Private ruling: Workers compensation
Date of advice: 6 November 2017
Published: March 2018
Ruling period: Year ending 30 June 2018
Date scheme commenced: 1 July 2014

Ruling: Q1: Is the lump sum settlement paid to you in accordance with a settlement deed regarded as ordinary assessable income? | A1: No. | Q2: Is the lump sum payment assessable under the capital gains tax provisions? | A2: Yes.

Relevant facts and circumstances: You sustained injury in the course of your employment. In 2014 you commenced your active work with your employer. A year later you sustained an injury, as a result of the injury and subsequent stress disorders, you have been incapacitated for work from then. You have suffered a loss of earning capacity and have had medical and like expenses. As a result of the injuries, you have submitted claims for compensation pursuant to the relevant state act. Your employer, through its insurer, has disputed your claim and declined to pay any benefits. The deed of settlement you have been offered states an undissected lump sum payment includes payment for ● past or future loss of earning capacity and entitlement to interest ● rehabilitation, training and workplace modification expenses, ● medical expenses ● your costs and disbursements

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 6-10. | Income Tax Assessment Act 1997 Subsection 82-130(1) | Income Tax Assessment Act 1997 Paragraph 82-130(1)(a) | Income Tax Assessment Act 1997 Section 102-5 | Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Section 118-37

Reasons for decision: Summary: Your un - dissected lump sum is not regarded as ordinary assessable income but is capital in nature. No exemption applies and the capital payment is assessable under the capital gains tax provisions. Ordinary Income Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income 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. Other characteristics of income that have evolved from case law include receipts that: ● are earned, ● are expected, ● are relied upon, and ● have an element of periodicity, recurrence or regularity. Payments of salary and wages are income according to ordinary concepts and are included in your assessable income. An amount paid to compensate for loss generally acquires the character of that for which it is substituted ( FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443;10 ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts ( FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411). Lump sum payments Taxation Determination TD 93/58 outlines the circumstances under which the receipt of a lump sum compensation/settlement payment is assessable as ordinary income. The determination states that where the compensation payment is for loss of income, the amount is assessable as ordinary income. Where a portion of a lump sum payment is identifiable and quantifiable as income, that portion of the payment will be assessable. In your case you were making a claim for workers’ compensation. You have now been offered a lump sum payment to give up your claim for workers compensation with your employer and their insurer. The lump sum settlement to be received does not relate to personal services, property, or the carrying on of a business. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from the performance of personal services. In your circumstances, the lump sum payment is not for loss of income and not ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997. Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income, and are also included in assessable income. Amounts received as a lump sum are generally capital in nature and are potentially taxable as statutory income under the capital gains tax (CGT) provisions of the ITAA 1997. Capital gains Part 3-1 of the ITAA 1997 contains the capital gains and capital loss provisions commonly referred to as the CGT provisions. You make a capital gain or capital loss if a CGT event happens in respect of a CGT asset. Section 104-25 of the ITAA 1997 provides that CGT event C2 happens on the ending of the right to seek compensation, that is, the right to take legal action. The lump sum amount you will receive will be capital proceeds for this CGT event and a capital gain will usually arise. The net capital gain you make is then included in your assessable income under section 102-5 of the ITAA 1997. CGT Exemption Paragraph 118-37(1)(a) (i) of the ITAA 1997 allows a capital gain to be disregarded if it is compensation or damages you receive for any wrong or injury you suffer in your occupation. Paragraph 118-37(1)(a)(ii) of the ITA 1997 allows a capital gain to be disregarded if it is compensation or damages you receive for any wrong, injury or illness you suffer personally. These provisions would have clear and direct application in relation to an insurance policy against a specific injury or illness. For example, trauma insurance that pays a lump sum if the person loses a limb or suffers a heart attack. Such a payment would be disregarded for CGT purposes under section 118-37 of the ITAA 1997. However, the application of section 118-37 of the ITAA 1997 in relation to settling a workers’ compensation claim may be more problematic. In the case of Purvis v. FC of T [2013] AATA 58 ( Purvis’ case) , the Administrative Appeal Tribunal considered the tax consequences of a pilot receiving a lump sum insurance payment for the loss of licence. Although the loss of licence came about as a result of illness or injury, the Tribunal found that the payment did not relate directly to compensation or damages within paragraph 118-37(1)(a) of the ITAA 1997. The amount was calculated without regard to the nature of the personal injury suffered, save that the personal injury had to result in the loss of licence. In cases where a dispute between the insurer and the insured is settled by way of the former making a lump sum payment to the latter; it would presumably be the case that the payment is intended to compensate the policy holder for the loss of entitlements under the policy, rather than to compensate the person for their injury or illness as such. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts outlines when it may be relevant to consider the compensation in the context of an underlying asset. Primarily the settlement of a dispute involving a workers’ compensation claim would amount to the disposal of a right to seek compensation. However, underlying this is the forfeiture of your rights under the RTWA – in most cases, this would predominantly involve forfeiting the right to receive an income stream; but in some cases, there may also be subsidiary benefits at issue. If the compensation is received in relation to multiple heads of claim, TR 95/35 allows a reasonable apportionment of that payment. For example, if a payment is intended to replace both an income stream and other potential benefit entitlements, the payment may be apportioned between the two heads of claim on a reasonable basis. However, if the payment is truly an un-dissected lump sum – that is, no reasonable apportionment can be made between the multiple heads of claim – no exemption can be applied unless you are able to prove that the amount received was solely for personal injury. This approach was confirmed in Dibb v Commissioner of Taxation [2004] FCAFC 126 which found that no part of a genuinely un-dissected lump sum could be said to be paid in relation to personal injury. The exemption in paragraph 118-37(1)(a) of the ITAA 1997 cannot apply if the compensation amount is received as a lump sum (and that lump sum is truly un-dissected) but there were rights to income type payments as well as rights relating to personal injury that are extinguished in the settlement. Application to your circumstances Your lump sum settlement is more than a straight income replacement and includes potential capital benefits such as incapacity, medical and rehabilitation payments. It is therefore accepted that the payment is an un-dissected settlement amount and that the lump sum payment is not assessable under section 6-5 of the ITAA 1997. Acceptance of the lump sum is considered to be a payment for the ending of your claim for workers compensation. This gives rise to CGT event C2. Your payment cannot be said to be for a single defined payment for an injury. As was the case in Sommer’s case and Purvis’ case , although your compensation may have been triggered by a personal injury, the actual lump sum payment is not a personal injury payment. The payment covers a loss of various rights and entitlements, including a loss of income. Therefore the lump sum payment is assessable as a capital gain and the exemption contained in section 118 - 37 of the ITAA 1997 cannot apply. CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. A C2 event can apply where there is a release or discharge of a right to seek compensation. Please note that as it has been 12 months or more since the compensable incident occurred, then you may be able to reduce the capital gain by 50%.