Private ruling: Taxation of lump sum settlement
Published: August 2013
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Will any part of your settlement amount constitute assessable income? | A1: No. | Q2: Will any part of your settlement amount be assessable under the capital gains tax (CGT) provisions? | A2: No.

Relevant facts and circumstances: You were involved in a motor vehicle accident. As the result of this accident you suffered physical injuries and incurred financial loss. You commenced legal proceeding against the third party insurer. You attended a settlement conference with the insurer and reached a negotiated settlement to compensate you for your non-economic loss and your past and future economic losses. Your received a lump sum settlement.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 6-10 | Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)

Reasons for decision: Summary: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). 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 · have an element of periodicity, recurrence or regularity. The lump sum payment you accepted is not income from rendering personal services, income from property or income from carrying on a business. The payment was a one off payment and thus it does not have an element of recurrence or regularity. An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments which substitute income, or which are paid to replace lost earnings, have been held by the courts to be ordinary income. 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. The payment you have received was not from rendering personal services, income from property or income from carrying on a business. Although the payment may have been expected and relied upon, it was not earned and was received in a lump sum. Your settlement is the result of a negotiated agreement entered into as part of the process undertaken to resolve motor accident compensation claims. It is not a lump sum payment which substitutes for an income stream but rather for entering into an agreement with the third party insurer for the purpose of finalising your claim for damages. The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997. Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but may be assessable under another provision called statutory income. | Detailed Reasoning - Capital gains tax (CGT): Amounts received in respect of personal injury which are not direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the CGT provisions of the ITAA 1997. Receipt of a lump sum payment may give rise to a capital gain (statutory income). However, paragraph 118-37(1)(b) of the ITAA 1997 disregards payment or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness. Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. When settling with a lump sum payment you would be surrendering your rights, not only to recover any such benefits in the action, but also to claim any further benefits to which you might now or in the future have an entitlement under your income protection policy. As each of these claims relate to your injury, any capital gain or loss arising from the surrender of your rights under your policy will be disregarded. Applying paragraph 118-37(1)(b) to your circumstances, the lump sum payment would not be considered as an assessable capital gain.