Edited version of private ruling

Authorisation Number: 1011667123587

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Ruling

Subject: Capital gains tax - Compensation receipts

Question 1:

Is your half share of the payment you received from Z an exempt capital receipt because of any wrong that Z may have done?

Answer 1:

No.

Question 2:

Is your half share of the payment you received from Z additional capital proceeds?

Answer 2:

Yes.

This ruling applies for the following period:

Year ended 30 June 2009.

The scheme commences on:

1 June 2008.

Relevant facts and circumstances

Relevant facts

You and your spouse were clients of X and received financial advice from X.

You commenced your investment with X in the particular year.

On the advice of X and with X's assistance you applied for a margin loan from Y. The margin loan was approved by Y 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 X branded index fund for which the responsible entity was Y or one of its related bodies.

You and your spouse's initial investment through X was for a certain amount comprising;

· personal cash reserves; and

· loan proceeds from Y Margin Loan.

Having drawn down the total of your Z Home Loan you invested a further amount in X Funds comprising the following;

· proceeds from your Z Home Loan; and

· an increase in Margin loan borrowings with Y.

The surplus proceeds of the Z Home Loan and additional personal equity were used as follows;

· a certain amount was placed in a cash management trust and cash reserves to fund living expenses and to meet all loan obligations;

· a certain amount was paid to X for their financial advice; and

· a certain amount was refunded to you for personal expenses.

The combined value of the X funds as at the particular year was a certain amount.

At the point immediately prior to liquidation of your investments you had the following borrowings:

· Y Margin Loan

· Z Home Loan.

Following the collapse of X in the particular year, your investments were sold down and your X funds were liquidated over a period.

You subsequently paid out your Y margin loan, which involved repaying a debt of a certain amount and contributed the remainder funds as follows;

· an amount to cash account to service Z Home Loan

· an amount to Superannuation in your name.

You were then left with your obligations under the Z Home Loan.

Having unsuccessfully applied for hardship concessions from Z in the particular year, you were forced to sell your home to pay down this debt.

You have, either directly or through your lawyers made a claim against Z for compensation concerning the circumstances surrounding any loss that you and your spouse may have suffered as a result of your investment with X.

Z sent a letter of a certain date to you and your spouse containing their offer. The details are as follows:

· the payment of the Settlement Sum by Z to you;

· certain conditions being agreed to; and

· the releases which are set out in the Deed.

You and your spouse have accepted Z's offer.

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 6-10

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

Income Tax Assessment Act 1997 Section 118-37

Reasons for decision

Question 1

Summary

Your half share of the payment that you received from Z is not an exempt capital receipt because of any wrong that Z may have done.

Detailed reasoning

Exemption for personal wrong or injury

A capital gain or capital loss may be disregarded if it is made from a CGT event that relates directly to compensation or damages received for any wrong or injury to you or a relative that is suffered personally. Paragraphs 118-37(1)(a) and (b) of the ITAA 1997 reads as follows;

A capital gain or capital loss you make from a CGT event relating directly to any of these is disregarded:

(a) compensation or damages you receive for any wrong or injury you suffer in your occupation;

(b) compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally;

The Commissioner states in Taxation Ruling TR 95/35 that the exemption will only apply where an individual receives compensation for a wrong or injury suffered to his or her person or in his or his occupation or profession.

Whilst at paragraph 214 of TR 95/35 it states that the terms 'to his or her person' and 'in his or her vocation' should be read as widely as possible, the intention of the 'wide' interpretation was to cover the full range of employment and professional type claims; for example to include claims for discrimination, harassment, victimisation, wrongful dismissal, and defamation as well as personal injury or illness.

The compensation amount was not a payment for any wrong, injury or illness that you have suffered personally as per the definition in paragraphs 118-37(1)(a) and (b) of the ITAA. The compensation amount was paid to you and your spouse by Z to reflect all of the Z's different motivations.

Question 2

Summary

Your half share of the payment that you received from Z is considered additional capital proceeds.

Detailed reasoning

Capital gains tax (CGT) consequences - equity component

The general CGT provisions are set out in Part 3-1 of the 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 reverences 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 X. You and your spouse applied for and were granted a margin loan from the Y. You also applied for a fixed rate interest only home loan with the Z of a certain amount, secured against your home for the purpose of investing in X. This enabled you to invest a further amount in X.

The margin loan and Z home loan were used to acquire various stocks and investments. It may have included units in a X branded index fund for which the responsible entity was the Y or one of its related bodies.

Some time later Y determined that you and your spouse's historical current loan to security ratio had exceeded its historical margin call loan-to-security ratio. Y did not sell your investments until after it determined that your loan had exceeded its loan to security ratio.

Either, you and your spouse or through your lawyers you and your spouse have made a claim against Z for compensation concerning the circumstances surrounding the loss that you and your spouse may have suffered as a result of your investment with X. You and your spouse were made an offer by the Z and details were contained in a letter from Z via their legal representatives. The Z offer was to pay you and your spouse compensation of a certain amount conditional upon you and your spouse entering into a Deed of Settlement with Z.

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 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.

Note: As the compensation amount is considered additional capital proceeds you will need to amend any capital gain or capital loss made in relation to the CGT events that happened when your investments were sold by the bank or its related body corporate. You will need to apportion the additional capital proceeds, firstly in line with your ownership interest in the original investments sold by X, (you jointly owned the investments with your spouse) and then secondly on a pro-rata basis to every CGT event that happened.

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