ATO Interpretative Decision
ATO ID 2003/984 (Withdrawn)
Income Tax
Compensation receipts: taxation of amounts paid in respect of personal injuryFOI status: may be released
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This ATO ID is withdrawn as it is a simple restatement of the law and does not contain an interpretative decision.This document has changed over time. View its history.
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
To what extent is compensation received by the taxpayer, in respect of a payment for personal injury, assessable as either ordinary or statutory income?
Decision
The taxation treatment of compensation relating to personal injury differs depending on the nature of the compensation. Compensation for loss of income will be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). The reimbursement of medical expenses is private in nature and is therefore not assessable. Amounts of compensation received in respect of personal injury are exempt from the application of the capital gains tax provisions under paragraph 118-37(1)(b) of the ITAA 1997.
Facts
The taxpayer suffered health problems as a result of the negligence of another person. The taxpayer required hospitalisation and was unable to work for some time. When the taxpayer returned to work, the taxpayer could not operate heavy machinery and was placed on light administrative duties at a reduced salary. After a few months, the taxpayer found that their health did not allow them to carry out administrative duties and they resigned.
The taxpayer took legal action against the person who was negligent in causing their health problems and obtained an out-of-court settlement. The amount received was reasonably allocated by the taxpayer to the following components:
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- Loss of income
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- Reimbursement of medical expenses
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- Other payments relating to their personal injury
Reasons for Decision
The assessable income of a resident of Australia includes ordinary and statutory income, derived directly and indirectly from all sources in or out of Australia.
In order to determine the taxation treatment of a compensation payment, the nature of the compensation payment must be examined, as 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) 5 ATR 443; (1952) 10 ATD 82).
Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. As such, the amount received to compensate for loss of income will be subject to tax under the ordinary income provisions of section 6-5 of the ITAA 1997.
Medical expenses are private expenditure of the taxpayer. Therefore, reimbursement of this amount does not give rise to assessable income.
Amounts received in respect of personal injury which are not for reimbursement of medical expenses, or direct compensation for loss of income, will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax provisions of the ITAA 1997.
Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.
As the amount received by the taxpayer is not in respect of any underlying asset, the whole of the settlement amount is treated as capital proceeds from a CGT event (CGT event C2) happening to the taxpayer's right to seek compensation.
However, paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any 'wrong, injury or illness you.....suffer personally'.
In this case, the taxpayer will be assessable only in respect of the amount received to compensate for the loss of income.
Date of decision: 23 October 2003Year of income: Year ended 30 June 2004
Legislative References:
Income Tax Assessment Act 1997
section 6-5
section 6-10
paragraph 118-37(1)(b)
Case References:
Federal Commissioner of Taxation v. Dixon
(1952) 86 CLR 540
(1952) 10 ATD 82
(1952) 5 ATR 443
Related Public Rulings (including Determinations)
Taxation Ruling TR 95/35
ATO ID 2003/954
Keywords
Capital gains tax
CGT capital proceeds
CGT events - C1-C3 - end of a CGT asset
Compensation income
Damages income
Income
Medical expenses
Medical Expenses Rebates
Medical goods
Negotiated settlements
Personal injury awards
ISSN: 1445-2782
| Date: | Version: | |
| 23 October 2003 | Original statement | |
| You are here | 19 March 2010 | Archived |
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