Re Gupta and FCT – it was not enough that arrears workers compensation paid were paid ‘for the injury’ – rather it was paid for loss of income (rather than loss of income earning capacity)

The AAT has confirmed that a taxpayer who received  a lump sum payment of arrears of workers’ compensation was assessable on the amount as ordinary assessable income under s 6-5 of the ITAA 1997.

The payment was made in respect of knee injury the taxpayer suffered at work and which later resulted in him having to resign his job. A workers’ compensation payment of $40,000 for 16 months of agreed incapacity was subsequently negotiated. The taxpayer was initially advised by the ATO that the amount was not assessable. However, the taxpayer also applied for a private ruling in which the ATO stated that the amount was assessable as the compensation payments were primarily compensation for loss of income.

In affirming the Commissioner’s decision to disallow the taxpayer’s objection to the ruling, the AAT found that the compensation payments had the character of “income support” and not compensation “for” injury or incapacity. It further found that the lump sum nature of the payment was not significant in its characterisation as ordinary assessable income in the circumstances. Accordingly, the AAT affirmed the decision under review.

(Re Gupta and FCT [2016] AATA 914, AAT, File No 2016/1389, Taylor SM, 16 November 2016.)

[LTN 224, 18/11/16]

Extract from the AAT’s reasons

1. In July 2010 Mr Gupta injured his knee at work. He had 5 weeks off, and then returned to work in about mid August 2010. But he resigned shortly afterwards (on 10 September 2010) because of on-going difficulties with his knee. In late 2011 (possibly from September to December) he worked for 3 months with another employer. Apart from that short period of employment he has not worked since the 2010 injury.
2. Mr Gupta started workers compensation proceedings in May 2013. They eventually resulted in a negotiated settlement, which was formally expressed in consent orders made by the Workers Compensation Commission of New South Wales on 19 May 2015. Their material effect was (i) to award Mr Gupta weekly compensation for a period of about 16 months after September 2010, and (ii) to determine that he had no ongoing compensation entitlement after January 2012.
3. The actual terms of the May 2015 orders (in which Mr Gupta is referred to as “the Applicant”), in so far as they are presently relevant, were as follows:
   1. Respondent pay the Applicant weekly compensation as follows:

(a)    At $1346 per week from 11 September 2010 to 12 March 2011 pursuant to the former s. 36 of the 1987 Act;

(b)    At $108.78 per week from 13 March 2011 to 27 January 2012 pursuant to the former s. 40 of the 1987 Act;

2. Award in favour of the Respondent in respect of the claim for weekly compensation from 28 January 2012 to date and continuing.

4. The practical effect of the orders for “weekly compensation” was to entitle Mr Gupta to receive a total of about $40,000, in respect of the 16 month period of agreed incapacity. The composition of that total, and the income years to which the compensation entitlement relates, is set out in the following Table:

…

5. Mr Gupta’s former employer (perhaps, more accurately, its workers’ compensation insurer) insisted on deducting from the total agreed compensation an amount reflecting Mr Gupta’s anticipated income tax liability [PAYG withholding – it seems]. This insistence gave rise to a dispute, which Mr Gupta resolved to his own satisfaction by contacting the ATO, and receiving an assurance that the total compensation amount was not assessable income. Mr Gupta says he was further informed that, if the insurer did not accept that position, he could himself apply for a private tax ruling.
6. The insurer did not accept that the agreed compensation amounts were not taxable, and deducted about $5,304 from the total amount when it actually paid Mr Gupta – on 17 July 2015. Four days later Mr Gupta applied for a private tax ruling. The Commissioner’s 21 August 2015 ruling rejected his contention that the settlement amount was not assessable income. The Commissioner considered that the weekly compensation payments provided for in the 19 May 2015 orders were primarily compensation for loss of income. As such they were “ordinary income” for the purposes of the Income Tax Assessment Act 1997 (“ITAA 1997”) s 6-5.
7. The Commissioner adhered to that position in the 4 March 2016 objection decision that is the subject of Mr Gupta’s review application to this Tribunal.

MR GUPTA’S CONTENTION

8. Mr Gupta’s primary contention was that his workers compensation settlement amount was compensation for a workplace injury, was not a substitute for “lost earnings” and consequently did not constitute “ordinary income” to which ITAA 1997 s 6-5 applied. He further contended, and the Commissioner agreed, that it did not constitute “statutory income” – because of the exemption contained in ITAA 1997 s 118-37(1)(b).
9. Mr Gupta said his contention about the characterisation of his compensation entitlement under the May 2015 order was supported by (i) Taxation Ruling No IT 2193, (ii) Taxation Ruling TR 95/35 (relating to ITAA 1997 s 118-37(1)(b)) and (iii) by numerous Private Rulings (under the Taxation Administration Act 1953, Schedule 1 Division 359). In particular he agreed that the substance of his contention was encapsulated by the following passage from Private Ruling 64919. (That ruling concerned a lump sum compensation payment made under a deed of release that specified the payment was for pain and suffering and loss of income earning capacity.)

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 of 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 you would have earned.
Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. However, no component of the amount received by you was received to compensate for loss of income.
In your case, you have received compensation for the loss of a capital asset, that is the capacity to earn income and for pain and suffering as a result of your service … The compensation is a capital receipt and is not ordinary income.
Accordingly, the lump sum payment is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

10. The phrase I have underlined in the preceding passage may, in the absence of specific information about any statutory compensation entitlement provisions, be the key to the conclusion reached in the particular ruling. It suggests that the ruling may have depended on the terms of the particular deed of release and, in particular, accepted the deed’s agreed stipulation that the payment was for “loss of earning capacity” rather than lost earnings. Although there was corresponding stipulation in the 19 May 2015 consent determination, Mr Gupta nevertheless emphasised that his entitlement payment was “for his injury”. He pointed out that his entitlement was determined years after his employment had ended, and was not in relation to any work he had performed. He claimed the agreed compensation was in “reality” for loss of capacity, and was not within the concept of “ordinary” income. Mr Gupta added to that argument by pointing out that he had in fact received a “one-off lump sum”. He said that in many of the “private rulings” he cited and relied upon, there was an apparent consistency in regarding “one-off lump sum” payments as a capital receipt, and not assessable income.