Private ruling: Assessable income - lump sum compensation payment
Date of advice: 12 November 2018
Published: January 2019
Ruling period: Income year ending 30 June 20XX.
Date scheme commenced: 1 July 20XX.

Ruling: Q1: Will the lump sum payment (the Payment) you received be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 ? | A1: Yes.

Relevant facts and circumstances: You were employed by Company A for a number of years prior to you suffering from a workplace injury. You sought medical attention and were referred to a specialist who treated you for your ongoing pain. After a number of years you were referred to a medical professional who recommended that you have an operation, which was scheduled, to be followed by a period of physiotherapy. Prior to the scheduled surgery, a representative of your employer evaluated the need for you to have surgery. Before the surgery occurred the approval for the funding of the surgery was withdrawn by your Company A’s insurer, being Company B. Company B denied total liability in respect of your claim in relation to your workplace injury. A short time later, you worked your last day for Company A. You requested Company B’s decision be reviewed and they responded a short time later, confirming their original decision of denial of liability for your claim. Your payments from Company B ceased. You engaged the services of Company XYZ to act as your legal representatives in relation to your claim. Company XYZ sent a letter to Company B stating that you were prepared to return to work in accordance with the medical certificate provided. After a short period you commenced receiving Centrelink payments. Company XYZ lodged a claim on your behalf. A hearing of your claim was set down to occur, however the matter was settled following conciliation just prior to the hearing date. As a result of the settlement you received a lump sum amount which consisted of weekly benefits of compensation relating to periods in prior income years. Centrelink sent you a letter which outlined that as a result of receiving the compensation payment you would need to repay them the difference between the amount that you were actually paid by Centrelink and the amount that you would have been paid if your back payment of compensation had been paid regularly throughout the period. The back payment period related to prior income years. A letter was sent to Company XYZ with a number of cheques enclosed for the total amount of the payment of the weekly settlement monies you received as a result of the settlement in addition to confirmation that a payment had been made directly to Centrelink in relation to the repayment amount. No pay as you go (PAYG) withholding was held from the payments. During the following year you resigned from your employment with Company A. You are still receiving Centrelink payments at this point.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 118-37 | Income Tax Assessment Act 1936 Section 159ZRA

Reasons for decision: Detailed Reasoning - Lump sum payments: Subsection 6-5(2) of the Income Tax Assessment Act (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 has generally been held to include three 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. Payments of salary and wages are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997. An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments which substitute income have been held by the courts to be income under ordinary concepts. Taxation Determination TD 93/58 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. Compensation amounts will be considered to be income under the ordinary concepts even though they may relate to a past or future income period in accordance with Taxation Ruling 98/1 . Taxation Ruling No IT 2107 sets out the Commissioner's policy on the derivation lump sum in arrears payments for sickness benefits and workers compensation. Paragraph 2 of the ruling states that workers compensation payments are derived when they are received. | Detailed Reasoning - Application to your situation: In your case, you received a lump sum worker’s compensation payment of $XX,XXX which consisted of weekly benefits of compensation relating to periods in earlier income years. Although your compensation claim was initiated due to your ongoing medical condition, the $XX,XXX payment you received was not made to compensate you for your pain and suffering, but had been paid to compensate you for the loss of wages you experienced. Additionally, while the lump sum payment was made up of amounts representing weekly benefits paid in relation to previous income years, the lump sum payment retained the character of being ordinary income as it was paid to replace lost wages. Therefore, the $XX,XXX payment is ordinary income which is assessable under section 6-5 of the ITAA 1997 in the income year in which you received it. | Detailed Reasoning - Centrelink repayment: You received support from Centrelink after your workplace injury. You were subsequently awarded a lump sum worker’s compensation payment. A portion of the lump sum received was used to repay Centrelink for the support that you had received. Centrelink sent you a letter, outlining that some of your Centrelink payments had to be repaid because of your compensation payment. While we cannot comment on Centrelink’s policy and procedures, it would be reasonable to expect that Centrelink should have issued assessment/s, or amended assessment/s potentially for the relevant income years to reflect the receipt of the $XX,XXX.XX repayment paid to them as a result of you receiving the lump sum payment, and to identify to which income year/s the payment/or parts of the payment, related to. Further information in relation to repayment of income can be viewed at the following link: | Detailed Reasoning - Repayment of income: The above link provides guidance on applying for an amendment of your income tax return if you have to repay an amount. However, we note from the information sourced from our systems that you do not have to amend your previous income tax return as it issued non-taxable, and you did not lodge a subsequent income tax return. | Detailed Reasoning - Further issues for you to consider: The following information is provided as written guidance. A taxpayer who relies on guidance will remain liable for any tax shortfall if the guidance is incorrect or misleading and they make a mistake as a result (unless a time limit imposed by the law precludes the liability). However, they will be protected against the shortfall penalty and interest on the tax shortfall provided they relied on that guidance reasonably and in good faith. As your lump sum payment contained amounts that relate to earlier income years you may be entitled to the following tax offset to reduce the tax you have to pay: | Detailed Reasoning - Lump sum payment in arrears tax offset: Individual taxpayers who receive certain assessable lump sum payments containing an amount that accrued in earlier income years may be entitled to a lump sum in arrears tax offset. The lump sum payment in arrears tax offset is designed to alleviate the problem of more tax being payable in the year in which the lump sum payment is received than would have been payable if the lump sum payment had been taxed in the years in which it accrued. To be eligible for the lump sum payment in arrears tax offset, certain conditions must be met. Broadly, the tax offset may be available where you receive an amount of specified income in a lump sum payment that contains an amount in arrears, and the arrears amount has been accrued for more than 12 months before the payment date, and is not less than 10% of your normal taxable income of the year in which payment is received. You don’t have to calculate the offset as we will do it using information you provide with your income tax return. Refer to the following link under the heading ‘Lump sum payments in arrears’ for information and guidance on how to complete an income tax return to obtain the lump sum tax offset, and the information that should be provided with your income tax return. | Detailed Reasoning - Deductions for legal expenses: A deduction is allowable for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. In determining whether a deduction for legal expenses is allowed the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of an income nature, then the expenses incurred in gaining the advantage will also be of an income nature and can be deducted. The deduction will be available in the income year in which the legal expenses were incurred for any legal expenses that you personally paid.