continuing weekly payments.

The Employer's undischarged liability to pay compensation for medical and other expenses is to be redeemed by a capital payment of $XXX to you.

The Employer also agrees to pay a retraining allowance of $XX to you.

You acknowledge that by making payment of $XXX, The Employer is full discharged from any further liability to make a capital payment for weekly payments and medical and like expenses.

The Employer and you agree that the agreement is not a reviewable decision under Section 97 of the Act.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 25.

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 subsection 6-5(1).

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

Income Tax Assessment Act 1936 subsection 160ZB(1).

Income Tax Assessment Act 1997 paragraph 118-37(1)(a).

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

Reasons for decision

Income tax treatment of lump sum compensation payment made pursuant to the redemption for medical services and the contribution towards retraining expenses

You received a lump sum payment as a result of a workers compensation claim against your employer. This payment is a once off payment and it was for the injury you sustained to your leg. The lump sum payment was comprised of three components:

1. One, an undischarged liability to make weekly payments, redeemed by a capital payment of $XX.

2. to pay compensation for medical and other expenses of the kind referred to in Section 33 of the Act for $XXX and

3. component of $XX in the form of a retraining allowance.

Your questions relate to components two and three (as listed above) only, as you acknowledge that the capital payment of $XX, which was an undischarged liability to make weekly payments will be assessable as ordinary income.

According to subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997), a person's assessable income includes income according to ordinary concepts, which is called ordinary income.

Subsection 6-5(2) of the ITAA 1997 then goes on to provide that if a person is an Australian resident, the person's assessable income includes the ordinary income the person derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Australian Taxation Office Interpretative Decision ATO ID 2002/192 specifies what the characteristics of income are and these include receipts that are earned, are expected, are relied upon and have an element of periodicity, recurrence or regularity.

The lump sum payment you received was not earned by you since it was not obtained in return for your labour done or services rendered. The lump sum payments relate to the injury you sustained to your leg at work. These payments are a once off payment and do not have the element of periodicity, recurrence or regularity of income receipts, therefore they would not be assessable under subsection 6-5(2) of the ITAA 1997.

Australian Taxation Office Interpretative Decision ATO ID 2002/423 also confirms that a lump sum payment received by a taxpayer as compensation for pain, suffering and medical expenses as a result of a personal wrong, injury or illness will not be assessable as ordinary income under section 6-5 of the ITAA 1997, as it does not have the characteristics of income.

According to State or Territory workers compensation statute. where lump sum payments are received as a redemption of all the injured worker's rights under a State or Territory workers compensation statute, these payments are of a capital nature and not included in assessable income of the individual.

Therefore, the State or Territory workers compensation statute can apply to your situation and this lump sum payment would not be assessable as ordinary income to you.

Capital gains treatment of compensation payment

Where lump sum damages are received in settlement of an unliquidated claim covering both income and capital elements, the whole amount is treated as capital, as seen in McLaurin v.Federal Commissioner of Taxation (1961) 104 CLR 381; (1961) 12 ATD 273; Allsop v. Federal Commissioner of Taxation (1965) 113 CLR 341; (1965) 14 ATD 288).

The capital gains and capital loss provisions expressly provide that no capital gain or capital loss arises to a taxpayer as a result of the receipt of compensation for any wrong or injury suffered by the taxpayer to his or her person.

Paragraph 118-37(1)(a) of ITAA 1997 states:

A capital gain or capital loss you make from a CGT event relating directly to any of these is disregarded:

(a) compensation or damages you receive for any wrong or injury you suffer in your occupation;

In your case, the above paragraph would apply, since the undissected lump sum payment you received was compensation or damages you received for the permanent injury you had to your leg while you were at work.

This view is also confirmed by Taxation Ruling TR 95/35. Paragraph 20 of TR 95/35 that states:

1. Exemption under Income Tax Assessment Act 1936 (ITAA 1936) subsection 160ZB(1) is available if the taxpayer receives compensation in an undissected lump sum which relates wholly to the personal wrong or injury suffered by the taxpayer.

See also ATO ID 2002/192.

Therefore no capital gain arises in respect of the capital payment you received under the agreement with your former employer because it relates wholly to the personal injury that you suffered in your occupation.