Edited version of your written advice

Authorisation Number: 3611034929588

Date of advice: 22 June 2018

Ruling

Subject: Compensation – lump sum payment

Question 1

Will the lump sum payment received be included in your assessable income as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the payment be included in your assessable income under the capital gains tax provisions?

Answer

No.

This ruling applies for the following period

Year ending 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

You are an employee.

You suffered an injury whilst performing your employment duties.

You are listed as a third party beneficiary under your employers insurance policy.

You made a claim under the policy and have received a lump sum payment in relation to the injury.

Relevant legislative provisions

Income Tax Assessment Act section 6-5

Income Tax Assessment Act section 6-10

Income Tax Assessment Act section 104-25

Income Tax Assessment Act paragraph 104-25(1)(b)

Income Tax Assessment Act subsection 104-25(2)

Income Tax Assessment Act paragraph 104-25(2)(a)

Income Tax Assessment Act paragraph 104-25(2)(b)

Income Tax Assessment Act paragraph 108-5(1)(b)

Income Tax Assessment Act subparagraph 118-37(1)(a)(i)

Reasons for decision

Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997).

Ordinary income has generally been held to include 3 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 earned

● are expected

● are relied upon, and

● have an element of periodicity, recurrence or regularity.

Compensation receipts which substitute for income have been held by the courts to be ordinary income; whereas, compensation paid for the loss of a capital asset or amount is regarded as a capital receipt and not ordinary income and is potentially taxable as statutory income.

In your case, the payment is not being made to compensate you for the loss of earnings; rather it is a one-off, lump sum amount, being paid to compensate you for the injury you suffered. The payment was not earned and does not have any element of periodicity, recurrence or regularity.

While it could be argued that the payment is expected, this expectation comes from your rights under the policy, rather than from a relationship with any personal services performed.

The payment is therefore not assessable as ordinary income under section 6-5 of the ITAA 1997.

Statutory income

Your assessable income also includes statutory income amounts which are not ordinary income but are included in your assessable income by another provision of the tax law (section 6-10 of the ITAA 1997).

Amounts received in respect of personal injury which are 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.

Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset. A taxpayer’s right to seek compensation is therefore classified as an intangible CGT asset.

Section 104-25 of the ITAA 1997 discusses CGT event C2 which refers to cancellation, surrender and similar endings. Paragraph 104-25(1)(b) of the ITAA 1997 states, in part, that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied.

Subsection 104-25(2) of the ITAA 1997 states that the time of the event is:

(a) when you enter into the contract which results in the asset ending; or

(b) if there is no contract when the asset ends.

Paragraph 3 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts, confirms that the right to seek compensation is a CGT asset and is taken to be acquired at the time of the compensable wrong or injury, and includes all 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.

However, under subparagraph 118-37(1)(a)(i) of the ITAA 1997 a capital gain or capital loss for a CGT event is disregarded when the CGT event relates directly to compensation or damages received for any wrong or injury you suffer in your occupation.

In your case, the payment relates wholly to the right to seek compensation for the personal injury you suffered and as such, the payment will be exempt from CGT.