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Is the taxpayer required to include an ex gratia lump sum payment made by a foreign government in their assessable income, under subsection 6-5(3) or subsection 6-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The taxpayer is not required to include an ex gratia lump sum payment made by a foreign government in their assessable income, under subsection 6-5(3) or subsection 6-10(4) of the ITAA 1997.

The taxpayer is a resident of Australia for tax purposes.

The taxpayer served in the merchant navy of a foreign country during World War II.

The taxpayer received an ex gratia lump sum payment from the foreign Government. The lump sum payment is tax-free in the foreign country.

Members of the armed forces of the foreign country were entitled to significant benefits after the war. The taxpayer was not entitled to these benefits. The lump sum received from the foreign government was paid in recognition of the fact that these benefits were not available to the taxpayer. The amount of the payment also depended on the length of the taxpayer's service in the merchant navy.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

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. The assessable income of an Australian resident includes statutory income from all sources, whether in or out of Australia (subsection 6-10(4) of the ITAA 1997).

Section 10-5 of the ITAA 1997 lists those provisions about assessable income. Included in this list is paragraph 26(e) of the Income Tax Assessment Act 1936 (ITAA 1936) which deals with allowances and benefits in relation to employment or rendering services.

The lump sum payment is not income according to ordinary concepts. It does not satisfy any of the established tests, even though it has a connection to an employment of the taxpayers who have received it. For an amount to be included in a taxpayer's assessable income under paragraph 26(e) of the ITAA 1936 it must be received 'in respect of, or for or in relation directly or indirectly to, any employment or services rendered by him'.

In order for an amount to be assessable under paragraph 26(e) the majority of the High Court in FC of T v. Dixon (1952) 86 CLR 540 held that there must be an existing or a contemporaneous existence of an employee and employer relationship. The taxpayer was not a employee of the foreign Merchant navy at the time they received the lump sum payment and therefore there is no employee and employer relationship.

Therefore the taxpayer is not assessable, under either subsection 6-5(2) or subsection 6-10(4) of the ITAA 1997, on the ex gratia lump sum payment. ( Note : The issue of whether this payment is subject to capital gains tax is dealt with in the Related ATO Interpretative Decision AT ID 2002/385)