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Edited version of your written advice

Authorisation Number: 1012763245323

Ruling

Subject: Compensation - other

Question 1

Is the compensation payment you received for the settlement of a class action brought against X Company, included in your assessable income as ordinary income or a net capital gain?

Answer

No

Question 2

Should the cost base of the shares in question be reduced by the amount of compensation received for paying excessive consideration for the shares?

Answer

Yes

Question 3

Should the capital loss you incurred on the disposal of the shares for the 20XX-XX financial year be reduced by the amount of compensation received in respect of the shares?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

In 20XX, a proceeding against X Company was filed seeking to recover losses suffered by shareholders as a result of alleged material non-disclosures and misleading conduct.

The proceeding was brought on behalf of X Company shareholders who acquired an interest in X Company securities between 20XX to 20XX (inclusive) and who suffered loss as a result of the alleged misconduct.

You were a shareholder as described above and a participant in a class action taken against X Company.

You purchased X shares in X Company in 20XX

The statement of claim in relation to the proceeding stated that you suffered loss and damage by the artificially inflated trading price.

As a consequence of X Company's conduct the trading price of its shares on the ASX was artificially inflated during the Relevant Period and that persons who purchased X Company shares during this period suffered loss and damage

A settlement was approved by the court in 20XX.

As a result you received a compensation payment of $X.

You sold your shares in 20XX.

As a result of the sale of your shares in X Company, you made a capital loss in the 20XX-XX financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 110-45(3)

Reasons for decision

Summary

The compensation payment you received is considered a capital receipt and not ordinary income. This is because the compensation payment was paid in relation to a capital asset, and was not to compensate for a loss of income.

We consider that the payment is compensation for paying an excessive amount for an asset (the shares). Therefore, the compensation payment is treated as a recoupment of the cost base of the shares.

Detailed reasoning

Ordinary income

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:

The compensation you received 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 acquisition of the shares at an inflated price. The compensation was paid in relation to a capital asset and accordingly, 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.

Capital gains tax provisions

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 transaction which generated the compensation receipt is the acquisition of the shares. Applying the 'look-through' approach to the acquisition of shares, the most relevant asset to which the compensation most directly relates is the shares in X Company. The compensation was for the acquisition of the shares at an inflated price.

Paragraph 10 of TR 95/35 provides that: 

Therefore, the cost base of the shares should be reduced by the amount of the compensation.

As you have already disposed of the x Company shares in the 20XX-XX financial year and reported a capital loss on the disposal of the shares, you will need to adjust the amount of capital losses you have available to carry forward for future years.

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