Compensation for Physical Injury to the Person

7.34. Compensation in a lump sum for personal injury is not included in income. The compensation is a composite receipt of a number of elements. These may include income already lost as a result of the injury, capacity to earn income in the future, pain and suffering and diminished expectation of life. Except perhaps for the first, none of the elements has an income character, whether by virtue of the ordinary usage of the word or the specific provision in section 26 (j) dealing with receipts by way of insurance or indemnity. Compensation for income already lost is income, but it is arguable that there is no such element in the compensation receipt: so far as the amount of compensation takes account of income already lost, this is only for the purpose of determining the amount of the loss of capacity to earn that resulted from the injury. The resolution of the question is, for the present, unlikely, because of the difficulties placed by the present law in the way of dissecting or apportioning composite receipts. These difficulties are considered later in paragraphs 7.101–7.102.

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7.35. So long as compensation received in a lump sum for personal injury is not included in income, the amount of compensation given by the Courts in personal injury cases will continue to be calculated on the basis that what has been lost as a result of the impairment of capacity to earn is the present value of what would have been earned less the present value of the tax that would have been paid on that amount. This results from the application of the principle in Gourley's Case.note The Court in applying the principle must estimate the deductions and concessions likely to have been available to the injured person and, presumably, what he might have done by way of tax planning to minimise his tax liability. The principle is sometimes criticised on the ground that the person who caused the injury receives a benefit at the expense of all other taxpayers who must make up the loss to revenue. The Committee does not see the matter in these terms, involving as they do notions of ensuring a full penalty for his wrongs on the person who caused the injury which, in the conditions of compulsory insurance of motor vehicle and industrial accident liabilities, are inappropriate. However, the Committee does not regard the application of the principle as sufficient in itself to justify the exemption of lump-sum receipts from tax. It is not intended as a substitute for tax: it is rather a consequence of the absence of tax. Moreover, the application of the principle cannot be precise even when a case comes to trial. There is no way of assessing the significance of the principle in out-of-Court settlements.

7.36. Where compensation for personal injury is received in a series of periodical payments, the amounts received are included in income without regard to whether they are for lost earnings, for loss of earning capacity or for pain and suffering. Thus periodical payments of workers’ compensation are included in income. There are, therefore, important tax implications in the recent proposal of the Committee of Inquiry into Compensation and Rehabilitation in Australia, that injury and sickness compensation be universally paid in periodical amounts. The Bill currently before Parliament preserves to some extent the system of lump-sum awards, but their role in compensation for physical injury has been significantly reduced.

7.37. The continuing exclusion from income of compensation for physical injury must rest primarily on the importance of the element of non-economic loss reflected in the compensation. Whatever the theory of the comprehensive tax base may suggest, it would be a significant departure from accepted ideas to include in income amounts received which are in respect of physical suffering and disability as distinct from being for the reduced capacity of a person to earn which may attend that suffering and disability.

7.38. If it were sought to separate the element of compensation for non-economic loss and to tax the remainder, this could only be done by some arbitrary apportionment. The award of damages by a Court or the award of a lump sum under workers’ compensation will not show the breakdown; and a lump sum payable under an accident insurance policy is expressed simply as an amount of money.

7.39. The taxing of that part of the compensation apportioned to the element representing a substitute for income would lead, in the case of compensation assessed by a Court or tribunal, to a considerable increase in the level of awards. Gourley's Case would no longer apply and awards would be made on predictions about the gross income of the injured person.

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[?] Committee for these reasons does not propose any change in the present [?] tax receipts of compensation for physical injury.