Edited version of private ruling

Authorisation Number: 1011509872658

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Ruling

Subject: company Q Financial collapse

Questions and Answers

Will equity component of the compensation be considered additional capital proceeds received and be used to calculate any capital gain or capital loss that you made?

Yes.

Does the Commissioner have the discretion to allow you to transfer the capital loss that you made to your spouse?

No.

This ruling applies for the following periods:

Year ending 30 June 2009

Year ending 30 June 2010

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You were a client of company Q (company Q) and received financial advice from company Q.

On the advice of company Q and with company Q's assistance you applied for a margin loan from entity S division. The margin loan was approved by entity X and the margin loan was advanced to you. The margin loan was secured by various stocks and investments purchased with the proceeds of the margin loan. The security may have included units in a company Q branded index fund for which the responsible entity was entity S or one of its related bodies corporate.

After a period of time, the entity S determined that your historical current loan to security ratio would have first exceeded its historical margin call loan to security ratio.

Over a period of time your investments with company Q were sold by the entity S or its related bodies corporate.

You were required to repay the margin loan to entity Y. To repay the amount you mortgaged your main residence and a rental property that was inherited by your spouse.

You negotiated with the banks however after no success you had no alternative but to seek advice from your accountant. Your accountant advised you that at your stage in life you should secure your home.

Your spouse sold the inherited property so that you could scrape together enough finance to be able to pay off both mortgages and retain your main residence. Your spouse made a capital gain on the sale. The capital gain extinguished all of your spouse's previously carried forward capital losses. You also lost a considerable amount of money due to large "break fees" to the banks to pay out your loans.

Effectively, you lost all of your life savings, superannuation and other investments.

You have, either directly or through your lawyers made a claim against the entity S for compensation concerning the circumstances of the margin loan and/or the security and repayment of indebtedness under the margin loan.

The parties have participated in a dispute resolution process known as the company Q Resolution Scheme (the scheme) on the terms set out in the Borrower Deed.

In a letter that you received the entity S offered details of the proposal and settlement deed.

By participating in the scheme the parties agreed to:

· the payment of the Settlement Sum by the entity S to you;

· the closure or variation of the margin loan as set out in the Deed, and

· the releases which are set out in the Deed.

The Deed provided for a settlement amount which included an equity amount and an interest component.

You have advised that the cheque from this scheme is in your name.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Subsection 6-5(1),

Income Tax Assessment Act 1997 Subsection 6-5(2),

Income Tax Assessment Act 1997 Section 104-10,

Income Tax Assessment Act 1997 Section 104-25,

Income Tax Assessment Act 1997 Subsection 104-25(1),

Income Tax Assessment Act 1997 Section 108-5 and

Income Tax Assessment Act 1997 Section 116-20

Reasons for decision

Summary

The payment that you received from the entity S was made up of an equity component and an interest component. The equity component is additional capital proceeds in relation to your assets that were sold by entity S or its related bodies. The interest component is assessable as income.

When considering the disposal of capital gains tax (CGT) assets the most important element in the application of the CGT provisions is ownership.

Generally, the legal owner of a CGT asset is the person who will make a capital gain or capital loss when a CGT event happens to the asset.

You held the investments in company Q jointly with your spouse. Therefore any capital proceeds in that you received under the deed of settlement will need to be apportioned in accordance with your ownership interest. This is the case even though the cheque for payment was in your name.

The Commissioner does not have the discretion to determine that a capital gain or capital loss can be transferred to another person.

Detailed reasons:

Capital gains tax (CGT) consequences - equity component

The general CGT provisions are set out in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997). Under the CGT provisions a taxpayer will make a capital gain or loss only if a CGT event happens.

To determine if a CGT event happens in respect of a compensation payment it is necessary to consider the nature of the asset to which the compensation payment relates.

The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 (capital gains: treatment of compensation receipts).

TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be:

· an underlying asset;

· a right to seek compensation; or

· a notional asset in terms of subsection 160M(7) - (section 104-155 of the ITAA 1997).

(TR 95/35 provides legislative references that relate to the Income Tax Assessment Act 1936). The equivalent provisions in the ITAA 1997 are cited where appropriate.)

In determining which is the most relevant asset it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt.

In TR 95/35 the term 'underlying asset' is used. The underlying asset is defined in TR 95/35 as:

the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

Taxation Ruling TR 97/3 also discusses compensation and deals with compensation received by landowners from public authorities. It explains at paragraph 2 that it extends the application of TR 95/35 and should be read in conjunction with that ruling.

Paragraphs 4 to 8 of TR 97/3 discuss the compensation received from a public authority for the compulsory acquisition of an easement and states that:-

4. Compensation in respect of an easement created by statute in favour of a public authority cannot be said to have been received for the grant of the easement. The Land Acquisition (Just Terms Compensation) Act 1991 (NSW) and similar Acts in other jurisdictions enable public authorities to take land or an interest in land (including an easement) for specified purposes and confer on the affected landowner a right to compensation. In these circumstances, the landowner cannot be said to have created an asset as required for subsection 160M(6) of the Act (now includes 104-35 of the ITAA 1997) to apply. The easement is created by operation of the relevant statute and is vested in the public authority. This constitutes a compulsory acquisition of the easement.

5. The compensation received by a landowner from a public authority that compulsorily acquires an easement is not excluded from the scope of TR 95/35 by paragraph 2 of that Ruling which states that:

'This Ruling does not consider:

· amounts received for the grant of easements, profits a prendre and licences - these are covered in detail in Taxation Ruling IT 2561 and in Taxation Determinations TD 93/235 and TD 93/236'.

6. A strict application of Part IIIA would require the compensation received from a public authority to be treated as consideration in respect of the disposal by the landowner of the right to compensation. However, TR 95/35 focuses on the asset to which the compensation receipt most directly relates. In the case of easements acquired under statute and the consequential disposal of the right to compensation, the most relevant asset is the landowner's pre-existing land with its rights of ownership including, for example, a right to exclude all others. This right to exclude all others is forfeited in part when the easement comes into existence. The loss of part of this right constitutes the disposal of part of the underlying asset (the land) for Part IIIA purposes (paragraph 160M(3)(b) (now 104-25(1) of the ITAA 1997), subsection 160M(1) (now 104-10(2) and 109-5(1) of the ITAA 1997) and section 160R (now 108-5(2)(a) of the ITAA 1997).

7. Paragraph 4 of TR 95/35 states that:

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation.

8. Applying this approach, an amount of compensation received by a landowner for the loss of part of the rights of ownership is accepted as being consideration received in respect of the part disposal of the underlying asset (the land). The amount is not consideration for disposal of the right to seek compensation.

The ruling also considers a number of other circumstances when a landowner grants an easement on their land and in all but one instance the amount received is treated as consideration in respect of the part disposal of the land.

To the extent that the payment relates to the disposal of an underlying asset, CGT event A1 under section 104-10 of the ITAA 1997 happens.

This case:

You and your spouse were clients of company Q. You applied and were granted a margin loan from the entity S's entity X division. The margin loan was used to acquire various stocks and investments. It may have included units in a company Q branded index fund for which the responsible entity was the entity S or one of its related bodies such as entity Y.

Some time later the entity S determined that your historical current loan to security ratio had exceeded its historical margin call loan-to-security ratio. The entity S did not sell your investments until after it determined that your loan had exceeded its loan to security ratio.

The entity S with either you or with your solicitors have made a claim against the entity S for compensation concerning the circumstances surrounding the margin call and/or the security and the repayment of indebtedness under the margin call. The entity S issued a letter to you offering details of the proposal and settlement deed. The settlement deed agreed to pay you an amount of compensation and an interest component.

On the facts of this case, it is considered that the compensation received had a direct and substantial link with the underlying asset (the investments). Accordingly, in line with the guidelines provided in paragraph 4 of TR 95/35 and TR 97/3 it is considered that the compensation amount was received as part of the underlying asset and it was not received for the disposal of any other asset, such as the right to seek compensation. The equity amount is therefore accepted as consideration received for the disposal of the underlying assets and CGT event A1 in section  104-10 of the ITAA 1997 occurred when your investments were sold. There are no provisions in the ITAA 1997 that allow spouses to transfer gains or losses made to each other.

Please note that because you have received additional capital proceeds in respect of previous CGT events this will mean you will need to adjust any capital gains or capital losses that you included in the income years.

Interest component

The taxation treatment of the interest component of the payment that you received is discussed in paragraph 26 of TR 95/35 when it states that:-

Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions. If the taxpayer receives an undissected lump sum compensation amount and the interest cannot be separately identified and segregated out of that receipt, no part of that receipt can be said to represent interest. If the compensation cannot be dissected it is likely that the whole amount relates to the disposal of the right to seek compensation.

In this instance the interest is separately identified and segregated out of the lump sum and as such is assessable income under the general income provisions in section 6-5 of the ITAA 1997.

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