Issue
Is compensation for loss of earning capacity received by the taxpayer assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. Compensation for loss of earning capacity received by the taxpayer is not assessable under section 6-5 of the ITAA 1997 as it is an amount of a capital nature.
Facts
The taxpayer suffered a personal injury as a result of a non work related incident.
As a result of this injury the taxpayer was unable to continue in their previous employment.
The taxpayer took legal action for compensation. They settled the claim out of court and received a lump sum payment.
This payment included an amount to compensate the taxpayer for their loss of capacity to earn income.
The amount of compensation for loss of earning capacity was calculated in part by reference to the income that the taxpayer would have earned had they not been injured.
Reasons for Decision
Section 6-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).
Ordinary income has generally been held to include 3 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 includes receipts that: • are earned; • are expected; • are relied upon; and • have an element of periodicity, recurrence or regularity.
The compensation received by the taxpayer was not income from rendering personal services, income from property or income from carrying on a business.
The payment is also a one off payment and thus it does not have an element of recurrence or regularity.
A compensation amount generally bears the character of that which it is designed to replace. 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.
Taxation Ruling IT 2193 deals with the issue of compensation for the loss of earning capacity. Although the discussion is in the context of compensation for motor vehicle accidents, the discussion is relevant to other types of compensation payments. IT 2193 makes it clear that compensation for loss of earning capacity will not lose its 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.
The taxpayer has received compensation for the loss of a capital asset, that is, the capacity to earn income. The compensation is a capital receipt and is not ordinary income. Therefore the compensation is not assessable under section 6-5 of the ITAA 1997. Note: the issue of the application of the Capital Gains Tax provisions is dealt with in Taxation Ruling TR 95/35.
Amendment History
Date of amendment Part Comment 30 January 2015 Facts Minor grammatical amendment Reasons for Decision Minor grammatical amendment
Date of amendment | Part | Comment
30 January 2015 | Facts | Minor grammatical amendment
Reasons for Decision | Minor grammatical amendment