Private ruling: Capital gains tax
Published: August 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Question and answer | Is the compensation payment assessable income? | No.

Relevant facts and circumstances: You had a medical procedure a number of years ago. The procedure was not successful. You had further treatment a few years later. You sought compensation for the treatment. You were offered payment and accepted it. You state this payment was for pain and suffering.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 118-37

Reasons for decision: Summary: The assessable income of an Australian resident taxpayer includes ordinary income and statutory income derived directly and indirectly from all sources, whether in or out of Australia. | Detailed Reasoning - Ordinary income: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that ordinary income is income according to ordinary concepts. 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 ordinary 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. | Detailed Reasoning - Statutory income: Subsection 6-10(2) of the ITAA 1997 provides that an amount is statutory income if it is not ordinary income but is included in assessable income by another provision. Section 10-5 of the ITAA 1997 lists those provisions about assessable income. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains. Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes the taxpayer's net capital gain, if any, for the income year. | Detailed Reasoning - Compensation payments: In order to determine the taxation treatment of a compensation payment, the nature of the compensation payment must be examined, as a compensation amount generally bears the character of that which it is designed to replace ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; (1952) 10 ATD 82). Compensation resulting from personal injuries represents a disposal of an asset for capital gains tax (CGT) purposes. The disposal of a CGT asset gives rise to a CGT event. However, section 118-37 of the ITAA 1997 disregards payments or receipts for the purposes of CGT where the amount relates to compensation or damages a taxpayer received for any personal wrong, injury or illness. A compensation amount generally bears the character of that which it is designed to replace. 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 lump sum compensation amount that you received for pain and suffering as a result of the treatment, was not earned by you as it does not relate to services performed. The payment is also a one-off payment and it does not have an element of recurrence or regularity. Although the payment can be said to be expected and perhaps relied upon, this expectation arises from the pain and suffering resulting from the treatment, rather than from a relationship to personal services performed. Under section 6-5 of the ITAA 1997, the amount that you received for pain and suffering is not assessable income. Taxation Ruling TR 95/35 - Income tax: capital gains: treatment of compensation receipts (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. As the amount you received for pain and suffering is not in respect of any underlying asset, the amount is treated as capital proceeds from a CGT event (CGT event C2) happening to your right to seek compensation. However paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any wrong, injury or illness you suffer personally. Accordingly, the payment that you received for pain and suffering is not assessable under either section 6-5 or section 102-5 of the ITAA 1997.