Edited version of private advice

Authorisation Number: 1051636656395

Date of advice: 16 March 2020

Ruling

Subject: Compensation - investment loan - loan not changed from interest only to principal and interest

Question 1

Is the refund of excess interest of $X you paid on your loan included in your assessable income?

Answer

Yes, to the extent that deductions were claimed for the interest.

Question 2

Did CGT event C2 happen when the financial institution credited your loan account due to them not switching your loan from interest only to principal and interest repayments?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2019

The scheme commenced on:

16 August 2007

Relevant facts and circumstances

You have a loan with a financial institution. The loan was used to finance the acquisition of a rental property and a motor vehicle.

The interest only period on your loan expired on XX August 20XX at which point you had the option to extend the loan term and your repayments should have switched to principal and interest.

Due to an error by the financial institution this did not happen.

As you were not reducing the principal amount of your loan you paid excess interest.

In a letter dated XX May 20XX, the financial institution advised you that they were:

·        refunding you the excess interest of $X you had paid

·        providing you with a lump sum payment of $X on account of future interest on principal not reduced because your repayment type did not switch to principal and interest

·        switching your repayments to principal and interest, and

·        extending your loan term to the full term available under your loan contract.

The total amount of $X was paid to your loan account.

You claimed deductions for the interest paid on your investment loan to the extent that the loan was used for income producing purposes.

You are an Australian resident for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 116-20(1)

Reasons for decision

Assessable recoupments

Subdivision 20-A of the Income Tax Assessment Act 1997 (ITAA 1997) provides that certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Subsection 20-20(1) of the ITAA 1997 provides that an amount is not an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside of Subdivision 20-A.

An amount received by way of insurance or indemnity is an assessable recoupment if it is paid for a deductible expense and the deduction can be claimed in the current year or in an earlier income year (subsection 20-20(2) of the ITAA 1997). [Current year means the income year for which you are working out your assessable income and deductions].

Capital gains

You make a capital gain or capital loss as a result of a capital gain (CGT) event happening (section 102-20 of the ITAA 1997). For most CGT events, your capital gain or loss is the difference between your capital proceeds and the cost base or reduced cost base of your CGT asset.

CGT event C2 happens when your ownership of an intangible CGT asset ends by cancellation, surrender, or release or similar means (subsection 104-25(1) of the ITAA 1997. The right to seek compensation is an intangible CGT asset.

The capital proceeds from a CGT event include the money you have received, or are entitled to receive, in respect of the happening of the CGT event (subsection 116-20(1) of the ITAA 1997).

Reducing capital gains if amount otherwise assessable - preventing double taxation

A capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act (outside of Part 3.1) includes an amount (for any income year) in your assessable income or exempt income (subsection 118-20(1) of the ITAA 1997).

Subsection 118-20(1) of the ITAA 1997 applies to an amount that, under a provision of this Act (outside of part 3.1), is included in your assessable income or exempt income in relation to a CGT asset as if it were so included because of the CGT event referred to in that subsection if the amount would also be taken into account in working out the amount of a capital gain you make (subsection 118-20(1A) of the ITAA 1997).

Treatment of settlement amounts if a CGT event happens (disposal of the asset)

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts and provides that in certain circumstances, it may be appropriate to adopt a 'look-through' approach to the transaction or arrangement which generates the compensation receipt to determine the most relevant asset in respect of which the compensation has been received.

Where the compensation amount is not received in relation to any underlying asset the most relevant asset is the right seek compensation.

Application to your circumstances

Assessable recoupments

The financial institution refunded you the excess interest costs of $X you paid on your loan, and you claimed deductions for them to the extent that the loan was used for income producing purposes. This amount is an assessable recoupment to the extent that you claimed deductions for the interest, and is included in your assessable income in the financial year ended 30 June 20XX.

Capital gains

The full amount paid to you as compensation relates to a failure by the financial institution, at the expiration of the interest only period of your loan, to provide you with the opportunity to extend the term of your loan and ensure that your repayments switched to principal and interest. As such, the amount you were entitled to receive is not in respect of any underlying asset and relates to the disposal of your right to seek compensation in relation to the financial institution's errors which resulted in the payment by you of excessive amounts of interest.

While the amount of compensation totalling $X has not been paid to you, it has been offset against the outstanding balance of your loan. You are considered to have disposed of your right to seek compensation in relation to the financial institution's errors when the compensation amount was credited to your loan account. CGT event C2 happened at that time.

The compensation amount of $X represents capital proceeds for the disposal of your right to seek compensation. It is unclear whether any amounts have been expended which would form part of the cost base or reduced cost base of your right to seek compensation. Your capital gain is the difference between those capital proceeds and your cost base to the extent to which there are such amounts.

Subsections 118-20(1) and 118-20(1A) of the ITAA 1997 will operate to reduce your capital gain to the extent that the compensation is an assessable recoupment (for excess interest costs as noted above). As a proportion of the excess interest costs is an assessable recoupment that is included in your assessable income under section 20-35, your capital gain will be reduced by this amount.

As such, your capital gain will be $X - ($X x income producing %) (if your cost base is $0).

Your right to seek compensation arose more than 12 months prior to the happening of the CGT event. Based on the information you have provided your capital gain will be a discount capital gain that can be reduced by the relevant discount percentage (in your case 50%) to calculate your net capital gain after the application of any capital losses and net capital losses from previous income years.

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