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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1013102415731

Date of advice: 5 October 2016

Ruling

Subject: Compensation payments

Question 1

Is the lump sum payment you received assessable to you as ordinary income?

Answer

No.

Question 2

Is the capital gain made as a result of the lump sum payment disregarded?

Answer

Yes.

Question 3.

If you transfer the lump sum payment you received as a compensation payment in into the Super Fund is it a non-concessional contribution?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 20ZZ

The scheme commenced on

1 July 20YY

Relevant facts and circumstances

You set up the Fund in conjunction with your spouse.

The Fund is a self-managed superannuation fund.

The trustees and member of the Fund are yourself, your spouse and another person.

In 20WW on the advice of a Financial Advisor, you relinquished your pension in another fund and transferred the funds into the Fund.

Your spouse rolled over the superannuation in managed funds they had accumulated during their working life into the Fund.

The Financial Advisor established the Fund and provided on-going financial investment advice and other advice.

In 20XX the trustees of the Fund lodged a complaint eventually with the Relevant Ombudsman Service Limited (OS) to the effect that the investment advice and other advice provided by the Financial Advisor had been unsatisfactory.

The Complaint was considered by OS and OS recommended a settlement of an amount of money to you (the Applicant) in your capacity as an individual and not as a trustee or member of the Fund.

You have provided two draft settlement deeds which you state were entered into between the Applicants and the Financial Advisor. The deed of release discharges the Financial Advisor from all suits, claims, demands, actions, causes of action, losses, liabilities, damages, costs and expenses in relation to the settlement sum.

You have confirmed that the final settlement and payments were as per the Drafts forwarded to the ATO in the information provided with respect to your application.

You have advised that the compensation payment was made into newly set up bank account.

You have provided documentation to support the claim that the payment was for compensation due to losses suffered in the Fund.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 118-305

Income Tax Assessment Act 1997 section 292-90

Reasons for decision

Summary

The lump sum payment you received in respect of the loss incurred by the superannuation fund investments is not ordinary income. Additionally, as the lump sum payment was made in respect of the permanent reduction in value of your right to a capital amount payable from your superannuation fund, any capital gain or loss made from the payment is disregarded.

Subject to satisfying a work test, if you transfer the lump sum payment you received as a compensation payment into the Fund, it will be considered a non-concessional contribution and subject to the relevant caps

Detailed Reasoning

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three 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:

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, 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.

The compensation payment you received is not earned by you as it does not relate to services performed. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from a relationship to personal services performed.

The compensation payment relates to your superannuation investments and is capital in nature. Accordingly, the payment is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Statutory income - capital gains

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts states that the particular asset for which compensation has been received may be:

Why the payment was made is an important factor in determining whether an asset has been disposed of for capital gains tax purposes. 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.

As outlined in the ruling, the Commissioner adopts an "underlying asset" approach to determine the asset to which the compensation amount is most directly related. In concluding that the underlying asset is the most relevant asset to which an amount of compensation relates, a person must be able to show that the compensation receipt has a direct and substantial link with the underlying asset. If an asset has not been disposed of and has not been permanently damaged or permanently reduced in value by the happening or event which generated the amount of compensation, the taxpayer is not able to demonstrate that link. It follows that the compensation cannot be directly related to that asset. In those cases, the most relevant asset may be the right to seek compensation, or the notional asset.

Paragraph 3 of TR 95/35 states that permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

In your case, the underlying asset is your right to a capital amount payable out of a superannuation fund. As a result of the actions of your financial advisor, there was a reduction in the value of your superannuation fund.

Paragraph 9 of TR 95/35 states that compensation received has no CGT consequences if the underlying asset which has suffered permanent damage or a permanent reduction in value was acquired before 20 September 1985 or is any other exempt CGT asset.

The value of your superannuation will always be lower than what it could have been had the loss not occurred. Therefore, it is considered that there has been a permanent reduction in value of your right to a capital amount payable out of your superannuation fund.

Subsection 118-305(1) of the ITAA 1997 disregards any capital gain or loss if you make it from a CGT event in relation to any of the following;

The compensation you received was in relation to the permanent reduction in value of your right to a capital amount payable out of a superannuation fund. Therefore, any capital gain or loss you made is disregarded under section 118-305 of the ITAA 1997.

Compensation amount transferred to the Fund

Work test

As you are in the 65-74 years old age bracket, you need to satisfy a work test in each financial year that a voluntary super contribution is made to your fund.

The work test requires you to be gainfully employed. To satisfy the work test, you must work at least 40 hours during a consecutive 30-day period each financial year in which the contributions are made

If you satisfy the work test you will be able to contribute the compensation payment to the Fund.

Non-concessional contributions

Non-concessional contributions are defined in section 292-90 of the ITAA 1997 and include certain contributions and amounts that are not included in the assessable income of a complying superannuation fund. Generally, non-concessional contributions include personal contributions for which an income tax deduction is not claimed, spouse contributions and excess concessional contributions.

Accordingly, any non-concessional contributions that you make to the Fund would not be included in the assessable income of the Fund.

Non-concessional contributions made to a complying superannuation fund are subject to an annual cap. In accordance with section 292-80 of the ITAA 1997, non-concessional contributions in excess of the relevant cap amount for the financial year, are subject to excess non-concessional contributions tax at the rate of 47% (section 5 the Superannuation (Excess Non-Concessional Contributions Tax) Act 2007).

The non-concessional cap is $180,000 for 20YY-ZZ.

If you were intending to transfer any of the compensation you received into the Fund you would have to give regard to the contribution caps requirement.

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