Private ruling: Compensation - commutation of weekly payments
Date of advice: 7 November 2017
Published: March 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the lump sum payment you have received exempt income? | A1: No. | Q2: Is the lump sum payment you received assessable as ordinary income? | A2: Yes.

Relevant facts and circumstances: You suffered a work related injury and had been in receipt of weekly incapacity payments. Your claim file was reviewed, and it was determined by the compensation authority that its liability to make further weekly payments be redeemed by the payment of a lump sum. A redemption payment is considered when the following criteria’s are evident: ● The compensation authority has a liability to make weekly payments under the legislation in respect of an injury resulting in incapacity. ● The weekly payments are less than the redemption eligibility ceiling rate and ● The degree of incapacity is unlikely to change in the future. You were advised that you met the above criteria and that your future incapacity payments would be paid as a lump sum instead of weekly. The calculation was based on the weekly incapacity payments you had been receiving for a future specified period. The compensation authority advised that the payment was subject to pay-as-you-go withholding tax and an amount was withheld.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1997 subsection 6-5(4) | Income Tax Assessment Act 1997 division 6 | Income Tax Assessment Act 1997 section 11-15

Reasons for decision: Summary: Ordinary and exempt income Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year, whether in or out of Australia, during the 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 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 However, if an amount of ordinary income is excluded from being assessable because it has been made exempt by a provision of the Income Tax Assessment Act, it is not included in your assessable income. (Division 6 of the ITAA) The principle exemptions are listed under section 11-15 of the ITAA 1997. Assessability of compensation payments Compensation payments which are a substitute for income (salary and wages for example) have been previously held by the courts to be assessable as ordinary income ( FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433), and the method of payment does not alter the character of the payment ( Brackenreg v. FC of T 2003 ATC 2196; Case X21 90 ATC 239; Case K34 10 TBRD 187). This position by the courts is reflected in Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? which specifies that receipt of a lump sum compensation payment will be assessable as ordinary income: ● if the payment is 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 payment is identifiable and quantifiable as being related to a loss of income. The conversion of periodic payments to a lump sum is addressed in Taxation Determination TD 93/3 Income tax: is a payment, being a partial commutation of weekly compensation payments, assessable income? Although Taxation Determination TD 93/3 deals with the issue of partial; commutation of weekly payments, the principles in terms of the assessability of lump sum payments that result from any commutation are the same. This is the case regardless of whether there is a full or partial commutation. As noted in paragraph 4 of TD 93/3 (and as stated above), weekly payments paid as compensation for loss of income or salary are assessable as ordinary income. Any lump sum payment that results from a commutation of such weekly payments (whether partial or in full) retains the assessable nature of the weekly payments. Effectively, the lump sum payment is simply an advance of future weekly payments of lost salary and wages and remains assessable as such under the provisions of section 6-5 of the ITAA 1997. Derivation of income As noted under section 6-5 of the ITAA 1997, ordinary income is assessable in the income year in which it is derived. Subsection 6-5(4) of the ITAA 1997 states that in working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct. Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings , deals with the derivation of ordinary income and states that the general rule with non-trading income is that it is derived when it is received. Paragraph 42 of TR 98/1, states that salary, wages or other employment remuneration is assessable when received. This is irrespective of whether that income relates to either a past or future income period. Application to your circumstances In your case, you had been in receipt of on-going weekly incapacity payments. While the weekly payments are described under specific sections of the legislation as in respect of ‘incapacity for work’, the sections are not concerned with any effects of incapacity other than a loss of income and are made to compensate the injured employee for their loss of earnings. Periodical payments paid under statute in substitution for earnings lost as a result of injury or accidents are assessable as ordinary income. The compensation authority reviewed your claim file and made a determination that its liability to make any further weekly payments would be redeemed by way of a lump sum. The lump sum you received is a commutation of your future weekly incapacity payments and is considered to be wholly of an income nature. As discussed above the conversion of periodic payments to a lump sum does not change its character of compensation for loss of income. The lump sum is considered to be ordinary assessable income and as there are no provisions within the tax laws that will exempt the payment from being assessable you are required to include the amount in your XXXX income tax return.