Private ruling: Motor vehicle compensation payments
Published: September 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Question and answer | Are the fortnightly payments received from the insurer assessable as ordinary or statutory income? | No.

Relevant facts and circumstances: You were involved in a motor vehicle accident. The insurer admitted liability for the injuries you sustained. You were unable to work due to the injury sustained in the motor vehicle accident. The insurer commenced paying you fortnightly payments. The payments received were equivalent to your net fortnightly after tax salary. These payments were 'advance payments' paid to you by the insurer on the following terms (as set out in correspondence received by the insurer): • Payment is made strictly on a 'without prejudice' basis and in a desire to assist with any financial difficulties. • Payment is not representative of any admission of liability for any past loss of earning capacity - any entitlement thereto will be determined at settlement. • The insurer reserves the right, at any time, to dispute any claim for past loss of earning capacity, up to the date of settlement. You expect your claim with insurer to be settled in the near future and a lump sum to be negotiated. The lump sum will be calculated to include loss of past earnings, loss of future earnings and pain and suffering. The lump sum will be reduced by $X to reflect the payments made to you by insurer in advance.

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: Detailed Reasoning - Ordinary income: 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. 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. | Detailed Reasoning - Statutory income - capital gains tax (CGT): 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. 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 CGT 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. The Federal Court has held that payments under the amended Motor Accidents Act are not assessable. In FC of T v Slaven 84 ATC 4077 (Slaven's case), the court held that compensation received by a motor accident victim was of a capital nature even though the compensation was paid in five instalments, and very closely approximated the victim's loss of earnings. The decision confirms that damages for loss of earning capacity are not assessable. The Commissioner accepts the decision in Slaven's case and will also apply it to payments made by other compensation boards where the payments made are in the nature of compensation for deprivation or impairment of earning capacity. | Detailed Reasoning - Application to your circumstances: In your case, you received fortnightly payments which were 'advance payments' of the lump sum you expect to receive from the insurer when your claim is settled. The eventual lump sum you receive will be calculated to include loss of past earnings, loss of future earnings and pain and suffering. The fortnightly payments you received were 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. The eventual lump sum you receive is not a lump sum payment which substitutes for an income stream but rather for compensation for impairment of earning capacity, and pain and suffering. The lump sum payment will be a capital receipt and not ordinary income. Therefore the amount will not be assessable under section 6-5 of the ITAA 1997. It follows, therefore, that the portion of this lump sum that you have already received in advance, is also capital in nature. The fact that you received a portion of this lump sum in periodic advance payments does not change the nature of the payments being capital in nature. 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. As the compensation relates to injury sustained in the motor vehicle accident, paragraph 118-37(1)(b) of the ITAA 1997 applies and therefore any capital gain or capital loss arising in relation the payments received is disregarded. The fortnightly payments are therefore not included in your income tax return as assessable income.