Edited version of your private ruling

Authorisation Number: 1012384745713

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Ruling

Subject: Compensation payment

Question 1

Is the payment you received for the final settlement of a complaint made against your financial advisor assessable income?

Answer

No.

Question 2

Is the payment you received for the final settlement of a complaint made against your financial advisor assessable as a capital gain?

Answer

No.

Question 3

Should the cost base of your investment portfolio be reduced by the amount of compensation received?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling dated

You lodged a complaint in regards to the provision of inadequate investment advice and inadequate service which led to both financial loss and emotional distress.

The financial advisor recommended you obtain a margin loan to give you more exposure to the share market.

The advice given by your financial advisor resulted in a loss to your personal investment portfolio.

You received an offer to settle the matter in full.

A Deed of Settlement was signed by both parties and a payment of $X was made in one lump sum payment.

You have no right to take any further action in relation to the matter.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5,

Income Tax Assessment Act 1997 section 102-20 and

Income Tax Assessment Act 1997 section 108-5.

Reasons for decision

Question 1

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Ordinary income has generally been held to include 3 categories, namely income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

· are earned;

· are expected;

· are relied upon; and

· have an element of periodicity, recurrence or regularity.

The compensation received by the taxpayer was not income from rendering personal services, income from property or income from carrying on a business. The payment is also a one off payment and thus it does not have an element of recurrence or regularity.

A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

You received compensation for the reduction in value of your personal investment portfolio. As you are not carrying on a share trading business, your investment portfolio is considered a capital asset.

Accordingly, as the compensation was paid in relation to your capital asset it is regarded as a capital receipt and not ordinary income. Therefore, the compensation payment is not assessable ordinary income under section 6-5 of the ITAA 1997.

Question 2 & 3

Capital gains tax (CGT) is the tax you pay on certain gains you make. Section 102-20 of the ITAA 1997 provides that you make a capital gain or capital loss as a result of a CGT event happening to an asset in which you have an ownership interest. Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property; or a legal or equitable right that is not property.

Taxation Ruling TR 95/35 discusses the capital gains tax implications for compensation receipts. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt.

The 'look-through' approach is defined in paragraph 3 of TR 95/35 to be:

…the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related.

The transaction which generated the compensation receipt was the acquisition of the margin loan. Applying the 'look-through' approach to the acquisition of the margin loan, the most relevant asset to which the compensation most directly relates is your share portfolio. The compensation was for the large loss to your personal investment portfolio.

Paragraph 6 of TR 95/35 provides that: 

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we considered that the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Therefore, the total acquisition costs of the asset should be reduced by the amount of the compensation. No capital gain or loss arises in respect of that asset until you actually dispose of the underlying asset.

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