Edited version of your written advice

Authorisation Number: 1013104803220

Date of advice: 10 October 2016

Ruling

Subject: Capital gain - disposal of right to seek compensation

Question

Is the payment of a settlement to you pursuant to a deed of settlement assessable as a capital gain or loss under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period

Financial year ending 30 June 20YY

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You were a client of a company. An authorised representative of the company misappropriated monies from you.

You entered into a deed of settlement where they agreed to pay an amount (Settlement Sum) in consideration of the release of the company. You received the Settlement Sum in financial year ending 30 June 20YY as a lump sum.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subdivision 110-A

Reasons for decision

A payment or other benefit received by a taxpayer is assessable income if it is:

a) income in the ordinary sense of the word (ordinary income); or

b) an amount or benefit that through the operation of the provisions of the tax law is included in assessable income (statutory income).

Ordinary income

Subsection 6-5(1) of the ITAA 1997 provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). The legislation does not provide specific guidance on the meaning of income according to ordinary concepts, however, a substantial body of case law exists which identifies likely characteristics.

Characteristics of ordinary income that have evolved from case law include receipts that:

a) are periodical, regular or recurrent;

b) are relied upon by the recipient for their regular expenditure and paid to them for that purpose; and

c) are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The payment is not assessable as ordinary income in your hands as it is not a product in a real sense of any employment, services or business carried on by you and it does not have the characteristics normally associated with ordinary income such as periodicity and reliance on the payments to meet regular expenditure.

The Settlement Sum received by you is capital in nature and does not constitute ordinary income under subsection 6-5(1) of the ITAA 1997.

Statutory income - capital gains

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes a net capital gain. A capital gain or loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

A CGT asset is defined in paragraph 108-5(1)(b) of the ITAA 1997 as including a legal or equitable right that is not property. Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation.

Paragraph 70 of TR 95/35 provides that in determining the most relevant asset for which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the payment.

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.

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

CGT event C2

CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. A C2 event can apply where there is a release or discharge of a right to sue on the settlement of a legal dispute (See Re Coshott and FCT [2014] AATA 622).

Any capital gain or loss arising on the disposal of that right is calculated using the cost base of that right. The cost base of the right to seek compensation is determined in accordance with the provisions of subdivision 110-A of the ITAA 1997. Expenditure or an outgoing forms part of the cost base of a right to seek compensation if there is a direct and substantial link between the expenditure or outgoing and the arising of the right to seek compensation.

Application to your circumstances

In this case we consider the compensation relates to the disposal of your right to seek compensation. The right to seek compensation was acquired at the time of the compensable wrong or injury and includes all the rights arising during the process of pursuing the compensation claim. A CGT event occurred when you entered into the settlement.

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