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.

General Australian Taxation Office requirements

The Australian Taxation Office (ATO) requires salary and wages to be assigned to an occupation when lodging a tax return. Currently, there is no ATO occupation code that covers income replacement payments from DVA. The ATO is aware of this and has indicated veterans in receipt of this type of payment are required to select the 'occupation that best describes the occupation from which you would have earned most of your payments had you not received them from another source' (i.e. the persons' previous profession.)

The ATO requires code "S" (denoting salary or wages) to be used on payment summaries to veterans in receipt of incapacity payments. This code does not indicate a person is receiving salary from actual employment, but ensures this compensation payment is taxed correctly (as per ATO requirements).

The Medicare Levy is collected by the ATO in the same way as income tax. Generally, the amount that is withheld from a pesons' income payment (as per the tax tables) includes an amount to cover the Medicare Levy. The amount of tax payable by a person is dependent on their personal circumstances, and the actual amount of Medicare Levy payable is calculated by the ATO when the individual's income tax return is lodged. DVA cannot collect an additional amount of tax for the Medicare Levy.