Private ruling: Income - assessable - insurance payout
Date of advice: 14 July 2015
Published: July 2015
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Is the lump sum compensation payment assessable income? | A1: No

Relevant facts and circumstances: You were injured in a motor vehicle accident. You lodged a motor vehicle accident claim under your compulsory third party (CTP) insurance policy (the insurer). You accepted a lump sum payment of $XXX,XXX inclusive of costs, in full and final satisfaction of all present and future claims against the insurer. There is no formal legal document showing the breakdown of your settlement payment; however you have provided the following list of damages that made up your claim lodged with the insurer: • General Damages (from injuries sustained in the accident) • Past and Future economic loss • Past and Future lost superannuation • Past and Future paid care • Past and Future medical expenses • Interest components on amounts claimed The amount of compensation for past or future economic loss was calculated in part by reference to your estimated employment income that you would have earned had you not been injured. It also refers to deprivation and impairment of earning capacity.

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 paragraph 118-37(1)(a)

Reasons for decision: Detailed Reasoning - Ordinary income: Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, 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. For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433). 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. Damages awarded for past or future loss or impairment of earning capacity is not ordinary income ( Groves v. United Pacific Transport Pty Ltd [1965] Qd R 62). | Detailed Reasoning - Lump sum compensation: Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income: • if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or • to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature. Taxation Ruling IT 2193 deals with the issue of compensation for loss of earning capacity received as a result of a motor vehicle accident. IT 2193 discusses the decision in FCT v. Slaven 84 ATC 4077; 15 ATR 242 ( Slaven's case ), and makes it clear that compensation for loss of earning capacity will not lose it's character as a capital receipt simply because the amount of compensation is calculated by reference to the amount of income the taxpayer would have earned. In Slaven's case , the taxpayer was injured in a motor vehicle accident which left her unable to work for a period of nine months. She received compensation for the deprivation or impairment of her earning capacity from the Motor Accidents Board, under the Motor Accidents Act (Vic) 1973 . The Board, in determining an adequate amount of compensation to be paid to an injured person, had to have regard to the loss of earnings actually suffered and to the likely loss of future earnings. The Federal Court held that the essential character of the compensation was compensation for loss or impairment of earning capacity, a capital asset, and that it was not liable to income tax. IT 2193 states that the decision in Slaven's case will extend to payments made by other compensation boards where the payments made are in the nature of compensation for deprivation or impairment of earning capacity. In this case, the compensation lump sum included amounts for injuries sustained, past and future medical costs and other items. We consider the payment was paid to compensate the individual for diminished capacity to earn income rather than the actual loss of income. The capacity to earn income is a capital asset and compensation for the loss of a capital asset is a capital receipt. It is considered that no component of the amount received was received as compensation for loss of income. Therefore, the compensation is not assessable as ordinary income under section 6-5 of the ITAA 1997. However, as the compensation for past and future loss of earning capacity is a capital receipt, it is also necessary to consider the provisions of the income tax law which deal with capital receipts. | Detailed Reasoning - Statutory income: Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997). These specific provisions are listed in section 10-5 of the ITAA 1997. The list includes capital gains, which are included in assessable income by virtue of the CGT provisions. Taxation Ruling TR 95/35 considers the CGT consequences for a person who receives an amount as compensation. The ruling states that a right to seek compensation is an asset for the purposes of the CGT provisions, and that a right to seek compensation is: • acquired at the time of the compensable wrong or injury, and • disposed of when it is satisfied, surrendered, released or discharged. TR 95/35 states that compensation received under a policy of insurance relates to a right to seek compensation. | Detailed Reasoning - CGT exemption: Paragraph 118-37(1)(a) of the ITAA 1997 disregards any capital gain or capital loss made where the amount relates to compensation or damages you receive for any wrong, injury or illness you suffer personally. In this case, paragraph 118-37(1)(a) of the ITAA 1997 will apply. Therefore, the compensation received is not assessable income by virtue of the CGT provisions.