ATO ID 2004/405: Assessability of a compensation payment to be made to an Australian resident pursuant to an Austrian court order for loss of earnings
Date of decision: 23 December 2003
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
Will a compensation payment to be made to an Australian resident taxpayer pursuant to an Austrian court order for loss of earnings in the Netherlands, be assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The compensation payment to be made to the Australian resident taxpayer for loss of earnings in the Netherlands will be assessable under subsection 6-5(2) of the ITAA 1997.

Facts
The taxpayer is a resident of Australia for taxation purposes. The taxpayer was involved in a motor vehicle accident in Austria. At the time of the accident, the taxpayer was a resident of the Netherlands and was working in the Netherlands. The taxpayer commenced proceedings in Austria for compensation for the period from the time of the accident until a subsequent date. The taxpayer was a resident of the Netherlands for the entire period. The compensation relates to loss of earnings in the Netherlands during that period. A lump sum payment will be made from the insurance company to the taxpayer pursuant to the court order.

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. Ordinary income is income according to ordinary concepts (subsection 6-5(1) of the ITAA 1997). Income according to ordinary concepts has been held by the courts to include income from the rendering of personal services, income from property and income from carrying on of a business. 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) 10 ATD 82; (1952) 8 AITR 443). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( FC of T v. Inkster 89 ATC 5142, (1989) 20 ATR 1516; Tinkler v. FC of T 79 ATC 4641, (1979) 10 ATR 411). In Case U165 87 ATC 955, a non-resident taxpayer, who had returned to his country of origin, received compensation under Australian legislation. It was held that the payments had an Australian source. The factors to be taken into account included: from where the payments were sent; by whom and to whom they were sent and received respectively; and where the liability to make the payment arose. The compensation payment to the taxpayer will be sent from Austria by an Austrian insurance company in discharge of a liability that arose under an Austrian court order due to an injury that occurred in Austria. The only connection that this payment will have with a place outside of Austria is its destination. Hence the payment will clearly be sourced in Austria. In determining liability to Australian tax on foreign sourced income received by an Australian resident, it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (Agreements Act). Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for section 160AO and Part IVA of the ITAA 1936). Schedule 27 to the Agreements Act contains the double tax agreement between Australia and Austria (Austrian Agreement). The Austrian Agreement operates to avoid the double taxation of income received by Australian and Austrian residents. Article 21 of the Austrian Agreement provides that items of income which are not specifically mentioned in the Austrian Agreement that are received by an Australian resident are taxable only in Australia. However, if the income is derived from sources in Austria, it may also be taxed in Austria. Article 21 does not apply to income derived by an Australian resident from a permanent establishment or fixed base in Austria. The taxpayer will receive a compensation payment from an Austrian source. There are no specific Articles in the Austrian Agreement that deal with compensation payments, therefore Article 21 of the Austrian Agreement will apply. Accordingly, the compensation payment may be taxed in Austria and Australia. As the income will be derived by a resident of Australia and may be taxed in Austria, the income will be deemed to be income from sources in Austria under Article 22 of the Austrian Agreement. Article 23(1) of the Austrian Agreement provides that where Austrian tax has been paid on income that has a source in Austria by an Australian resident, a credit of tax will be allowed against Australian tax payable in respect of that income. Accordingly, the compensation payment to be made to the Australian resident taxpayer will be assessable under subsection 6-5(2) of the ITAA 1997. The taxpayer will be entitled to a foreign tax credit.

Legislative references: Income Tax Assessment Act 1997 subsection 6-5(1) subsection 6-5(2)
Case references: Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540 (1952) 10 ATD 82 (1952) 8 AITR 443
Subject references: Austria Compensation income Double tax agreements Foreign tax credits International tax