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Edited version of your written advice
Authorisation Number: 1012743534256
Ruling
Subject: Compensation
Question 1
Will a capital gains tax (CGT) event occur in the 2013-14 financial year in relation to the compensation payment?
Answer
No.
Question 2
Is the compensation payment considered additional capital proceeds that relate to the underlying investments?
Answer
Yes.
This ruling applies for the following period
Year ended 30 June 2008
Year ended 30 June 2009
Year ended 30 June 2010
Year ended 30 June 2011
Year ended 30 June 2012
Year ended 30 June 2013
Year ended 30 June 2014
The scheme commences on
1 July 2007
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 Deed of Release.
You and your spouse received compensation following a dispute with a financial advisor.
This was awarded as a result of poor financial advice provided by the advisor in relation to a tailored investment strategy.
You and your spouse incurred costs relating to loans utilised to fund the investment strategy as well as losses in the market value of the investments.
You and your spouse made capital losses through the years ended 30 June 2008 to 30 June 2013.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 102-20
Income Tax Assessment Act 1997 section 104-10
Income Tax Assessment Act 1997 section 108-5
Reasons for decision
CGT is the tax you pay on certain gains you make. Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you make a capital gain or capital loss as a result of a CGT event happening. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset. 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 'look-through' approach is 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. It is also referred to in this Ruling as the underlying asset approach.
'Underlying asset' is also defined in paragraph 3 of TR 95/35 as:
The underlying asset is 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.
The transaction which generated the compensation receipt is the alleged inappropriate advice provided by the financial advisor which caused you to take out additional loans and purchase interests in a managed fund. These investments were later sold which resulted in capital losses. Applying the look through approach, the most relevant asset to which the compensation most directly related is the investments.
Treatment of compensation if a CGT event occurs (disposal of the asset)
Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. units) is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs.
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.
In some cases, you may receive additional 'capital proceeds' after the CGT event has occurred, including in a later financial year. For example, compensation may be offered and accepted after the CGT event has occurred, or litigation may result in compensation for losses arising from an investor's former investments. In this situation, your receipts from compensation payments can reasonably be treated as additional 'capital proceeds' for the previous redemption of your investments. This means that the capital gain or capital loss made for the previous CGT event needs to be recalculated. The calculation will be for the CGT event that occurred in that tax year and not in the year of income the extra proceeds were obtained.
Application to your circumstances
In this case, you and your spouse were clients of a financial advisor. You and your spouse applied for and were granted a margin loan which was used to acquire various investments.
You and your spouse made a claim against the advisor for compensation for investment losses. It is considered that the compensation received had a direct and substantial link with the underlying asset (the investments). Accordingly, 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 of compensation 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.
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