Edited version of private advice

Authorisation Number: 1052046562581

Date of advice: 19 October 2022

Ruling

Subject: Compensation payment for personal injury

Question 1

Where the Damages are awarded as a lump sum, will the lump sum (including the interim payments) constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that the payment is specified as being awarded for past loss of earnings, future loss of earnings or future loss of pension?

Answer

Yes.

Question 2

Where the Damages are awarded as a lump sum, will the lump sum (including the interim payments) constitute assessable income under section 6-5 of the ITAA 1997 to the extent that the payment is specified as being awarded for general damages, future care and medical costs and other recurring or capital costs?

Answer

No.

Question 3

Where the Damages are awarded as a lump sum (including the interim payments), will the capital gain resulting from CGT event C2 be disregarded under paragraph 118-37(1)(a) of the ITAA 1997 to the extent that the payment is specified as being awarded for general damages, future care and medical costs and other recurring or capital costs?

Answer

Yes.

Question 4

Where the Damages are paid as periodical payments, will the payments constitute assessable income under section 6-5 of the ITAA 1997 to the extent that the payments are specified as being awarded for future loss of earnings or future loss of pension?

Answer

Yes.

Question 5

Where the Damages are paid as periodical payments, will the payments constitute assessable income under section 6-5 of the ITAA 1997 to the extent that the payments are specified as being awarded for future care, future medical costs and other recurring or capital costs?

Answer

No.

This private ruling applies for the following period:

The end of the income year in which the last amount is received by you with respect to the Damages paid under the court order.

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You presented to a medical facility with a health condition which was misdiagnosed. The misdiagnosis resulted in a serious injury to you along with permanent impairment.

You sent a letter of claim to the organisation in respect of the injury. The organisation admitted liability with damages to be assessed by a court.

In the court proceedings, you claimed that you suffered pain, injury, loss and damage as a result of negligence by the organisation. You claimed damages, including damages for pain and suffering (Damages).

The court may order that the Damages be paid as a lump sum, or as periodical payments, or partly as a lump sum and partly as periodical payments.

The court ordered that the organisation make interim payments to you to be used for your immediate benefit and rehabilitation needs.

At a later time, the court ordered that another interim payment be made to you. You requested this amount to provide for an intensive care regime for you and to allow you to ensure independence with necessary support. The funds were also requested to allow you to finish the building of your adapted accommodation.

The particular components of the interim payments you received were not listed or specified.

As part of determining the Damages to be paid to you, you are required to submit a schedule to the court itemising all amounts claimed. The amounts claimed are divided into three categories as follows:

(1) General damages (for personal injury)

(2)  Past loss (eg travel, care, therapies, treatments, loss of earnings, accommodation)

(1)  Future loss (eg care, therapies, treatments, loss of earnings, loss of pension, accommodation)

The following is noted from the schedule:

•         Past loss of earnings - the amount claimed will be based on the employment income you may have been expected to earn had you not sustained the injury.

•         Future loss of earnings - you have been unable to return to work since the injury and will be incapable of returning to work in the future. Loss of earnings are claimed until your retirement.

•         Future loss of pension - you suffered a loss of pension as a result of your inability to resume employment.

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 paragraph 118-37(1)(a)

Reasons for decision

Questions 1 and 2

Receipt of lump sum - ordinary income

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

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? states that a lump sum will constitute assessable income:

(a) if the payment is compensation for loss of income only e.g. past year profits, and/or interest (even when the basis of the calculation of the lump sum cannot be determined); or

(b) to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature [cf. Mc Laurin v. FC of T (1961) 104 CLR 381; (1961) 8 AITR 180 and Allsop v. FC of T(1965) 113 CLR 341; 1965) 9 AITR 724].

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) states that an undissected lump sum compensation receipt is any amount of compensation received by a taxpayer where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated. Further:

188. Whether a receipt constitutes income or capital in the hands of the taxpayer depends on the circumstances of the receipt and the reasons why it was paid to the taxpayer (FC of T v. Slaven 84 ATC 4077; (1984) 15 ATR 242). In that case, the Federal Court was required to consider the nature of an amount of compensation received by the taxpayer following a motor vehicle accident. The Court (Bowen CJ, Lockhart and Sheppard JJ), in concluding that the amount was paid as compensation for loss or impairment of the taxpayer's earning capacity, stated (84 ATC at 4085; 15 ATR at 252):

'It is the character of the receipt in the hands of the taxpayer as recipient that must be determined'.

189. The Courts have also emphasised that there is a clear distinction between the character of a payment and how it is calculated or quantified (for example, Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411) and that the method used:

'may provide a quite misleading guide to the character of the payment' (Deane and Fisher JJ, in the Tinkler case, 79 ATC at 4648; 10 ATR at 418).

Application to your circumstances

Interim lump sum payments

In your case, you received three undissected interim lump sum payments in relation to your claim for damages that were paid to assist you with various costs and wellbeing needs related to the injuries you suffered.

As such, it is considered that no part of the payments can be identified as being of an income nature and therefore, the payments are not assessable as ordinary income under section 6-5 of the ITAA 1997.

Future lump sum payment

You may also receive a further lump sum payment in settlement of your claim that may relate to, broadly:

a)    past loss of earnings, future loss of earnings or future loss of pension, and

b)    general damages, future care and medical costs, and other recurring or capital costs.

Consequently, that part of a future lump sum payment that is specified as being awarded for past or future loss of earnings and pension will be assessable as income as that part of the payment will be a substitute for income. The character of the receipt of those components in your hands will be that of income, whether paid in a lump sum or periodically.

However, that part of a future lump sum payment that is specified as being awarded for general damages, future care and medical costs, and other recurring or capital costs will not have the character of income and will not constitute assessable income under section 6-5 of the ITAA 1997.

Question 3

Receipt of lump sum - 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.

The right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. A right to seek compensation is an intangible CGT asset. The right to seek compensation is acquired at the time of the compensable wrong or injury and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged.

The receipt of a lump sum compensation payment may give rise to a capital gain under CGT event C2 which relates to the satisfaction, surrender, release, discharge or similar ending of an intangible CGT asset (section 104-25 of the ITAA 1997).

However, a capital gain or loss made upon the ending of a CGT asset is disregarded under paragraph

118-37(1)(a) of the ITAA 1997 if the CGT event relates to compensation or damages received for any wrong, injury or illness suffered by a person or a relative of that person.

As mentioned above, TR 95/35 states that an undissected lump sum compensation receipt is any amount of compensation received by a taxpayer where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated. Where this is the case, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.

A capital gain is disregarded under paragraph 118-37(1)(a) of the ITAA 1997 if a taxpayer receives compensation in an undissected lump sum which relates wholly to a personal wrong or injury suffered by the taxpayer.

If compensation is received in a lump sum paid in settlement of a number of claims, including a personal injury claim, and its individual components cannot be determined or reasonably estimated, no part of the compensation can be quantified as relating to the personal injury of the taxpayer.

However, if the taxpayer can show that all of the separate heads of claim relate to the personal injury of the taxpayer, and that there are no other non-personal injury elements of compensation within the total claim, any capital gain can still be disregarded (TR 95/35).

Application to your circumstances

In your case, CGT event C2 happened on receipt of each of the interim payments and will happen on receipt of a future lump sum payment; however, it is evident that the payments related or will relate wholly to a personal wrong or injury suffered by you.

As such, any capital gain arising from CGT event C2 is disregarded under paragraph 118-37(1)(a) of the ITAA 1997.

Questions 4 and 5

Receipt of periodical payments

As previously mentioned, section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived 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.

In Tinkler v. Federal Commissioner of Taxation 79 ATC 4641; (1979) 10 ATR 411 (Tinkler) the taxpayer received periodic payments under a scheme where if a person suffered a loss of income in the capacity of employee as a result of injuries in a motor car accident, they were entitled to statutory compensation in respect of the loss of that income; calculated as a proportion of the person's weekly income as an employee. It was held by the Federal Court that the payments were ordinary income as they were a substitute for part of the wages which would have been earned if the accident had not taken place.

The Tinkler case can be contrasted with the later decision in Federal Commissioner of Taxation v. Slaven (1984) 1 FCR 11; 84 ATC 4077; (1984) 15 ATR 242 (Slaven) where it was found that the payments received were not assessable as income on the basis that they were in the nature of compensation for deprivation or impairment of earning capacity.

The Slaven case is discussed in Taxation Ruling IT 2193 Income tax: compensation for loss of earning capacity:

6. In the Slaven Case the taxpayer received five irregular payments totalling $4,360 as compensation in respect of the deprivation or impairment of her earning capacity suffered as a result of a motor vehicle accident which left her unable to work for a period of nine months.

7. The Federal Court accepted that the 1979 amendments to the Motor Accidents Act achieved a fundamental difference in the nature of a payment made to an injured person. The Court found that the essential character of payments following the amendments is compensation for loss or impairment of earning capacity - they are no longer payments in substitution for lost earnings.

8. In reaching its conclusion that the amounts involved were not liable to income tax the Court relied on the following factors:-

(i) "the purpose of a statutory payment, as disclosed by the terms of the statute itself, must be a powerful, though not conclusive, aid to the determination of the character of the payment";

(ii) earning capacity is a capital asset;

(iii) "the Board's task is essentially to determine the compensation payable to a person having regard to the deprivation or impairment of his earning capacity";

(iv) "the exercise in which the Board is required to engage by the Act is not merely one of assessing lost earnings. It is in fact an exercise in valuation".

9. The decision should be applied to other similar payments made by the Motor Accidents Board of Victoria. In addition, the decision will extend to payments made by other compensation boards where the payments made are in the nature of compensation for deprivation or impairment of earning capacity.

Taxation Ruling 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? explains that weekly payments to compensate an injured worker for loss of income may be distinguished from payments pursuant to statutory compensation provisions dealing specifically with loss of future earning capacity.

Amounts paid in respect of loss of future earning capacity do not have the character of ordinary income as they are based on a sum prescribed by statute which bears no relationship to the employee's current or former earnings. In contrast, the calculation of weekly payments according to the worker's past and current earnings indicates that they reflect an actual loss of income as opposed to a loss of income earning capacity (paragraphs 19 to 21 of TD 2016/18)).

Application to your circumstances

In your case, you may receive a portion of the Damages as periodical payments to assist you with your future living expenses, care, medical related expenses and other recurring or capital costs.

Consequently, to the extent that the periodical payments are specified as being awarded for future loss of earnings or future loss of pension, the payments will have the character of income and will therefore, be assessable as income under section 6-5 of the ITAA 1997.

However, to the extent that the periodical payments are specified as being awarded for future care, future medical costs and other recurring or capital costs, it is evident that the payments will be unrelated to a loss of income and will not have the character of income. As such, the payments will not be assessable as income under section 6-5 of the ITAA 1997.