Private ruling: Assessability of your compensation payment
Date of advice: 21 August 2017
Published: December 2017
Ruling period: Year ending 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Is the compensation payment made to you for non-economic and future economic loss regarded as assessable income? | A1: No.

Relevant facts and circumstances: You lodged a claim for compensation under the scheme for Compensation for Detriment caused by Defective Administration (CDDA) with a Government department. CDDA schemes are administrative schemes that provide compensation for people who experience detriment as a result of a defective administrative action, such as an unreasonable failure to institute appropriate administrative procedures or where an unreasonable delay in complying with existing administrative procedures occurs. The Government department approved your CDDA claim and offered you compensation for non-economic and future economic loss. The Government department stated that the payment for future economic loss was not a payment in lieu of income or salary. The payment is intended to compensate you for the cost of the medical services that you would require.

Relevant legislative provisions: Income Tax Assessment Act 1997 6-5(2), | Income Tax Assessment Act 1997 6-15 and | Income Tax Assessment Act 1997 118-37(1)(a)(i).

Reasons for decision: Summary: Ordinary income Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an Australian resident’s assessable income includes the ordinary income they derive directly or indirectly from all sources, whether in or out of Australia, during the income year. Ordinary income has generally been held to include income from three sources: ● income from rendering personal services; ● income from property; or ● income from carrying on a business. The following factors have been developed by the courts to help determine whether a receipt has the characteristics of income: ● The receipt is earned; ● The receipt is expected; ● The receipt is relied upon; ● The receipt has an element of periodicity, recurrence or regularity; or ● The receipt is for the replacement of income. As highlighted by the High Court in Federal Commissioner of Taxation v. Montgomery (1999) 198 CLR 639, no single factor is determinative of the receipt’s character but some factors may be more relevant than others in light of the circumstances of the case. Compensation payments Where an amount is paid to compensate for a loss, that payment generally acquires the character of that for which it is substituted: pursuant to Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82. As a result, compensation payments that intend to substitute income have been regarded by the courts as having the characteristic of income: Federal Commissioner of Taxation v. Darcy Peter Smith (1981) 147 CLR 578; (1981) 11 ATR 538; 81 ATC 4114; Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142; and, Case Y47 (1991) 22 ATR 3422; 91 ATC 433. This is reaffirmed in Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? (TD 93/58). TD 93/58 states that a lump sum compensation payment is assessable: ● if the payment for compensation is for loss of income only; or ● to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. If the compensation payment does not have the characteristics of income, then the payment may be regarded as a capital gain and, as a result, may have CGT consequences. Impact of capital gains tax (CGT) Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) considers whether a compensation payment has CGT consequences. TR 95/35 provides that, if an amount of compensation is not received in relation to an underlying asset then the amount is treated as being related to the disposal by the taxpayer of the right to seek compensation. As a result, the receipt of the compensation payment may give rise to a capital gain (statutory income). However, subparagraph 118-37(1)(a)(i) of the ITAA 1997 disregards any capital gain or capital loss made from compensation received for any wrong or injury suffered in a taxpayer’s occupation. If the receipt does not fall within the scope of ordinary income or statutory income, the receipt is not considered to be assessable income: pursuant to section 6-15 of the ITAA 1997. Applying the law to your circumstances You were offered compensation from the Government department for non-economic loss and future economic loss. The payment for future economic loss is not a payment to substitute your income, but is intended to compensate you for the cost of the medical services that you would require. As a result, your compensation payment does not possess the characteristics of income. This is because the payment is not earned by you due to services performed or from carrying on a business. The payment is a once-off payment and, therefore, lacks periodicity, recurrence, or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the defective administration rather than from a relationship to personal services performed. Therefore, your compensation claim payment is not considered ordinary income under section 6-5 of the ITAA 1997. As highlighted above, your compensation is also exempt from CGT consequences due to the operation of subparagraph 118-37(1)(a)(i) of the ITAA 1997. Conclusion Your compensation payment is not assessable under section 6-5 of the ITAA 1997 because the payment was not made to substitute your income. Your compensation payment is also exempt from CGT consequences pursuant to subparagraph 118-37(1)(a)(i) of the ITAA 1997. Therefore, your compensation payment is not regarded as assessable income for income tax purposes. This means that you do not need to include your compensation payment in your relevant income tax return.