Edited version of private advice

Authorisation Number: 1052261883701

Date of advice: 24 June 2024

Ruling

Subject: Assessable income - lump sum payment

Question 1

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

Answer

Yes.

Question 2

Is the Settlement Sum assessable under the capital gains tax provisions?

Answer

Yes.

However, any capital gain will be reduced by the anti-overlap provision contained in section 118-20 of the ITAA 1997 by the amount that is otherwise assessed to you as ordinary income under section 6-5 of the ITAA 1997.

Question 3

Can you disregard any of the capital gain resulting from the capital gains tax event C2 occurring under section 118-37 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You sustained injuries in your workplace while you were employed by Company A.

You received worker's compensation payments as income replacement in relation to your injury over several years in addition to receiving Government payments during several years.

You made a claim (the Claim) several years after you were injured that was separate to your worker's compensation claim against your former employer, being Company A (the Proceedings) in which you were seeking the following:

•         Relief being claimed for damages, interest, costs and any further orders the court may make; and

•         A claim for economic loss for:

o   Past loss calculated using your net weekly salary amount when you were injured multiplied by a specified number of weeks covering the period from the date of injury until the assumed mediation date as provided, less earnings and payments of Workers Compensation. Additionally, a claim for a specified percentage of your superannuation contributions for the past economic loss period; and

o   Future economic loss for a period up until you would have reached retirement age, with the amount calculated as a specified percentage of an estimated weekly salary amount multiplied by a specified number of weeks until you reached retirement age. A claim for a specified percentage of your superannuation contribution for the period covered by the future economic loss period.

After several months you entered into a Deed of Release (the Deed) under which:

•         You and Company A had agreed to settle all claims and allegations made against Company A by you without admission of liability by Company A and to finalise all entitlements that may exist between you and Company A

•         Company A had agreed to pay you in full and final settlement of Proceedings, in consideration of your agreement to wholly and forever abandon any claim against Company A in relation to the injury, the allegations of negligence and the Proceedings, and to provide release and the indemnity set out in the Deed, damages of a specified amount (the Settlement Sum) which was clear of workers compensation payments made to date, and inclusive of costs and all disbursements.

You signed the settlement instructions in relation to the Proceedings in which:

•         You authorised and directed the payment of the Settlement Sum to be paid to your solicitors (the Lawyers), inclusive of costs and clear of all previous compensation payments made to settle your compensation claim in relation to the Injury.

•         You acknowledged that it was your understanding that the Settlement Sum was a once and for all settlement, and as of the date of the settlement you would not have any further claim or entitlement to weekly benefits, payments of medical and related expenses, or lump sum compensation for permanent impairment.

•         You understood that some specified amounts would be deducted from the Settlement Sum, with the agreed payment including costs of obtaining independent legal advice in relation to the settlement in the Deed, and any statutory charges relevant to the injury and the claim, including but not limited to repayment to Centrelink and Medicare Australia.

The Lawyers sent you a letter advising that they had received a specified amount, advising what the balance of the Settlement Sum was after specified amounts had been deducted (the Balance Amount).

The Balance amount was deposited into your bank account.

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 10-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-23

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 118-37

Income Tax Assessment Act 1997 Division 115

Reasons for decision

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (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, duringthe income year.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; (1952) 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 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. Federal Commissioner of Taxation 79 ATC 4641; (1979) 10 ATR 411).

Lump sum damages or out-of-court settlements may be a compromise of a claim made up of a number of items, some being of a revenue nature and others of a capital nature.

If different components of a lump sum compensation payment can be identified, those components that are of an income nature, such as those to compensate for loss of income, are assessable as such.

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? outlines the circumstances under which the receipt of a lump sum compensation/settlement payment is assessable as ordinary income. The determination states that where the compensation payment is for loss of income, the amount is assessable as ordinary income. Where a portion of a lump sum payment is identifiable and quantifiable as income, that portion of the payment will be assessable.

Applying the general principles contained in Taxation Ruling IT 2424 Income tax: compensation payments in respect of unlawful acts of discrimination, if the payment is intended to be a payment in relation to income, either past or future, then the payment is revenue in nature.

Paragraph 8 of IT 2424 states:

By way of general comment the determination of the character of a compensation payment, and in particular whether it is liable to tax in the hands of an employee, depends upon the nature of the payment. A compensation payment to make up for lost earnings or in substitution for income which would otherwise have been earned is in the nature of income and is liable to income tax in the hands of the employee. On the other hand a payment to compensate for personal injury, injury to feelings, humiliation, embarrassment, depression, anxiety, etc. is not liable to income tax. It is a payment of a capital nature. Nor is the payment liable to tax under the capital gains tax provisions by reason of the exemption provided in sub-section 160ZB(1) for compensation or damages paid for wrong or injury suffered by a taxpayer to his or her person or in his or her profession or vocation.

Statutory income

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by specific provisions of the income tax law, are called statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a capital gains tax (CGT) asset. A taxpayer's right to seek compensation is therefore classified as an intangible CGT asset which is acquired at the time of the compensable wrong or injury.

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens on the ending of the right to seek compensation, that is, the right to take legal action, when it is satisfied, surrendered, released or discharged. The date the CGT asset ends is relevant when considering eligibility to being able to reduce any capital gain made as a result of the CGT event occurring by the 50% CGT discount.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts provides the Commissioner's view on the CGT consequences for recipients of compensation amounts received. 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.

Paragraph 11 of TR 95/35 states that if the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

Paragraph 18 of TR 95/35 states that if the amount received is an undissected lump sum, the whole amount is treated as being consideration received on the disposal of the right to seek compensation.

Paragraph 188 of TR 95/35 states the whether the 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.

Paragraph 190 of TR 95/35 outlines that the mere fact that compensation has been awarded as a lump sum and has not been dissected into its component elements is not sufficient to treat the whole receipt as one of capital. The facts and circumstances surrounding the receipt may enable an apportionment of the lump sum payment on a reasonable basis into its constituent elements.

Paragraph 203 of TR 95/35 outlines that if a taxpayer cannot or does not make a reasonable estimate, valuation or calculation of the amounts which are reasonably attributable to each claim, we will make that allocation using the information which is available in relation to those claims.

Paragraph 28 of TR 95/35 states that it is likely that some information is available when a compensation claim is made which can be used to dissect a lump sum amount of compensation. Alternatively, the components of the lump sum ordinarily are able to be estimated or valued on a reasonable basis.

Paragraph 118-37(1)(a) of the ITAA 1997 disregards payments or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness, to his or her person.

Paragraph 214 of TR 95/35 states that the terms 'to his or her person' and 'in his or her vocation' should be read as widely as possible, the intention of the 'wide' interpretation was to cover the full range of employment and professional type claims, such as claims for discrimination, harassment, victimisation, wrongful dismissal, and defamation as well as personal injury or illness.

Paragraph 21 of TR 95/35 outlines that if compensation is received by a taxpayer 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.

Paragraph 215 of the TR 95/35 outlines that compensation for personal injury for damages are generally received for the loss of earning capacity rather than for loss of income.

Where it can be shown that all of the separate heads of claim relate to the personal injury of the taxpayer and that there are no other non-personal elements of compensation within the total claim, the exemption under section 118-37 of the ITAA would apply.

The anti-double taxation provisions contained in section 118-20 of the ITAA 1997 apply to prevent double taxation. The provision reduces a capital gain arising from a CGT event to the extent that an amount has already been included in the assessable income of a taxpayer. For example, being included as assessable income under section 6-5 of the ITAA 1997.

Application to your situation

You were injured in your workplace after which you had received Work Cover and Government payments during several income years prior to lodging the Claim in which:

•         You were seeking relief for damages, interest, costs and any further orders the Court may see fit to make.

•         Your claim was for:

o   Past loss calculated using your net weekly salary amount when you were injured multiplied by a specified number of weeks covering the period from the date of injury until the assumed mediation date as provided, less earnings and payments of Workers Compensation. Additionally, a claim for a specified percentage of your superannuation contributions for the past economic loss period; and

o   Future economic loss for a period up until you would have reached retirement age, with the amount calculated as a specified percentage of an estimated weekly salary amount multiplied by a specified number of weeks until you reached retirement age. A claim for a specified percentage of your superannuation contribution for the period covered by the future economic loss period.

The Deed was entered into in settlement of the Claim under which you would receive the Settlement Sum, being full and final settlement of the claims for past and future economic loss you had made in the Claim.

The Settlement Sum amount would have been calculated on some basis. It is therefore reasonable that you would be able to identify and allocate any component amounts included in the undissected lump sum amount of the Settlement Sum. However, no information and/or explanation has been provided to enable us to identify how the Settlement Sum amount had been calculated and/or if it comprised of amounts of either capital and/or revenue in nature.

Therefore, we have looked at the information provided in relation to your claims made in the Claim and the Deed to assist us in determining the nature of the Settlement Sum in your hands. Nothing has been provided to support that the undissected Settlement Sum amount you received relates to any amount that is capital in nature which would require the Settlement Sum to be apportioned between the revenue and capital amounts.

The amounts you were seeking in the Claim were for amounts calculated in relation to salary and superannuation contributions which are both revenue in nature.

Based on the claims for economic loss included in the Claim it is viewed that sufficient information has been provided for us to reasonably conclude that the whole of the Settlement Sum was revenue in nature given that you were seeking compensation for revenue loss in relation to both past and future economic loss.

Therefore, we view that whole Settlement Sum is revenue in nature it is assessable as ordinary income under section 6-5 of the ITAA 1997.

For CGT purposes, you had a CGT asset being your right to seek compensation as there was no underlying asset in this situation.

CGT event C2 occurred in relation to your CGT asset when you entered into the Deed. Any capital gain made in relation to the CGT event C2 occurring cannot be disregarded under section 118-37 of the ITAA 1997 as the Settlement Sum was not paid because of any injury or personal wrong to your person. The payment was made to you in settlement for your claim for damages in relation to your revenue loss for past and future economic loss.

There is no other CGT legislation that would enable any of the capital gain made as a result of the CGT event C2 occurring to be disregarded and/or reduced other than the provisions relating to the 50% CGT discount contained in Division 115 of the ITAA 1997.

Any capital gain made as a result of the CGT event C2 occurring will be reduced to nil under section 118-20 of the ITAA 1997 as the whole amount will be assessed as ordinary income under section 6-5 of the ITAA 1997.

Therefore, the whole Settlement Sum amount will be assessable as ordinary income under section 6-5 of the ITAA 1997, with no amount being assessable under the CGT provisions.

Conclusion:

Taking all of the available facts into consideration, and on weighing the various factors it has been determined that:

•         The Settlement Sum amount is in settlement of your claims for revenue loss. Therefore, the whole amount will be assessed under section 6-5 of the ITAA 1997.

•         Your CGT asset was your right to seek compensation. Even though the whole amount will be assessed under section 6-5 of the ITAA 1997, CGT event C2 still occurred to your CGT asset and the CGT calculation in relation to the CGT event occurring still needs to be considered under section 102-23 of the ITAA 1997.

•         You are not eligible to apply section 118-37 of the ITAA or any other provision to disregard/reduce any capital gain made as a result of the CGT event C2 occurring other than the 50% CGT discount provisions contained in Division 115 of the ITAA 1997; and

•         As the whole Settlement Sum amount is assessed under 6-5 of the ITAA 1997, any capital gain made as a result of the CGT event C2 occurring is reduced to nil to avoid double taxation in accordance with section 118-20 of the ITAA 1997.