Edited version of private advice

Authorisation Number: 1052237627586

Date of advice: 2 April 2024

Ruling

Subject: Foreign lump sum compensation

Question 1

Is the Lump Sum Amount assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No. The Lump Sum Amount is capital in nature and is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 2

Are the Monthly Payments assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No. The Monthly Payments are capital in nature and are not assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 3

Will any capital gain or loss made on the receipt of the amounts included in the Payment be disregarded under section 118-37 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You and your family lived in Country X.

The Government of Country X made a resolution for the issuing of payments to persons such as military personnel and their families during martial law. This included a one-time financial assistance payment to be distributed in equal shares to all eligible recipients. Persons with the right to receive the one-time payment could exercise the right from the date of its occurrence, being the date of death of the relevant person as provided on their death certificate.

You and your dependent children, Person A and Person, migrated to Australia where you have settled, with you gaining employment and your children being enrolled in school.

You and your children currently have visas that allow you to stay until after the end of the ruling period.

You are a resident of Australia for taxation purposes.

You will be staying in Australia indefinitely and do not anticipate returning to Country X.

Your spouse was killed in Country X while completing military service.

A claim was lodged with the relevant Government Department in Country X in relation to the one-time financial assistance payment, with you and your children being listed as claimants.

You were notified by the Country X Ministry of Defence that the claim in relation to the one-time monetary assistance had been granted, payable to you, your children, and a relative of your spouse in equal parts.

Due to Country X's limited budget, the one-time financial assistance payment (collectively referred to as the Payment) would be paid as follows:

•         A smaller specified percentage of the Payment to be paid as a lump sum amount (the Lump Sum Amount): and

•         The remaining larger specified percentage of the Payment to be paid at a specified amount over a specified number of monthly payments (the Monthly Payments).

You have received the Lump Sum Amount and several of the Monthly Payments at this point and will receive other Monthly Payments during the ruling period.

You will pay tax in relation to the Payment in Country X.

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 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 103-10

Income Tax Assessment Act 1997 Paragraph 104-25(1)(b)

Income Tax Assessment Act 1997 Subsection 116-20(1)(a)

Income Tax Assessment Act 1997 Section 118-37

Income Tax Assessment Act 1997 Subparagraph 118-37(1)(a)(ii)

Reasons for decision

Question 1: Is the Lump Sum Amount assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Question 2: Are the Monthly Payments assessable as ordinary income under section 6-5 of the ITAA 1997?

Ordinary assessable income?

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes 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, being 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 earned, 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 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).

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.

Capital gains tax

Under section 102-5 of the ITAA 1997, your assessable income includes your net capital gain for the income year with a capital gain or capital loss only being made if a capital gains tax (CGT) event happens under section 102-20 of the ITAA 1997. You make a capital gain if the capital proceeds you receive in relation to the CGT event are more than the cost base of the asset. You make a capital loss if the capital proceeds are less than the reduced cost base of the asset.

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. Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset, such as a taxpayer's right to seek compensation.

Subsection 116-20(1)(a) of the ITAA 1997 provides that the capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, in respect of the event happening.

Under section 103-10 of the ITAA 1997, if the money or other property in relation to a CGT event will not be received until a later time or is payable by instalments, the CGT provisions apply as if the taxpayer is immediately entitled to the money or other property. The fact that one category of capital proceeds referred to in section 103-10 of the ITAA 1997 includes moneys which have not yet been received but which the taxpayer is entitled to receive, supports that a debt payable for the disposal of a CGT asset is not to be treated as a separate CGT asset when considering the effect of the disposal of the first CGT asset and later payment for it.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the capital gains tax implications for compensation receipts discusses various scenarios, such as receiving compensation from a right to seek compensation in relation to a personal jury or other compensable damage or injury. The right to seek compensation, being a CGT asset, is disposed of when it is satisfied, released, or discharged.

Under paragraph 104-25(1)(b) of the ITAA 1997, a CGT event C2 happens if your ownership of an intangible CGT asset ends when it is released, discharged or satisfied, such as when an acceptance of an offer to receive an amount in relation to a right to seek compensation occurs.

Application to your situation

In your case, your spouse was killed while undertaking military services in Country X. You made a claim for yourself and your children to receive a one-time family assistance payment, the Payment, which was approved.

The Payment could not be made to you in one payment due to the financial situation of the Government in Country X, with the Payment to be made in numerous payments consisting of the Lump Sum Amount, with the remainder of the Payment to be made in monthly payments, the Monthly Payments.

At this point you have received the Lump Sum Amount and several of the Monthly Payments.

You had not provided any personal services to earn the Payment, nor is it being received in relation to lost income. Nor does the Payment have the characteristics of being ordinary income as it lacked any element of periodicity, recurrence or regularity as it was a one-time payment.

While you have received the Lump Sum Amount and several of the Monthly Payments at this point, and will receive the remainder of the Payment in future monthly instalments, it cannot be viewed that the way the payments are being made to you will change the nature of the payments in your hands, with the Payment being capital in nature.

The claim made with the Government Department in Country X generated the receipt of the Payment, with the relevant CGT asset being your right to seek compensation. The Payment is being made in full settlement of the claim you made on behalf of yourself and your children with a CGT event C2 occurring because of the ending of your right to seek compensation when you accepted the Payment.

The Payment represents capital proceeds for the ending of your CGT asset when CGT event C2 occurred. While you have received the Lump Sum Amount, and several Monthly Payments, with future Monthly Payments still to be received, the whole amount of the Payment will be viewed as being your capital proceeds.

Therefore, as the Payment is capital in nature and assessable under the CGT provisions, the Payment consisting of the Lump Sum Amount and the Monthly Payments, will not be assessable as ordinary income under section 6-5 of the ITAA 1997.payments,

Question 3: Will any capital gain or loss made on the receipt of the lump sum amount and monthly payments be disregarded under section 118-37 of the ITAA 1997?

CGT exemption

Under subparagraph 118-37(1)(a)(ii) of the ITAA 1997, any capital gain or capital loss you make from a CGT event is disregarded if it relates directly to compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally.

Application to your situation

As outlined above, the Payment is viewed as being capital in nature with it being received as compensation for the death of your spouse.

Therefore, as the Payment falls within the CGT exemption under subparagraph 118-37(1)(a)(ii) of the ITAA 1997, you can disregard any capital gain or loss arising in relation to the Payment.

Conclusion

As outlined above, it has been determined that:

•         The Payment, consisting of the Lump Sum Amount and the Monthly Payments are capital in nature and are not assessable as ordinary income under section 6-5 of the ITAA 1997; and

•         Any capital gain or capital loss made in relation to the Payment will be disregarded under subparagraph 118-37(1)(a)(ii) of the ITAA 1997.