Incapacity payments are made as economic loss compensation by way of income replacement, as distinct from non-economic loss compensation such as for permanent impairment.  Incapacity payments are generally linked to a person's pre-injury earnings and are taxable at the appropriate marginal tax rate prior to payment to the person.  Instructions as noted on a person's Tax Declaration form must be followed.

Incapacity payments are generally taxable because they are income-related payments.  However, where the earnings being replaced are non-taxable, so too are the incapacity payments.

The following types of incapacity payments are exempt from taxation by virtue of sections 51-32 and 51-33 of Income Tax Assessment Act 1997:

• Payments for the loss of pay and allowances while on a period of warlike service;

• Payment for the loss of allowances while on a period of non-warlike service; and

• Payment for the loss of pay or allowances as a part time reservist.

However if a person's NE is calculated by reference to the DRCA ‘minimum earnings provision’ or MRCA ‘national minimum wage’ provision, those incapacity payments are assessable for income tax purposes.