Private ruling: Lump sum compensation payment
Date of advice: 14 June 2017
Published: October 2017
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the lump sum compensation payment or any portion thereof be assessable as either ordinary income or as a capital gain? | A1: No.

Relevant facts and circumstances: You suffered a work injury which was compounded by subsequent mismanagement by medical providers. The injuries you have suffered are severe and you have been diagnosed as having suffered a percentage of whole person impairment. You took legal action against the medical provider for negligence in. The medical provider admitted liability in the action. A monetary settlement made in respect to the nature and extent of the injury has now finalised the legal action.

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 104-25 | Income Tax Assessment Act 1997 subsection 104-25(2) | Income Tax Assessment Act 1997 paragraph 108-5(1)(b) | Income Tax Assessment Act 1997 section 118-37 | Income Tax Assessment Act 1997 paragraph 118-37(1)(a)

Reasons for decision: Summary: Sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary and statutory income (for example, capital gains) derived directly and indirectly from all sources, whether in or out of Australia during the income year The ITAA 1997 does not provide specific guidance on the meaning of ordinary income. However, a substantial body of case law exists which identifies its likely characteristics. Amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income, as are amounts that are the product of any employment of, or services rendered by, the recipient. Further, amounts which compensate for lost income or serve as a substitute for other income are themselves income according to ordinary concepts. 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) 10 ATD 82; (1952) 5 AITR 443; (1952) 10 ATD 82). 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 assessable as ordinary income. Generally, payments that are income (such as lost wages) will be assessable under the ordinary income provisions of section 6-5 of the ITAA 1997. Amounts identifiable as reimbursement for private expenses (such as medical expenses) of which are otherwise capital in nature (such as compensation for pain and suffering) are not assessable as ordinary income. Therefore, in order to determine the taxation treatment of a compensation payment the nature of the payment must be examined. In your case you have sustained permanent impairment due to medical mismanagement and have taken legal action against the medical provider. The lump sum payment you are to receive has no characteristics of ordinary income as it lacks any element of periodicity, recurrence or regularity, and the components used to calculate the compensation amount are of a capital nature Therefore, the lump sum payment is not assessable as ordinary income. Capital gains tax (CGT) Section 6-10 of the ITAA 1997 provides that a taxpayer’s assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision of the tax law. Section 10-5 of the ITAA 1997 lists those other provisions and included in the list are: ● amounts received by way of insurance or indemnity payments in respect of a lost amount, and ● capital gains. The right to seek compensation is considered to be a CGT asset. The timing of the event is when you acquired the right. In your circumstances, the events that occurred in 200X when you suffered a work injury gave rise to the CGT asset, being your right to seek compensation. Paragraph 108-5(1)(a) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset. A taxpayer’s right to seek compensation is therefore classified as an intangible CGT asset. Section 104-25 of the ITAA 1997 discusses CGT event C2 which refers to cancellation, surrender and similar endings. Subparagraph 104-25(1)(d) of the ITAA 1997 states, in part, that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being surrendered or forfeited. Subsection 104-25(2) of the ITAA 1997 states that the time of the event is: (a) when you enter into the contract which results in the asset ending; or (b) if there is no contract when the asset ends. Paragraph 3 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts, confirms that the right to seek compensation is a CGT asset. It states that it is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract. It is acquired at the time of the compensable wrong and is disposed of when it is satisfied, surrendered, released or discharged. Section 118-37 of the ITAA 1997 provides that certain capital gains or capital losses are disregarded. Paragraph 118-37(1)(a) of the ITAA 1997 provides that a capital gain or capital loss you make from a CGT event which relates directly to compensation or damages received by you for any wrong, injury or illness you or your relative suffers personally is disregarded. In your case, the lump sum payment will be made as a result of a personal wrong or injury, and as such the payment will be exempt from CGT. Accordingly, the lump sum payment you will receive is not assessable as either ordinary or statutory income and you will not be required to include the amount in your assessable income.