Edited version of your written advice

Authorisation Number: 1051246868810

Date of advice: 12 July 2017

Ruling

Subject: Financial compensation

Question 1

Is the compensation payment exempt from tax?

Answer

No

Question 2

Is the interest component assessable as ordinary income?

Answer

Yes

Question 3

Is the investment compensation assessable under Capital Gains Tax provisions?

Answer

Yes

Question 4

Are you entitled to a 50% discount on the Capital Gain?

Answer

Yes

This ruling applies for the following period

Year ending 30 June 2017

The scheme commenced on

1 July 2016

Relevant facts and circumstances

Over 9 years ago, you entered into an agreement with a financial planner to provide you with financial advice in relation to superannuation rollover and insurance replacement.

In 2017, after a review of the financial planner’s records, their former employer offered you a compensation payment, as the advice provided by the financial planner did not meet agreed service expectations.

The Financial Planner had determined the offer of compensation based on the following components:

a) an amount representing interest compensation at X% per annum.

b) an amount representing the disadvantage you experienced as a result of being invested differently from your agreed risk profile.

In order to receive the compensation payment you signed and returned the deeds of settlement and release.

The refund was paid directly to your personal account.

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 307-5

Reasons for decision

Summary

The interest received is assessable as ordinary income.

The amount received which represents the underperformance of the investment is not regarded as ordinary assessable income. This amount is considered to be capital in nature and assessable under the capital gains tax provisions as capital proceeds from your right to seek compensation.

Superannuation benefit

A superannuation benefit includes a superannuation fund payment made to you from a superannuation fund because you are a fund member. When it is paid to you as a lump sum, this is referred to as a superannuation lump sum payment.

In this instance, the lump sum payment will be made from Financial Planning and not from your superannuation fund.

Accordingly, the payment does not meet the definition of a superannuation fund payment set out in Income Tax Assessment Act 1997 section 307-5.

As the compensation lump sum payment was not made out of the superannuation fund it is not an exempt superannuation lump sum payment.

Interest received

Interest income is regarded as ordinary income and therefore assessable under subsection 6-5(2) of the ITAA 1997.

Compensation payments which substitute income are regarded as ordinary income.

Therefore the compensation for lost interest is regarded as ordinary assessable income.

Investment compensation

Summary

The investment compensation payment is not regarded as ordinary assessable income.

The compensation payment received is considered to be capital in nature and assessable under the capital gains tax provisions as capital proceeds from your right to seek compensation.

Detailed Reasoning

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 Income Tax Assessment Act 1997 (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 acceptance of the offer of compensation was to resolve the dispute between the Financial Planner and you. You agreed to release the bank in consideration of the refund. We consider this to be compensation not related to income lost but paid in consideration of the releases contained in the offer of compensation.

Accordingly, the investment compensation 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 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).

In this case we consider that the investment compensation you received 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. CGT event C2 happened when you accepted the offer of compensation.

Please note that as it has been 12 months or more since the previous underperforming advice has been received, then you can reduce the capital gain by 50%.

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