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Edited version of your written advice
Authorisation Number: 1051273592530
Date of advice: 24 August 2017
Ruling
Subject: Compensation payment
Question 1
Is the lump sum payment you received assessable as ordinary income?
Answer
No.
Question 2
Are there any capital gains tax (CGT) consequences as a result of the lump sum payment you received?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2017
The scheme commences on:
1 July 2016
Relevant facts and circumstances
After a review, you received a compensation offer in regards to bad financial planning advice in relation to your superannuation account.
The compensation amount was aimed to place you in the financial position you would have been in had you received appropriate advice. The amount of the compensation made to you was the difference between the performance of your actual investment portfolio and the performance of the appropriate advice portfolio plus a separate amount for interest.
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
Reasons for decision
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).
Based on case law, it can be said that ordinary income generally includes receipts that:
● are earned
● are expected
● are relied upon, and
● have an element of periodicity, recurrence or regularity.
In your situation the payment that you will receive is in respect of a review conducted because you had been provided bad financial planning advice which caused your superannuation account to not perform as well as it should have. The payment was 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.
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.
Capital gains
Taxation Ruling TR 95/35 considers the treatment of compensation payments and the capital gains tax (CGT) consequences for the recipient. TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be:
● an underlying asset;
● a right to seek compensation; or
● a notional asset in terms of section 104-155 of the ITAA 1997.
In determining which the most relevant asset is, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt.
Paragraph 3 of TR 95/35 provides definitions for some of the key terms used in the ruling. The definitions provide that 'permanent damage or reduction in value' does not mean everlasting damage or reduced value, but refers to damage or reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.
'Underlying asset' is defined as 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 (TR 95/35).
Paragraphs 6 to 9 of TR 95/35 provide the following guidelines on the treatment of compensation for permanent damage to or permanent reduction in the value of the underlying asset:
If an amount of compensation is received by the taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of the underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset.
Accordingly, the total acquisition costs of the post-CGT asset should be reduced in terms of section 110-25 of the ITAA 1997 by the amount of the compensation. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset.
The adjustment of the total acquisition costs effectively reduces those costs by the amount of the recoupment as if those costs had not been incurred.
Compensation received by a taxpayer has no CGT consequences if the underlying asset which has suffered permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985 or is any other exempt CGT asset.
In your case, the underlying asset is your right to a capital amount payable out of a superannuation fund in the form. As a result of the actions of your financial advisor, there was a reduction in the value of your superannuation account. 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;
● a right to an allowance, annuity or capital amount payable out of a superannuation fund
● a right to an asset of such a fund
● a right to any part of such an allowance, annuity, capital amount or asset.
The compensation you will receive is 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.
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