| Disclaimer This edited version has been archived due to the length of time since original publication.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: 1051416841589
Date of advice: 14 February 2019
Ruling
Subject: Compensation payment
Question 1
Is the Interest Compensation you received of as part of the compensation payment assessable as ordinary income?
Answer
Yes
Question 2
Is the Investment Compensation you received as part of the compensation payment assessable under the capital gains tax (CGT) provisions?
Answer
Yes
Question 3
Is the capital gain or loss on the Investment Compensation disregarded under section 118-305 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
Yes
This ruling applies for the following period:
Financial year ending 30 June 20XX
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
During the Investment Period, you had an interest in a superannuation fund.
You were advised by the fund’s advisors to invest your balance into an aggressive investment strategy with a high growth return (Advice).
You acted on the Advice and, as a result, suffered losses to your interest in the fund.
You were offered compensation in respect of the Advice, based on the difference between your actual balance and what your balance would have been at the end of the Investment Period had you received appropriate advice.
You were paid a settlement sum.
The settlement sum comprised of:
a) an amount representing the difference between the performance of your actual investment portfolio and the performance of your portfolio had you received appropriate advice (Investment Compensation), and
b) an separate amount of interest (Interest Compensation).
The settlement sum was received in the year ending 30 June 20XX.
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 Section 118-305
Reasons for Decision
Summary
The Interest Compensation component of the Settlement Sum is assessable as ordinary income. The Investment Compensation component of the Settlement Sum is assessable under the capital gains tax provisions however the gain is disregarded under section 118-305(1) of the ITAA 1997.
Detailed reasoning
Interest Compensation
Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts. This ‘ordinary income’ includes amongst other things, income from salary and wages and interest.
Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts deals with the tax treatment of compensation receipts. Paragraph 26 of this ruling specifically deals with the treatment of interest awarded as a part of a compensation amount:
Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions. If the taxpayer receives an undissected lump sum compensation amount and the interest cannot be separately identified and segregated out of that receipt, no part of that receipt can be said to represent interest.
In your case, you received the Settlement Sum in relation to inappropriate financial advice. The Settlement Sum was not an undissected lump sum as you were provided with a breakdown showing the components of the compensation payment and how this was calculated. The Interest Compensation was separately identified as being interest. Therefore the Interest Compensation amount is assessable as ordinary income.
Investment Compensation
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 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.
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.
In your case, the relevant underlying asset is your right to a capital amount payable out of the superannuation fund.
As a result of the inappropriate advice, there has been a permanent reduction in value to the underlying asset which gave right to the right to seek compensation from the person or entity that caused the loss in value to that asset.
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.
However, 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 Investment Compensation you received is in relation to the permanent reduction in value of your right to a capital amount payable out the superannuation fund. Therefore, any capital gain or loss you made is disregarded under section 118-305 of the ITAA 1997.
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).
