Edited version of your written advice

Authorisation Number: 1051285330095

Date of advice: 13 October 2017

Ruling

Subject: Compensation payment

Question 1

Is the interest received assessable as ordinary income?

Answer

Yes

Question 2

Are the amounts received as refund of fees an assessable recoupment?

Answer

Yes

Question 3

Are the amounts received which represent the underperformance of your investments assessable under the Capital Gains tax provisions?

Answers

Yes.

This ruling applies for the following period

Year ending 30 June 2017

The scheme commences on

1 July 2016

Relevant facts and circumstances

You received financial advice in regard to your investment from a bank.

The bank wrote to you and offered to pay compensation in respect of inappropriate advice.

The compensation was made up of three components: an amount for reimbursement of advice fees which may have been incorrectly charged at the time, an amount for losses due to gearing recommendations that were potentially inappropriate at the time, and an amount of interest calculated based on the first two amounts.

You have apportioned the adviser fees that you paid and claimed as deductions in the year of payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 Subsection 20-20

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 108-5

Reasons for decision

Summary

The amount received which represents the underperformance of your investments 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.

The amount received as refunds of your adviser fees is an assessable recoupment.

The interest received is assessable as ordinary income.

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.

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.

The refund of fees and the payment representing the underperformance of your portfolio are not regarded as ordinary income under section 6-5 of the ITAA 1997.

Recoupment

Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss of outgoing is an assessable recoupment if:

● you received the amount by way of insurance or indemnity, and

● you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act.

In your case you received an amount for the refund of the advisor fees you had incurred and previously claimed as deductions. You are therefore required to include these as an assessable recoupment.

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 seek compensation.

In this case we consider that the amounts received which represent the underperformances of your investments relate 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. CGT event C2 happened when you accepted the offer of compensation.

Please note that if it has been 12 months or more since the underperforming advice has been received, then you may be able to reduce the capital gain by 50%.

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