COWARD v FC of T

Members:
Mathews J

Tribunal:
Administrative Appeals Tribunal

Decision date: 9 March 1999

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Mathews J (President)

Introduction

1. This case involves the assessability for income tax purposes of a lump sum payment made to the applicant under the Safety, Rehabilitation and Compensation Act 1988 (the SRC Act) in redemption of his entitlement to receive weekly payments of compensation under that Act.

2. On 13 April 1983 the applicant, who was then employed by the Department of Aviation, injured his neck and shoulder as a result of a workplace accident. Liability to compensate the applicant in relation to this injury was admitted. In July 1985 the applicant was formally retired from his employment by reason of his incapacity. Thereafter the applicant received weekly compensation payments under the Compensation (Commonwealth Employees) Act 1971 (the 1971 Act) and, since December 1988, under the SRC Act. On 16 February 1996 the applicant turned 65. In accordance with s 134 of the SRC Act, the rate of compensation payable to him was reduced to $62.46 per week. The applicant was informed that as his weekly rate was now below $65.99 he was entitled to request a redemption under s 137 of the Act. Section 137(1) provides as follows:

``Redemption on request by former employee

137(1) If:

• (a) a relevant authority is liable to make weekly payments of compensation to a former employee in respect of an injury resulting in an incapacity; and
• (b) the amount of those payments is $62.99 per week or less; and
• (c) the relevant authority is satisfied that the degree of the former employee's incapacity is unlikely to change;

the relevant authority must, on written request by the former employee, make a determination that its liability to make further payments to the former employee be redeemed by the payment to the former employee of a lump sum.''

3. Subsections (2) to (5) specify the means by which the redemption payment is to be calculated. It is unnecessary to describe it in detail here. In essence, it involves calculating the weekly amounts which would have been paid to the applicant for the remainder of his actuarially calculated life expectancy, and discounting it by three per cent.

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4. In due course the applicant exercised his right under s 137. In accordance with the formula set out in that section, his redemption payment was calculated to be $39,590.24. Income tax of $11,206.70 was deducted from this amount by Comcare and the balance was paid to the applicant. In deducting the tax Comcare was acting in accordance with an advice issued by the Deputy Commissioner of Taxation to the effect that a lump sum redemption payment is ``classically an income substitute'' and is therefore assessable pursuant to subs 25(1) of the Income Tax Assessment Act 1936 (the ITA Act). The applicant objected to the assessment of income tax on this payment. On 2 September 1997 the Australian Taxation Office (ATO) disallowed the objection. It is this decision which the applicant seeks to have reviewed in these proceedings.

5. At the hearing of the matter the applicant was represented by Mr Terry Murphy of the Victorian Bar and the respondent by Ms Arlene Macdonald of the South Australian Bar. No evidence was called, as the parties were in agreement as to the factual background.

Issues in this case

6. The case has been treated since its inception as a test case. I was told by both Counsel that there are no decisions which directly touch upon the point in contention. It is, the respondent says, a case which involves a consideration of basic principles in determining how the redemption payment should be categorised.

7. The respondent's primary contention is that the weekly payments made to the applicant were income in the ordinary sense under s 25(1) of the ITA Act. They compensated him for loss of earnings and were directly related to the amount of earnings to which he would have been entitled had he been earning wages. The redemption was nothing more than a lump sum prepayment of future weekly payments. It was in substitution for income and therefore maintained the character of income. It matters not, Ms Macdonald says, that the payment might also be characterised in a manner which would give it the quality of capital. So long as it is income in the ordinary sense, then it is unnecessary and unprofitable to go further and determine whether some other analysis might lead to its being categorised as capital.

8. If I were to find, against the respondent, that the redemption payment was not income under s 25(1), then there is a further question as to whether it constitutes statutory income under s 26(j) of the ITA Act. This involves quite different issues, and I shall defer any discussion of it until after dealing with the s 25(1) question.

9. As to s 25(1), the applicant says that, even if his weekly payments were income in the ordinary sense (which he disputes) the redemption payment was made in consideration of his disposal of his statutory right to receive those payments, and was capital in nature. In this respect, Mr Murphy says that the redemption of the applicant's periodic payments is analogous to the assignment of an annuity.

10. Mr Murphy has two further submissions which I shall discuss later. They depend to a large extent upon the categorisation of the weekly payments of compensation received by the applicant before and after he turned 65.

11. It is the status of the redemption payment which is in issue in this case, not that of the earlier weekly payments. However the status of the redemption payment cannot be considered in isolation from the earlier payments. In the result, there are three sets of payments received by the applicant which require examination in this case. They are, sequentially: the periodic payments of compensation which the applicant received until he turned 65; the periodic payments which he was entitled to receive thereafter; and the redemption payment. The characterisation of each of the first two of these is relevant to, but not necessarily determinative of, the nature of the following payment.

1. Weekly compensation before the applicant turned 65

12. The applicant sustained his injuries in April 1983. From about May of that year until February 1996 he received regular payments of compensation under s 45 of the 1971 Act. Subsections (1) and (2) of that section provide as follows:

``45(1) Where an injury to an employee results in the employee being totally incapacitated for work, the succeeding provisions of this section have effect.

45(2) Subject to this section, compensation is payable to the employee, during the

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period of the incapacity, of an amount per week equal to-

• (a) $90, or such higher amount as is prescribed, plus any amount or amounts required to be added to that amount in accordance with the succeeding provisions of this section; or
• (b) the average weekly earnings of the employee before the injury,

whichever is the less.''

13. The formulae set out in the following subsections do not require discussion here. Suffice it to say that, despite the ceiling contained in s 45(2)(a) (which has varied over the years), the amount of compensation payable is directly referable to the average weekly earnings of the employee before the injury.

14. During the 13 years between 1983 and 1996 the applicant's weekly compensation payment varied from month to month in accordance with determinations made by the Compensation Commission and, as from 1 July 1988, by Comcare pursuant to the provisions of the SRC Act. Also during that period, as already mentioned, the applicant was formally retired from his employment by reason of his incapacity. However this did not affect his weekly payments of compensation, which continued at much the same rate until the applicant turned 65 in February 1996.

15. Ms Macdonald, for the respondent, suggests that the weekly payments received by the applicant during this period were clearly income as they were in substitution for his wages. She was under the impression that this was not in dispute. However as I understand it, the applicant does take issue with this proposition. In particular, Mr Murphy submits that having regard to the language of s 45, and particularly to the phrases ``totally incapacitated for work'' and ``the period of the incapacity'', the weekly payments were compensation for the applicant's loss of earning capacity rather than for loss of income. It follows, Mr Murphy urges, that the payments were capital in nature.

16. In this regard Mr Murphy relies on a line of cases which commenced with
Tinkler v. FC of T 79 ATC 4641. The taxpayer in that case was injured in a motor vehicle accident in 1974. She was incapacitated for a period from her employment during which time she received regular payments under s 25(1) of the Motor Accidents Act 1973 (Vic) (the Victorian Act). Section 25(1) provided as follows:

``25(1) Where a person injured as a result of an accident suffers a loss of income by reason of the injury and makes an application under this Act for payments under this sub-section in respect of the loss of that income, the Board shall, subject to this Act, pay to that person an amount calculated in accordance with the formula...''

17. The formula which followed provided for payment to be calculated having regard to the person's ``average weekly income'' during the period of incapacity.

18. The Commissioner assessed taxation in respect of the compensation received by Ms Tinkler, who appealed to the Supreme Court of Victoria and then to the Full Federal Court (Brennan, Deane and Fisher JJ). It was submitted that the payments were not income, being compensation for loss of earning capacity which was said to be a capital asset. The taxpayer placed reliance on s 25(2) which, it was said, clearly showed this to be the case. Section 25(2) was in the following terms:

``25(2) Where a person injured as the result of an accident suffers by reason of the injury a reduction in his capacity to earn income by personal exertion and makes an application under this Act for payments under this sub- section in respect of that reduction in capacity, the Board shall, subject to this Act, pay to that person an amount calculated in accordance with the formula...''

19. The formula which followed provided for the person to receive weekly payments based upon the extent to which the capacity of the person to earn income had been reduced by reason of the injury.

20. It was submitted on behalf of the taxpayer that it would be incongruous if payments made to employees under s 25(1) were taxable but payments under s 25(2) were not. Neither class of payment was taxable, it was urged, because each class of payment was intended to provide compensation for loss of earning capacity, this being a capital asset.

21. This submission did not find favour with Jenkinson J, of the Victorian Supreme Court [ reported at 78 ATC 4565], nor with the Full Federal Court. Brennan J noted that the character of a statutory payment made

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otherwise than as compensation for an asset or right which is acquired or sterilised, depends upon the purpose of the payment as revealed by the statute, and the circumstances of its receipt by the taxpayer. In relation to payments under s 25(1), his Honour observed that the statutory indicia uniformly pointed to a purpose of providing the taxpayer with a partial recoupment of lost income. From the taxpayer's viewpoint, the payments were received at intervals during the period when she was not earning income. Thus the purpose of the payments and the circumstances of their receipt combined in that case to establish the income character of the amounts paid. As to s 25(2), Brennan J made the following observation:

``... And it may be necessary to consider whether the description of a capacity to earn income as a capital asset - however useful that description may be thought to be in working out the principles of compensation for personal injury at common law - is accurate for the purposes of the Income Tax Assessment Act...''

(p 4644)

22. Deane and Fisher JJ, in a joint judgment, noted that the taxpayer's argument was based on the assumption that compensation for loss of earning capacity is capital in the hands of a taxpayer, whereas compensation for loss of earnings is income. Their Honours declined to express a considered view as to the validity of this assumption, thus implicitly putting it into question. They proceeded to analyse the purpose of payments made under s 25(2), noting that the reference in that subsection to ``reduction in economic capacity'' was not necessarily determinative of the character of payments made under it. They concluded:

``... we are not persuaded that the payments made pursuant to sec. 25(2) of the Act should be characterized as capital payments for loss or impairment of earning capacity as distinct from payments in partial substitution for earnings which would have been earned but for the relevant accident. In these circumstances, sec. 25(1) falls to be considered uninhibited by preconceived notions as to the character for income tax purposes of a payment under sec. 25(2). As we have said, we agree... with the conclusion of the learned judge at first instance that the payments received by the appellant under sec. 25(1) were in substitution, pro tanto, for income which she would have earned were it not for the accident and constituted income pursuant to the provisions of sec. 25(1)(a) of the Income Tax Assessment Act.''

(p 4648)

23. Following the decision in Tinkler the Victorian Act was amended. A new s 25(1) was substituted for the old section in the following terms:

``25(1) Where a person injured as a result of an accident suffers deprivation or impairment of his earning capacity by reason of the injury and makes an application under this Act for a payment under this section in respect of that deprivation or impairment, the Board shall, subject to this Act, pay to that person-

• (a) such amount as, in the opinion of the Board, will adequately compensate that person for the deprivation or impairment of earning capacity which he has suffered; or
• (b) $20,800-

whichever is the lesser.''

24. In assessing ``adequate compensation'' under s 25(1)(a) the Board was required to have regard to the person's loss of past earnings and likely loss of future earnings (s 25(2)). By subs (4), the Board was to measure the impairment of earning capacity having regard to ``all relevant matters'' and in particular to (a) the nature of the injury, (b) the nature of the person's trade, business or profession and (c) the medical evidence relating to the injury. A new s 32 was inserted which enabled the Board to make payments under s 25(1) by way of instalments.

25. These new provisions were considered in
FC of T v. Slaven 84 ATC 4077; (1984) 1 FCR 11. The taxpayer in that case had been injured in a motor car accident in 1980. The Commissioner treated payments she received under s 25(1) as assessable income and assessed her accordingly. Her objection was disallowed and she appealed to the Victorian Supreme Court which allowed her appeal. A further appeal to the Full Federal Court was dismissed. The Court (Bowen CJ, Lockhart and Sheppard JJ) noted that it was plain from the second reading speeches that the 1979 amendments were intended to overcome the position that benefits paid under the Act attracted income tax. As to s 25, and the Board's function in

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assessing compensation, the Court made the following observation:

``The exercise in which the Board is required to engage by the Act is not merely one of assessing lost earnings. It is in fact an exercise in valuation. It is true to say that the amount of compensation payable to an injured person is quantified by a consideration of what the use of the lost or diminished earning capacity might be expected to produce. In some simple situations the amount of lost earnings may be a certain and ready guide to the amount of entitlement. But the Board's task is essentially to determine the compensation payable to a person having regard to the deprivation or impairment of his earning capacity by reason of the injury. The distinction between loss of earnings and loss of earning capacity is well established; it is by no means fictional. See for example
Paff v. Speed (1961) 106 CLR 549 per Windeyer J. at pp 566-567;
Graham v. Baker (1961) 106 CLR 340 per Dixon CJ, and Kitto and Taylor JJ. at pp 346-347;
Skelton v. Collins (1966) 115 CLR 94 per Windeyer J. at p 129; and
Atlas Tiles Limited v. Briers 78 ATC 4536; (1978) 144 CLR 202 per Barwick CJ at ATC p 4540; CLR p 210. Nothing in the judgment of the majority in
Cullen v. Trappell 80 ATC 4185; (1980) 146 CLR 1 detracts from what Barwick CJ said on this topic in the Atlas Tiles case.''

(ATC pp 4084-4085; FCR p 21)

26. Their Honours concluded that the payments under s 25(1) were capital by nature. They did so in the following terms:

``Whether a receipt constitutes income or capital must, of course, depend upon a consideration of all the circumstances. It is the character of the receipt in the hands of the taxpayer as recipient that must be determined:
Hayes v. FC of T (1956) 11 ATD 68 at p 72; (1956) 96 CLR 47 at p 55;
Scott v. FC of T (1966) 14 ATD 286 at p 293; (1966) 117 CLR 514 at p 526;
Federal Coke Company Pty Limited v. FC of T 77 ATC 4255 at p 4264; (1977) 34 FLR 375 at p 388.

The Parliament of Victoria cannot determine by its own legislation whether the receipt of a statutory payment answers the description of income or capital in the hands of the recipient within the meaning of sec 25 of the Assessment Act, a Commonwealth Act. But the purpose of a statutory payment, as disclosed by the terms of the statute itself, must be a powerful, though not conclusive, aid to the determination of the character of the payment and in particular as to whether its receipt constitutes income in the hands of a taxpayer.

These considerations do not support the notion that payments made pursuant to determinations of the Board are in partial substitution for earnings which would have been earned but for the relevant accident. The essential character of those payments is in our opinion, as compensation for loss or impairment of earning capacity. The receipt of those payments is a capital receipt.''

(ATC p 4085; FCR p 22)

27. The third case in the series is
FC of T v. Inkster 89 ATC 5142. The circumstances of that case were a little unusual. Between 1948 and 1951 the taxpayer worked as a fitter and turner in the Western Australian Government Railways Workshop (WESTRAIL). He then worked with the Western Australian Police Department from which he retired in September 1982 at the age of 60. In 1983 he was diagnosed as suffering from asbestosis as a result of his exposure to asbestos dust whilst working with WESTRAIL. At that time he was living on his superannuation pension from the Police Force and had no intention of ever working again for a living. Between 1984 and 1987 the applicant received compensation under the Workers' Compensation and Assistance Act 1981 (WA) (the Western Australian Act). This was treated by the Commissioner as assessable income, and the matter was eventually appealed to the Full Federal Court (Pincus, Gummow and Lee JJ). The Court unanimously found that the payments were income by nature.

28. The following is a brief distillation of the relevant provisions of the Western Australian Act. Under s 18 of the Act, an employer was liable to pay compensation to a worker who was ``disabled from earning full wages''. Compensation was to be assessed in accordance with Schedule 1 of the Act. If the disability resulted in either a total incapacity or a partial incapacity for work a weekly payment was to be made to the worker during the period of incapacity. The amount of weekly payment was calculated by reference to the weekly earnings of the worker, being the remuneration which

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was payable in the employment in which the disability occurred. In the case of Mr Inkster, the disability was taken to have occurred when he contracted the disease, namely during his employment with WESTRAIL over 30 years before his condition was diagnosed.

29. Mr Inkster continued to receive weekly payments of compensation under the Western Australian Act until he reached the age of 65 in September 1987. At that time he elected to take a redemption payment under a provision of the Western Australian Act similar to s 137 of the SRC Act. Unfortunately, for present purposes, the dispute between the taxpayer and the Commissioner related to the weekly payments received during the earlier years of income and not to the redemption amount received subsequently.

30. Lee J (with whom Gummow J agreed) noted that the weekly payments made to the taxpayer were assessed according to a notional calculation. No loss of income had been established or sought to be established. The calculation proceeded as if the taxpayer had an entitlement to compensation which represented the extent of the impairment of his ability to gain income by personal exertion. As such, Lee J concluded that it was the loss of his capacity to earn income rather than a calculation designed to offset any actual loss of income. His Honour continued with the following observation:

``The fact that the amount of a compensation payment is a notional calculation will not prevent the payment being of a revenue nature if it is designed as a contribution to diminish the adverse economic consequences of a disability, that is to say the income loss caused by it.''

(p 5157)

31. His Honour then referred to
FC of T v. DP Smith 81 ATC 4114; (1980-1981) 147 CLR 578 (referred to later in these Reasons) and continued:

``In the respondent's case, there was no loss of income to which the payments were directed as a substitution for such earnings and the payments had their genesis in an assessment of a loss of earning capacity.

For this reason any one payment may have had the character of capital rather than revenue. (See F.C. of T. v. Slaven at ATC pp. 4085-4086; ALR p. 93). This was the conclusion of the Tribunal and in my opinion the Tribunal did not err in so finding.''

(p 5157)

32. His Honour then proceeded to consider whether compensation payments, calculated as weekly payments and paid regularly, took on the character of income by virtue of their periodicity. On this question the AAT had found that periodicity of payments alone was not sufficient to convert capital payments to income. His Honour, after quoting the Tribunal's reasons, made the following observations

``With respect to the Tribunal, there were surrounding circumstances more than capable of characterising the periodical payments as income. Although the payments had their origins in capital, they were not in the nature of payments by instalments of a fixed sum due and owing. The payments were intended to serve the purpose of providing a regular income supplement to the respondent notwithstanding that the payments were generated by calculations which related to capital considerations. Although it is the character of the receipt in the hands of the taxpayer as recipient that must be determined (F.C. of T. v. Slaven at ATC pp. 4085-4086; ALR p. 93), part of the consideration of that matter must involve consideration of the motive of the payer (Hayes v. F.C. of T. (1956) 96 CLR 47 per Fullagar J. at p. 55) and the part the receipt played in the payee's affairs.

Although the respondent may not have relied upon the payments to meet his regular expenditures... the payments were calculated as weekly payments by reference to notional weekly earnings and were received fortnightly by the respondent over a significant period of time. The Compensation Act provided for the payments to be calculated as weekly payments and paid regularly. The calculation of such payments by reference to, and as part of, a weekly income and regular receipt thereof may be sufficient to attract the character of income to the payments. (See F.C. of T. v. Slaven at ATC pp. 4084-4085; ALR p. 92)....''

(p 5158)

33. His Honour referred to further authorities and then concluded in the following terms:

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``Periodicity of payment alone may not be determinative of the question of whether the payments are in the nature of income but such a circumstance is important and additional circumstances may make it clear that the periodical payments do have such a character. Although the payments made to the respondent were not in substitution for wages lost, the payments were intended to be a supplement to whatever income the respondent enjoyed and, furthermore, each payment as it was made was intended to operate as a weekly amelioration of any realisation of his impaired capacity to earn a weekly income. (See Tinkler v. F.C. of T. 79 ATC 4641 per Brennan J. at pp. 4643-4644.)

Soon after the payments commenced, the respondent sought to redeem his entitlement to compensation for his incapacity, measured under the Act in the terms of weekly payments, by redeeming his entitlement to such payments in the manner provided by sec. 67 of the Compensation Act. However, the respondent could not reach agreement with the insurer of his former employer as to the sum to be paid to discharge the employee's liability under the Act. If the respondent had been able to commute his entitlement, the sum received may have been a capital receipt as far as the respondent was concerned having regard to the particular circumstances of his case, but the receipt of regular periodical payments pursuant to the scheme for such payments provided by the Compensation Act was able to give what otherwise may have been a capital receipt the character of income. The circumstances and manner of payment may convert what would otherwise be capital payments into income. (See
Egerton Warburton v. F.C. of T. (1934) 51 CLR 568 per Rich, Dixon and McTiernan JJ. at pp. 572-573.)

The Tribunal erred in finding that periodicity of payment stood alone and that no other pertinent factors were present. For the reasons set out above, the Tribunal was obliged to consider a number of factors which in fact gave the periodical payments the character of income.''

(pp 5159-5160)

34. Pincus J, in a separate judgment, reached the same conclusion, albeit through different reasoning. He referred to what he described as ``the basic rule'', applied in Tinkler, that payments to compensate for lost income are themselves income (p 5145). Notwithstanding that the compensation received by Mr Inkster was not truly representative of lost earnings, his Honour noted that the provisions of the Act seemed to be designed to compensate for lost earnings rather than for loss of earning capacity. His Honour observed that it was difficult to reconcile what was said by Deane and Fisher JJ about s 25(2) in Tinkler with the line of reasoning in Slaven (ibid). Ultimately his Honour decided the case by following Tinkler and Smith and distinguishing Slaven.

35. The final case which deserves mention is particularly relevant here as it involves compensation payments made under precisely the same provisions as are involved in this case, namely s 45 of the 1971 Commonwealth Act. That is Case X21,
90 ATC 239. The taxpayer in that case had received a lump sum payment of nearly $50,000, being weekly compensation which had accrued over an eight year period and which was paid retrospectively. Deputy President Gerber discussed the judgments in Inkster and expressed the view that the 1971 Act was indistinguishable from its Western Australian counterpart. The compensation payable under the 1971 Act was, as he expressed it, ``directly related to the amount of earnings which the employee would have been entitled to receive if he had been earning it in the form of wages'' (Case X21, p 242). He concluded that compensation was thus in substitution for earnings and was assessable under s 25(1) of the ITA Act. It was irrelevant, in Dr Gerber's view, that the compensation was paid in a lump sum. It consisted of an aggregation of weekly payments and the method of payment did not alter its inherent character.

36. Returning to the circumstances of the present case. Mr Murphy, in pressing what he conceded may not have been his strongest point, urged that the language of s 45 makes it clear that the weekly compensation paid to the claimant between 1983 and 1996 was compensation for the loss of a capital item, namely a capacity to earn income. As such it cannot be distinguished from the more recent s 25 of the Victorian Act. In my view this argument cannot be sustained. I do not accept that s 45 of the 1971 Act is in any relevant way comparable with s 25 of the Victorian Act as applied in Slaven. I agree with Dr Gerber that

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compensation under s 45 is paid for loss of earnings and is thus, for all relevant purposes, indistinguishable from compensation paid under the Western Australian Act, as considered in Inkster. Accordingly, in my finding, the weekly payments made to the applicant during this period clearly constituted income in his hands.

2. Weekly compensation after the applicant turned 65

37. As already mentioned, the applicant turned 65 on 16 February 1996. At that time, by virtue of the combined effect of ss 132 (or possibly s 131) and 134(1) of the SRC Act, the weekly compensation payable to him was reduced to $62.46 per week.

38. It seems that it was very shortly after his 65th birthday that the applicant exercised his right under s 137 to redeem his weekly payments, and it is questionable whether he ever actually received a weekly payment at the reduced rate. That, however, does not affect the validity of the current analysis. For it was the weekly payments to which the applicant was entitled after he turned 65, which formed the basis of the calculation of the lump sum redemption payment, and which are thus relevant in determining the nature of that payment.

39. In my opinion, neither the fact that the applicant had turned 65, nor the reduction in the compensation payable to him, had the effect of converting these payments to capital, at least so long as they were being paid regularly. I shall be discussing the nature of these payments in more detail later, as this is a crucial feature in this case. It is sufficient to say here that, using Lee J's phrase in Inkster, ``[t]he payments were intended to serve the purpose of providing a regular income supplement'' to the respondent (Inkster, p 5158). This fact, together with the periodicity of the payments, clearly made them income in the hands of the applicant, notwithstanding that there was no loss of income to which the payments were directed as a substitute.

3. The redemption payment

40. In accordance with s 137 of the SRC Act, the redemption of weekly payments of compensation by the payment of a lump sum is entirely at the discretion of the recipient. If he or she makes a written request for a redemption, Comcare is obliged to accede, so long as it is satisfied that the degree of incapacity is unlikely to change. Thereupon the former employee will receive the appropriately calculated lump sum, and Comcare's liability to make further weekly payments is extinguished.

41. As to the nature of the lump sum payment, the respondent's submission, very simply, is that as the weekly payments were income, and the lump sum was an income substitute, the character of the payment did not change. It is administratively inconvenient, Ms Macdonald urges, for small amounts to be paid on a weekly basis. The redemption of future weekly payments, she says, is merely an expedient method of paying compensation under the SRC Act. The mere fact that it is paid in a lump sum at the beginning of the period does not affect its nature as income. A lump sum prepayment of salaries or long service leave does not, she observes, convert the payment into capital. The fundamental question is, what is the nature of the payment in the hands of the recipient? In this case it is clearly a substitute for income and therefore retains that quality.

42. Mr Murphy, on behalf of the applicant, submits that there are a number of bases upon which I should find that the redemption payment was capital in the hands of the applicant. First, the lump sum redemption payment was in consideration for the applicant's disposal of his statutory right, namely his right to receive weekly compensation payments for the rest of his life. This was a capital asset and the consideration was thus also capital. Secondly, the weekly payments of compensation which the applicant received after he turned 65 were inherently capital in nature and became income only by virtue of, inter alia, their periodicity. When this was removed and the payment was made in a lump sum it reverted to being capital. Finally, Mr Murphy submitted that all compensation payments made to the applicant under the 1971 Act and the SRC Act were capital in nature, as they were designed to compensate him for loss of earning capacity. Accordingly the redemption payment was also capital.

43. I have already found, against the applicant, that the weekly payments of compensation which he received, both before and after he turned 65, were income by nature. The status of the payments in the latter period was to some degree ambiguous, thus leaving open Mr Murphy's second submission.

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However my findings relating to those payments dispose effectively of his third submission. I will thus proceed to deal with Mr Murphy's two major submissions.

Was the lump sum paid in exchange for a capital asset?

44. Mr Murphy's primary submission, as already mentioned, is that the applicant's right to receive weekly compensation payments was a capital asset, even if the payments themselves were income. The consideration he received for disposing of this right was thus also capital. In relation to this submission I was referred to a number of cases relating to the character of lump sum payments. It is expedient, at least in the first instance, to deal with these sequentially.

45. The first case referred to was
Van den Berghs Ltd v. Clark [1935] AC 431. In that case a complex set of contractual arrangements had been entered into between an English and a Dutch company in 1908. These arrangements could not be observed during World War I, and disputes arose between the companies as a result of which the Dutch company paid the English company a large amount by way of damages. An issue arose as to whether this was assessable income. The House of Lords held that it was not, as it represented more than the balance of profits due to the English company under the aborted agreements. Lord Macmillan, with whose opinion the other members of the House of Lords agreed, made the following observation:

``... If the appellants were merely receiving in one sum down the aggregate of profits which they would otherwise have received over a series of years the lump sum might be regarded as of the same nature as the ingredients of which it was composed. But even it a payment is measured by annual receipts, it is not necessarily itself an item of income.''

(p 442)

46. In
C of T (Vic) v. Phillips (1936) 3 ATD 330; (1936) 55 CLR 144 the taxpayer was employed as governing director of a company for a period of 10 years with a remuneration based on a percentage of the company's annual profits. His employment was terminated before the expiration of the 10 years when the company disposed of its business. It was agreed that he would receive by way of compensation a sum which represented his likely earnings under the balance of the contract, which was to be payable monthly during that period. The High Court held that the compensation was assessable income. Dixon and Evatt JJ, said:

``... It is true that to treat a sum of money as income because it is computed or measured by reference to loss of future income is an erroneous method of reasoning. cf.
Californian Oil Products Ltd (in Liq) v. FC of T 52 CLR 28 at pp 46, 49 and 51; 3 ATD 10
Van den Berghs Ltd v. Clark (1935) AC 431 at p 442. It is erroneous because, for example, the right to future income may be an asset of a capital nature and the sum measured by reference to the loss of the future income may be a capital payment made to replace that right. Or, again, the computation may be done for the purpose of ascertaining what capitalized equivalent should be paid for the future income. But, where one right to future periodical payments during a term of years is exchanged for another right to payments of the same periodicity over the same term of years, the fact that the new payments are an estimated equivalent of the old cannot but have weight in considering whether they have the character of income which the old would have possessed.... A contract of service is valuable only because of the income it will bring during the residue of its term. It is not a piece of marketable property. Unless it is rescinded or broken, it is not usually possible to obtain a lump sum or any other consideration representing its value. When such an occasion arises its value is likely to be expressed in terms of income and is by no means to be translated into capital. No prima facie reason exists for regarding as instalments of capital annual payments which are taken in place of the contractual rights such a contract gave.''

(ATD pp 334-335; CLR p 156)

47. In FC of T v. DP Smith (referred to earlier in these Reasons) the taxpayer was a medical practitioner who had taken out a personal disability insurance policy. Following a car accident he was disabled for a number of months during which he received benefits under the policy. The High Court found that the benefits were assessable income in the hands of the taxpayer. Gibbs, Stephen, Mason and Wilson JJ said:

``In our opinion the conclusion is inescapable that the purpose of the policy is

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to diminish the adverse economic consequences of injury by accident. It was to provide a monthly indemnity against the income loss arising from the inability to earn..''

(ATC p 4116; CLR p 584)

48. Elsewhere their Honours made the following observation:

``... If the ability to earn is the tree, and income the fruit thereof, a policy of insurance against impairment of the fruit- bearing capacity of the tree may well take the form of providing the fruit until such time as the tree recovers its proper role. The degree of correspondence, if any, between the moneys payable under the policy and the actual pecuniary loss of revenue suffered by the insured is a relevant factor, but it is not necessary to look for an indemnity measured with any precision against the loss. Any fruit is better than none, whether or not it represents adequate compensation for the loss.''

(ATC p 4116; CLR p 583)

49. The next case, which Mr Murphy rightly described as a landmark decision, was
FC of T v. The Myer Emporium Ltd 87 ATC 4363; (1987) 163 CLR 199. The taxpayer there had lent a large amount of money to a subsidiary company for a lengthy period, with interest at 12.5 per cent per annum. Three days later the taxpayer assigned to an independent third party all interest payments to be made under the contract. It received in consideration an amount which was calculated as the value, at the date of assignment, of the interest payments over the period of the loan. The High Court held that the payment constituted assessable income. There were two bases for this finding, which have since become known as the two ``strands'' in the case. The first strand, which does not concern us here, is that a gain may be income if it arises from an isolated business operation or commercial transaction entered into otherwise than in the ordinary course of the taxpayer's business but with the intention or purpose of making a profit or gain. The second strand of this decision, which is of particular relevance here, is that an amount received by way of consideration for the assignment of a right to receive interest will generally be income. As the court said:

``If the lender sells his mere right to interest for a lump sum, the lump sum is received in exchange for, and ordinarily as the present value of, the future interest which he would have received. This is a revenue not a capital item - the taxpayer simply converts future income into present income....''

(ATC p 4371; CLR p 218)

50. The court distinguished the assignment of interest, the consideration for which will be income, from the assignment of rights under an annuity. It made the following observation:

``... Interest is not like an annuity. Annuity payments are not derived from the money paid for the annuity: they are derived solely from the annuity contract. And so, when a contractual right to be paid an annuity is sold for a price, the proceeds of sale are ordinarily capital in the hands of the vendor: Paget... [[1938] 2 KB at pp. 35, 44-45]; cf. Kelsall Parsons & Co. v. IR Commrs... [ (1938) 21 TC 608, at p. 624]. The vendor receives the price in exchange for a capital asset - the contractual right which produces payment of the annuity....''

(ATC 4371; CLR 218)

51. Their Honours also made the following general observation:

``... the consideration for an assignment of the right to future income may constitute income in a variety of circumstances. Many instances may be given of the sale of a capital asset for a consideration which is income in the hands of the seller. For the most part these are instances of the sale of a capital asset for periodic, regular or recurrent receipts, periodicity, regularity or recurrence being characteristics of an income receipt. See, for example, Egerton- Warburton v. DFC of T... [(1934) 51 CLR 568], where a property was sold in return for an annuity. But there is no reason for thinking that the conversion of a capital asset into an income receipt is confined to such cases.

The periodicity, regularity and recurrence of a receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind. Likewise, the need to distinguish capital and income for trust purposes and other purposes has focused attention on the difference between the right to receive future income and the receipt of that income, a difference which has given rise to the analogical difference between the fruit and the tree (see Shepherd v. FC of T

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(1965) 113 CLR 385 at p. 396)....''

(ATC pp 4369-4370; CLR p 215)

52. The impact of the Myer decision was considered by the Full Federal Court in
Henry Jones (IXL) Limited v. FC of T 91 ATC 4663. In that case the taxpayer had entered into a licence agreement which entitled the licensee to use the taxpayer's labels over a period of 10 years, on payment of an annual royalty. The taxpayer later assigned its rights to receive royalties under the agreement to a third party on payment of a lump sum. The Commissioner included this amount as taxable income and the taxpayer appealed. The Federal Court dismissed the appeal. Hill J, with whom Jenkinson agreed, said that the first strand of the Myer decision did not apply as the taxpayer had not entered into the licence agreement for the purpose of making a profit by sale. However the second strand did apply. Hill J posed the following ``difficult question'':

``The difficult question is whether in Myer the High Court was propounding a view of the law that the assignment of every right to receive income in the future, other than a right arising under a contract dissociated from any other underlying property from which the income may be said to be derived, results in the consideration for the assignment being of a revenue nature as being in substitution for the income that would otherwise have been derived, or whether the decision was intended to be more narrowly confined.''

(p 4673)

53. Hill J went on to refer to the ``obvious'' distinction between royalty and interest payments and concluded that a royalty which is payable periodically will clearly have the character of income (p 4674). He then proceeded, in the following terms, to answer his earlier question:

``... Notwithstanding some doubt, I think Myer must be taken as establishing that, except in the case of the assignment of an annuity where the income arises from the very contract assigned, an assignment of income from property without an assignment of the underlying property right will, no matter what its form, bring about the result that the consideration for that assignment will be on revenue account, as being merely a substitution for the future income that is to be derived. Thus, the fact that the future income may be secured by an agreement, and that the assignment is of the right title and interest of the assignor in that agreement will not affect the result.

So stated the principle is consistent with the development of the law in cases involving compensation for rights of income. Amounts received as compensation for an income right, amounts which thus fill the hole of income, have the character of income....''

(p 4675)

54. As Hill J observed, the decisive factor in that case which led to the payment being characterised as income, was the fact that the taxpayer retained the underlying property, namely the trademarks, from which the assigned royalties were to be derived.

55. The next case,
SP Investments Pty Ltd v. FC of T 93 ATC 4170; (1993) 41 FCR 282 was also a decision of the Full Federal Court. In that case the taxpayer, who was the trustee of a family trust, entered into two separate transactions, in 1979 and 1980, by which it assigned to National Mutual Life Association (NMLA) the trustee's interest, over the ensuing seven years, in certain moneys the trustee was entitled to receive during that period. The moneys represented the proceeds of oil sales from a mining property. The trustee received from NMLA, by way of consideration, two substantial lump sums which were equal to the present value of NMLA's entitlement under the assignment. Hill J, with whom Burchett and O'Loughlin JJ agreed, found that the second strand of Myer applied and that the consideration was assessable as income because it replaced the income stream which would otherwise have been received by the trustee. The underlying property from which the income derived was retained by the trustee. The consideration was accordingly categorised as income.

56. I return to the circumstances of the present case. Mr Murphy's analysis of the transaction between the applicant and Comcare is as follows. Under s 137 of the SRC Act, the applicant was entitled to request that Comcare redeem its liability to make weekly payments of compensation by the payment of a lump sum. In doing so, the applicant was relinquishing his entitlement to receive future weekly payments. This involved, Mr Murphy says, the applicant relinquishing not only the prospective compensation payments themselves, but also disposing of an underlying asset, being the

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statutory entitlement to receive them. To use the tree/fruit analogy, Mr Murphy says that the applicant was disposing not only of the fruit, being the weekly payments, but of the right to receive them, namely the tree. This, he says, was a capital asset and accordingly the consideration for it was also capital.

57. Mr Murphy also contends that it is fallacious to categorise the redemption payment as a prepayment of the applicant's weekly compensation payments. This is because the redemption payment was calculated upon the basis of the applicant's actuarially calculated life expectancy. This might constitute a statistical average, but as Mr Murphy points out, it is highly unlikely that the applicant's remaining life would actually span this precise period. The amount received by way of weekly payments of compensation would have varied according to the applicant's actual lifespan, whereas the redemption payment remained the same, regardless of whether the applicant were to live for a further six months or 30 years.

58. Both these arguments ultimately go to the same issue, namely whether the redemption payment constituted an income substitute so as to itself be income. They do so, however, by different routes. The argument relating to the applicant's lifespan is directed to show that the redemption payment was never capable of being an income substitute. The argument relating to the disposal of the underlying asset is directed to show that it was paid in consideration for a capital item rather than for income, and was thus itself capital.

59. Dealing first with Mr Murphy's submission as to the applicant's anticipated lifespan and the method of calculation of the redemption payment. It is true that in all cases to which I have been referred by the parties, there was an assignment of income over a specified period. The consideration for the assignment could thus be readily calculated according to a fixed time span. This is clearly not the situation here, for no one knows what the applicant's actual lifespan will be. For this reason it is difficult to equate the redemption payment in this case with the prepayment of salary or long service leave, as Ms Macdonald sought to do. But does it follow from this that the redemption payment is, as Mr Murphy would urge, incapable of being an income substitute? In my view the answer must be in the negative. Human life is inherently of uncertain duration. The most we can do when we are trying to provide a lump sum which will meet an individual's future needs is to use his or her current life expectation as a yardstick. This device is used in a wide variety of fields, most particularly in the assessment of damages for future losses and expenses. Certainly it can lead to eccentric results in certain cases. But it cannot, in my view, alter the underlying nature of a transaction. In this case, as I have already found, the applicant's compensation payments, even after the age of 65, constituted income when paid on a weekly basis. The fact that the redemption payment was then calculated according to an average figure, rather than a known figure, is not in my view relevant to the question of whether it constituted an income substitute in the hands of the applicant.

60. This brings me again to Mr Murphy's main submission, namely that the redemption payment was made in consideration for the disposal of a capital asset, being the applicant's entitlement to weekly compensation payments for the remainder of his life. Mr Murphy says that the second strand of Myer does not apply in this case, for Myer deals only with the situation where the disputed payment is received in consideration for an assignment of income, without an assignment of the underlying property right from which the income derives. Mr Murphy says that in this case the underlying property right was surrendered by the applicant in exchange for the redemption, thus removing the case from the rubric of Myer. He relies, by way of analogy, on the assignment of an annuity, which has classically been held to be a capital transaction.

61. There are two obvious points of difference between the surrender of a person's entitlement to weekly compensation through the receipt of a redemption payment on the one hand, and the assignment of an annuity on the other. They are, first, that the redemption situation involves the surrender of an entitlement rather than its assignment; and second, that benefits under an annuity contract constitute a marketable asset, whereas a statutory entitlement to compensation does not. There is some interrelation between these two features. The right to receive weekly compensation payments cannot be assigned, it can only be surrendered. It is inherently incapable of assignment, because, being

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personal to the recipient, it is not a marketable commodity.

62. An assignee of entitlements under an annuity contract gains the right to receive annuity payments in accordance with the contract, and to sue for breach of contract in the event that the payments are not forthcoming. The assignment thus constitutes a transfer not only of the payments themselves, but also, in the words of the High Court in Myer, of the contractual right which produces payment of the annuity. The applicant's situation as the recipient of compensation payments is entirely different. It is simply not possible for the recipient of weekly compensation payments under the SRC Act or the 1971 Act to assign his or her entitlements in the way that the holder of an annuity can do. The right to receive compensation payments is personal to the recipient, and can only arise when a work related injury has resulted in an incapacity. This right is incapable of assignment, at least as an enforceable entity. There is thus no underlying capital asset which is capable of transfer.

63. This is sufficient, in my view, to demonstrate that no relevant analogy can be drawn between the surrender of an individual's compensation entitlements and the assignment of an annuity.

64. The same reasoning leads inexorably to the conclusion that the fruit/tree argument cannot avail the applicant. This argument rests upon the proposition that the tree constitutes capital and the fruit income. A person with a statutory entitlement to receive compensation payments possesses, so Mr Murphy would say, both the tree and the fruit. The fruit consists of the regular payments of compensation, the tree is the statutory entitlement to receive them. The surrender of this entitlement upon the payment of a lump sum involves the disposal of the tree, as well as the fruit which will be borne in the future. This is a capital asset, and the consideration for it is thus also capital.

65. This argument breaks down when one seeks to ascertain the value of the tree. For the fact is that the tree has no intrinsic value at all. Its value consists only of the fruit which it produces. Putting it another way, the tree is not a marketable commodity. Only its fruit has any value. And it is the value of the fruit, being the weekly compensation payments, which constitutes the measure by which the lump sum consideration is calculated.

66. It follows from the above discussion that Mr Murphy's primary submission must fail. I turn to discuss his second submission.

Did the nature of the weekly payment mean that the redemption payment was capital?

67. Mr Murphy's second submission relies primarily on the judgment of Lee J (with whom Gummow J agreed) in Inkster. It is based on the proposition that the weekly payments of compensation which the applicant was entitled to receive after he turned 65 could no longer be regarded as a substitute for lost income. Thus, to use Lee J's words, the payments had their genesis in an assessment of a loss of earning capacity. According to this analysis, it was the periodicity of the payments, together with the fact that they were intended to provide a regular income supplement for the applicant, which gave them their revenue quality. The applicant relies upon the passage in Lee J's judgment, quoted above, in which his Honour observed that had a lump sum payment been made to the taxpayer in that case in redemption of his periodic compensation payments, it ``may have been a capital receipt... but the receipt of regular periodical payments... was able to give what otherwise may have been a capital receipt the character of income'' (pp 5159-5160).

68. In order to explore this submission it is necessary to turn, albeit briefly, to the legislative provisions under which the applicant was entitled to receive compensation payments after he turned 65. These provisions, together with s 137 itself, are contained in Part X - Transitional Provisions, Consequential Amendments and Repeals, Division 3 - Special transitional provisions relating to certain former employees of the SRC Act. A ``former employee'' is defined as a person who received weekly payments of compensation under the 1971 Act and who had ceased to be an employee before the commencement of the SRC Act (s 123). The applicant clearly falls within this definition.

69. Section 132 of the SRC Act stipulates the amount of compensation payable to a former employee who was under 65 at the commencing date (1 December 1988) and who was incapable of engaging in any work. The compensation is measured by reference to a percentage of the employee's ``normal weekly earnings'' being the employee's average earnings within the last two weeks before the injury was sustained. In the applicant's case this was measured by his

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earnings, back in 1983, when he was employed by the Department of Aviation.

70. Section 131 of the Act provides for a reduction in the amount of compensation otherwise payable under s 132 if the former employee is in receipt of superannuation benefits.

71. The applicant received compensation under s 132 (or possibly s 131) between 1 December 1988 and 16 February 1996 when he turned 65. On the latter date, by virtue of s 134 of the SRC Act, the amount payable to him was reduced by a formula which had, amongst its ingredients, the amount of weekly compensation then currently payable to the applicant, and his age as at 1 December 1988.

72. The fact that there is a statutory reduction in the rate of weekly compensation payments when the recipient turns 65 plainly recognises that most members of the community are no longer in the workforce at that age. The object of compensation which then becomes payable can no longer be to compensate the individual for lost earnings, for it is assumed at that stage that there would not in any event be any earnings. What, then, was the nature of the payments to which the applicant was entitled after he turned 65? The answer provided by the majority in Inkster, in not dissimilar circumstances, is that the payments represented compensation for loss of earning capacity. As such, the payments had their genesis in capital, but nevertheless were income in the hands of the applicant so long as they were paid on a weekly basis.

73. Lee J's observation in Inkster as to the likelihood of a redemption payment being capital in the hands of the taxpayer was clearly obiter, and the circumstances of that case were by no means identical to those of the applicant here. In particular, the weekly payments made to Mr Inkster were calculated on a ``notional'' basis which had no relevance to his present circumstances. The weekly payments made to the present applicant, at least before he turned 65, had their basis in his ``normal weekly earnings'' at the time he received his injury. However when he turned 65, and the payments were reduced under the formula contained in s 134, any relevance that the resultant amount had to his present circumstances was so remote as to be indistinguishable from the circumstances in Inkster. Accordingly I consider that the analysis undertaken by Lee J is both relevant and applicable in this case. Under this analysis, the weekly payments which the applicant was entitled to receive after he turned 65 constituted income in his hand notwithstanding that they were designed to compensate him for a capital loss. The periodicity of the payment was the principal feature which converted them from capital to income. The lump sum redemption payment, which clearly lacked this feature, therefore reverted to capital.

74. It follows that Mr Murphy's second submission must prevail. The amount paid to the applicant by way of lump sum redemption of his compensation entitlements was a payment of capital and was therefore not assessable income under s 25(1) of the ITA Act.

Is the payment statutory income under s 26(j)?

75. This is not the end of the matter. For the respondent, as I indicated earlier in these Reasons, contends that the redemption payment in this case constitutes statutory income under s 26(j) of the ITA Act. At the relevant time that subsection provided as follows:

``Certain items of assessable income

26 The assessable income of a taxpayer shall include:

• ...
• (j) any amount received by way of insurance or indemnity for or in respect of any loss:
  • (i) of trading stock which would have been taken into account in computing taxable income; or
  • (ii) of profit or income which would have been assessable income;

if the loss had not occurred, and any amount so received for or in respect of any loss or outgoing which is an available deduction;''

76. The respondent's submission, put simply, is that the weekly payments received by the applicant were assessable income under s 26(j), being amounts received from Comcare by way of insurance in respect of the applicant's loss of income which would otherwise have been assessable income. The same reasoning, it is urged, would lead the lump sum redemption payment to also constitute assessable income under s 26(j).

77. Clearly the weekly payments the applicant received before he turned 65 would have fallen within the terms of s 26(j). But the

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position is different in relation to compensation payments made after that date. As to the status of the lump sum redemption payment, there is a judicial disagreement as to whether s 26(j) applies to insurance received in relation to future losses. The majority of the South Australian Supreme Court (Hogarth and King JJ) in
Lonie v. Perugini and Perugini 77 ATC 4318 decided that it did not. Bray CJ, dissenting, considered that s 26(j) embraces future as well as past loss of profits or income. Hutley J of the New South Wales Court of Appeal discussed the competing considerations in
Pennant Hills Restaurants Pty Ltd v. Barrell Insurances Pty Ltd 78 ATC 4032 and concluded that Bray CJ's findings were correct.

78. However it is unnecessary for present purposes to resolve this issue. For there is a more fundamental reason why s 26(j) cannot apply in the present case. The very feature of this case which, according to my earlier findings, took the redemption payment outside the scope of s 25(1), also removes it from the purview of s 26(j). This is the fact that, after the applicant turned 65, his weekly compensation, which then formed the basis for the calculation of his redemption payment, was not paid ``in respect of any loss of profit or income'' (s 26(j)(ii)).

79. This same issue arose in Inkster. Lee J, after quoting s 26(j) said as follows:

``The respondent did not suffer any loss of earnings and did not claim that he had. He no longer sought to earn income by personal exertion. For subsec. 26(j) to have applied, it would have been necessary to demonstrate that an actual loss of income had been indemnified. In the respondent's case no such loss was shown and nor was it necessary. The respondent qualified for the payment of compensation when he established that he was less able to earn the ordinary wages payable to a fitter if he were to seek employment on the open market. Whatever the width of the meaning of `insurance or indemnity' may be, the respondent did not receive any amount for, or in respect of, any loss of income.

The facts of this appeal may be distinguished from those considered by the High Court in F.C. of T. v. Smith where it was decided that in addition to being income within the meaning of sec. 25 of the Act, the benefits received by the taxpayer under a policy of insurance were also assessable income pursuant to subsec. 26(j). In that case the payments made to the taxpayer under the policy were an indemnity against actual losses of a revenue nature suffered by the insured. The necessary characteristics were present for subsec. 26(j) to apply. The Tribunal correctly decided that subsec. 26(j) had no application.''

(pp 5157-5158)

80. In my view this reasoning applies equally in the present case. Accordingly I find that s 26(j) has no application here.

81. It follows from the above discussion that I must set aside the decision under review. In substitution therefor I decide that the amount in dispute, namely $39,590.24 is not assessable income under ss 25(1) or 26(j) of the ITA Act.