ATO ID 2003/404: Assessable income: lump sum compensation - pre-judgment interest - non personal injury
Date of decision: 7 May 2003
Year of income: Year ended 30 June 1994 Year ended 30 June 1995 Year ended 30 June 1996 Year ended 30 June 1997 Year ended 30 June 1998 Year ended 30 June 1999 Year ended 30 June 2000 Year ended 30 June 2001 Year ended 30 June 2002 Year ended 30 June 2003
Business line: Small Business/Individual Taxpayers

Issue
Is the pre-judgment interest awarded in a settlement for underpayment of wages assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. Pre-judgment interest awarded in a settlement for underpayment of wages is assessable income under section 6-5 of the ITAA 1997.

Facts
The taxpayer was awarded a lump sum payment by the Federal Court for underpayment of wages by the Federal Court. The payment included an amount of pre-judgment interest awarded under section 179A of the Workplace Relations Act 1996 . The pre-judgment interest was based on the amount of underpayment of wages and was calculated over the period between the date when the cause of action arose and the date on which the judgment was entered.

Reasons for decision
Summary: Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Taxation Ruling TR 95/35 deals with the taxation treatment of compensation receipts. In paragraph 26 of TR 95/35, the receipt of interest as part of the compensation payment is considered to be assessable income of the taxpayer under the general income provisions. However, the treatment of the pre-judgment interest in a compensation payment may be different depending on the nature of the damages being sought. The receipt of pre-judgment interest in the context of personal injury is considered to be capital in nature (refer ATO Interpretative Decision ATO ID 2010/213 and Whitaker v. Federal Commissioner of Taxation (1998) 82 FCR 261; 98 ATC 4285; (1998) 38 ATR 219 ( Whitaker )). In Whitaker , the interest was considered to be paid as part of a global amount for judgment awarded for pain and suffering. The interest was not calculated based on a sum ascertained before the judgment. The receipt of pre-judgment interest in a commercial situation was also discussed in Whitaker and distinguished from lump sum compensation payments that are for personal injury. In that case Black CJ stated (at 335): In other contexts the characterisation of an amount ordered to be paid as 'interest' as compensation for the loss or detriment suffered by a person by being kept out of his or her money would point to an amount receivable as income rather than as capital... And further (also at 335) I would add that the position here differs greatly from the commercial situation in which interest is payable as the price of being kept out of a specific or calculable principal sum... The receipt of interest as part of a compensation payment for personal injury is to be contrasted with a situation where the interest is part of a compensation payment made to replace lost wages rather than to compensate for the loss of earning capacity. In Atlas Tiles Ltd v. Briers (1978) 144 CLR 202; (1978) 9 ATR 142 at CLR 223; ATR 155, Barwick CJ said: If the award of damages for such an injury destroying or diminishing his earning capacity were merely a matter of replacing those earnings, the amount of the award would be taxable... In the taxpayer's case, the pre-judgment interest was awarded as part of their compensation for underpayment of wages. The principal amount was awarded to replace the earnings that were due to the taxpayer but were not paid. Therefore, the amount on which the interest was calculated was identifiable before the judgment was made and the interest was not part of a global amount for which judgment was made as in a personal injury case. The pre-judgment interest in the taxpayer's award was paid in respect of a specific or calculable principal sum. Accordingly, the pre-judgment interest is considered to be ordinary income and assessable under section 6-5 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 6-5 subsection 6-5(2)
Case references: Whitaker v. Federal Commissioner of Taxation (1998) 82 FCR 261 [1998] FCA 262 98 ATC 4285 (1998) 38 ATR 219
Related public rulings and determinations: Taxation Ruling TR 95/35
Related ATO interpretative decisions: ATO ID 2010/213