Edited version of private ruling

Authorisation Number: 1011645528593

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Ruling

Subject: Storm Financial collapse

1. Does the application of the settlement amount against your home loan have taxation consequences?

Yes.

2. Is the equity component of the compensation payment that you received additional capital proceeds?

Yes.

3. Will the interest component of the compensation payment be assessable income?

Yes.

4. Would the taxation consequences be different if you were to accept a cash settlement?

No.

This ruling applies for the following periods:

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You and your spouse were clients of Storm Financial Limited (Storm) and received financial advice from Storm.

On the advice of Storm and with Storm's assistance, at various times you and your spouse applied for one or more home loans from the Commonwealth Banks of Australia's (CBA) retail division and one or more margin loans from CBA's Colonial Geared Investments division.

The CBA's retail division approved the home loan application and advanced funds to you and your spouse. The home loan is/was secured by one or more registered mortgages over your property.

Proceeds of the facilities comprising the home loan were used from time to time by you and your spouse to purchase various investments on the advice of Storm, which were then offered by you and your spouse to the CBA (together with investments to be purchased with the proceeds of the proposed margin loan) as part of the security for the proposed margin loan (the ML security).

Colonial Geared Investments approved the margin loan application and a margin loan was advanced to you and your spouse against the ML security.

Proceeds of the home loan were used from time to time by you and your spouse to purchase additional ML security on the advice of Storm, which in turn was used to increase the borrowings under the margin loan.

The ML security may have included units in a Storm-badged index fund for which the responsible entity was a CBA party.

The CBA notified you and your spouse and/or Storm of the ML security value and the Loan-to-Security ratios of the margin loan from time to time.

Between June 2008 and the effective date, one or more (but not necessarily all) of the following occurred in relation to the margin loan:

· the Current Loan-to-Security ratio of the margin loan exceeded the Base Loan-to-Security ratio of the margin loan

· the margin loan went into margin call when the Current Loan-to-Security ration of the margin loan exceeded the margin call Loan-to-Security ratio

· the CBA notified Storm, as your agent, of the margin call

· the margin loan went into default

· you and your spouse converted some, or all, of the ML security held as securities or units in managed funds into cash held in an Accelerator Cash Account as ML security

· you and your spouse sold some, or all, of the ML security to repay indebtedness under the margin loan

· the CBA sold some, or all of the ML security and applied the proceeds to repay indebtedness under the margin loan

· the margin loan was repaid, including through the breakage of any fixed rate component of the margin loan

· break costs were charged to the margin loan by the CBA in relation to the breakage of a fixed rate component of the margin loan

· one or more of the index funds comprising the ML security was suspended and/or closed by the relevant responsible entity

· the margin loan was closed

· the ML security sale proceeds were insufficient to cover your indebtedness under the margin loan and there remains money owing by you and your spouse to the CBA under the margin loan.

Returns generated by the ML security are no longer available to you and your spouse to apply towards meeting, or are insufficient to meet, repayment obligations under the home loan or (if different) the Current loan.

You and your spouse have, either directly or through your lawyers Slater & Gordon made a claim against the CBA for compensation concerning the circumstances of the home loan, the margin loan, the security, the repayment of indebtedness under the margin loan and/or the repayment of indebtedness under the home loan.

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

As a result of their participation in the scheme and the CBA's construction of a proposal, the parties have agreed upon:

· the release and waiver of certain amounts of indebtedness owed by you and your spouse to the CBA, and/or

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

· the payment of certain amounts to you and your spouse by the CBA, and

· the releases which are set out in the Deed.

The Deed provided for a settlement amount a specific amount.

This amount was made up of an equity amount and an interest amount.

Under the proposal:

· the settlement amount will be applied towards your home loan

· your existing loans will be closed and all liabilities under these loans will be discharged and extinguished in full, and

· a new home loan will be approved under the proposal.

You and your spouse have the option to counteroffer this settlement and you plan to apply for a partial cash payout.

The proposal from the CBA has been based on the fact that you should have retained a margin of 10% of your capital and that they have further committed to repay any negative equity that you incurred on the loans and subsequently paid. Therefore, you believe that the scheme represents a return of capital and not a compensation payment.

You and your spouse have not yet decided whether to accept this settlement.

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

Income Tax Assessment Act 1997 Section 116-20.

Reasons for decision

The settlement amount is effectively a payment that you and your spouse will receive. While you and your spouse may not necessarily take physical possession of the amount in cash, because the amount is to be applied towards your home loan, this does not alter the fact that it is an amount that you and your spouse will be taken to receive.

The settlement amount is made up of two separate components. One being an equity component and the other an interest component.

These two components are taxed separately.

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 Storm. You and your spouse applied and were granted a home loan from the CBA's retail division and a margin loan from the CBA's Colonial Geared Investments division. The loans were used to acquire various stocks and investments. It may have included units in a Storm branded index fund for which the responsible entity was the CBA or one of its related bodies such as Colonial First State.

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

The CBA with either you or with your solicitors Slater & Gordon have made a claim against the CBA for compensation concerning the circumstances surrounding the home loan, margin call, the security, the repayment of indebtedness under the margin loan and/or the repayment of indebtedness under the home loan. The settlement deed agreed to pay you compensation and interest.

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.

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 made in the 2008-09 and 2009-10 income years.

Interest component

The taxation treatment of the interest component of the payment that you and your spouse 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. Half of this amount will need to be included as assessable income in your 2009-2010 income tax return.

Settlement - cash v application of payment to home loan

As previously stated, the settlement amount is a payment that you and your spouse are taken to have received.

Therefore, the taxation consequences will remain the same regardless of whether the amount is taken in cash or applied against your home loan.

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