Edited version of your private ruling

Authorisation Number: 1052181536812

Date of advice: 14 December 2023

Ruling

Subject: Compensation

Question 1

Is the X component of the compensation payment made by your employer to you under the Settlement and Release Agreement assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Are the components of the compensation payment for X and X made by your employer to you under the Settlement and Release Agreement assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer

No.

Question 3

Is any part of the compensation payment made by your employer to you under the Settlement and Release Agreement assessable as a net capital gain under section 102-5 of the ITAA 1997?

Answer

No.

Question 4

Is the X component of the compensation payment included in your assessable income?

Answer

No.

Question 5

Are the remaining components of the compensation payment included in your assessable income?

Answer

No.

This ruling applies for the following period:

For the period ended DDMMYYYY

The scheme commenced on:

DDMMYYYY

Relevant facts and circumstances

You submitted a claim against your employer for injury or illness you suffered at work.

Any leave you took away from work as a result of the claimed injury or illness was paid personal leave.

Your claim was denied.

You requested reconsideration of the decision however it was affirmed.

You sought a further review of the decision with a tribunal about whether compensation was to be paid to you relating to the claimed injury or illness (the dispute).

You and the employer entered into a Settlement and Release Agreement

You were paid an amount of money as compensation in settlement of the personal injury, X and X.

Detailed reasoning

Question 1 - ordinary income and compensation payments

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.

Ordinary income generally includes receipts that are earned, expected, 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. Compensation payments which substitute income have been held by the courts to be income under ordinary concepts.

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Application to your circumstances

In your case, the component of the compensation payment was in lieu of the claim for personal injury you suffered in your occupation. The amount paid is not income from rendering personal services, income from property or income from carrying on a business. The payment was not earned by you as it does not relate to services you performed. It was also not paid as a substitute, replacement or in lieu of lost earnings or income from your employment.

The amount is also a one-off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation only arises from the settlement of the Dispute rather than from a relationship to personal services performed by you.

Therefore, this component of the payment is not ordinary income and is of a capital nature.

Question 2 - payment for x and x

In your case, the compensation payment you received also included components for X and X.

As such, it is evident that these amounts are also not income from rendering personal services, income from property or income from carrying on a business. Further, the amounts do not have an element of periodicity, recurrence, or regularity.

Therefore, it is considered that these amounts are not ordinary income and are of a capital nature.

Question 3 - capital gains tax and compensation payments

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

Section 10-5 of the ITAA 1997 lists those provisions. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains. Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is only made if a capital gains tax (CGT) event happens.

Amounts received in respect of personal injury which is not direct compensation for loss of income will usually be capital in nature. Any net capital gain arising from the receipt, worked out in accordance with the CGT provisions of the ITAA 1997, is potentially assessable under section 102-5 of the ITAA 1997 as statutory income.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

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 a 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 where the amount relates to compensation or damages received for any 'wrong or injury you suffer in your occupation ... or illness you or your relative suffers personally'.

Application to your circumstances

In your case, the entire payment you received is not ordinary income and is capital in nature.

As the amount is not in respect of any underlying asset, the whole of the settlement amount is treated as capital proceeds from a CGT event (CGT event C2) happening to your right to seek compensation.

The Agreement was entered into in settlement of the Dispute about your claim for personal injury. The compensation payment followed as a result of the wrong or injury you suffered in your occupation.

Therefore, the capital gain you made from the CGT event happening to your right to seek compensation is disregarded under subparagraph 118-37(1)(a)(i) of the ITAA 1997 as in your case, the wrong or injury was suffered in your occupation at work.

The amount you received is not assessable as statutory income as the capital gain can be disregarded.

Question 4

The X component is of a capital nature and is not included in your assessable income.

Question 5

The reimbursement for X and X is of a capital nature and is not included in your assessable income.