If you receive workers compensation or other similar payments, it’s important to find out how to properly account for them in your tax return. Working out the correct tax treatment for these sorts of payments can be tricky at times, so it may be a good idea to seek professional advice.
The primary question to address is whether a payment you have received is assessable as your income, or is exempt from tax. Generally, payments will be assessable as income to the extent that they are factually and legally made to compensate for lost income (whether past, present or future). On the other hand, amounts will be exempt from tax to the extent that they are compensation for injury or lost capacity to earn.
This distinction between assessable and exempt components of a payment may not always be easy to draw. There may also be capital gains tax (CGT) considerations to take into account – in particular whether a particular payment is exempt from CGT under the rules for the exemption of payments for personal injury.
Where compensation is assessable as income and is received as a lump sum, a new question arises: in what income year (or years) will the compensation be assessable and will tax be payable? The answer generally depend on whether you are a cash basis or an accruals basis taxpayer. In the case of a cash basis taxpayer – such as an employee receiving salary and wages – a lump sum payment will be assessable in the year it is received, regardless of whether it may relate to several years of lost salary. However, a special rebate or “tax offset” may be available to alleviate any inequitable tax consequences.
It’s important to remember that the tax treatment of compensation and similar payments will depend on their precise nature – and there are a range of such payments, varying from state to state.
In the recent Administrative Appeals Tribunal case of Re Edwards and FCT [2016] AATA 781, ComCare had made a lump sum payment of $86,000 to a former Australian Federal Police officer for arrears of workers compensation. This payment was ruled assessable in the year the former officer received it, and not over the six income years to which it related. However, the taxpayer was entitled to a “lump sum payment in arrears tax offset” to, in effect, “even out” the tax liability as if amounts had been earned in each of the six income years.
It is important to remember that the tax treatment of compensation and similar payments will depend on their precise nature – and there are a range of such payments, varying from state to state.
For example, Tax Determination TD 2016/18 deals with whether a “redemption payment” received by a worker under the South Australian Return to Work Act 2014 is assessable income of that worker.
It provides that this type of payment is ordinary income of the worker, and is therefore assessable in the income year in which they receive it. Equally importantly, the Determination defines exactly what a “redemption payment” is, by referring to the extent that the amount received is:
-made under subs 53(1) of the Return to Work Act 2014 (SA);
-made to redeem a liability to make weekly payments under ss 39 or 41 of that Act; and
-not an employment termination payment (ETP) under the tax law.
Illustrating the initial observation in this article that establishing the tax treatment of workers compensation and similar payments can be tricky and specific at times, this particular Determination only applies to redemption payments made under agreements from 10 August 2016. This is because the Commissioner of Taxation had already made private rulings in earlier years that substantially similar payments were not assessable income.
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These are complex matters to consider, especially if you’re already dealing with a difficult situation that has lead to compensation. Contact us if you’d like help working out how receiving payments may affect your tax obligations.
