Edited version of private advice

Authorisation Number: 1052385506621

Date of advice: 16 April 2025

Ruling

Subject: Compensation payment - lump sum

Issue 1

Question 1

Are the determination amounts and interest components of the compensation payment made under the Compensation Scheme of Last Resort (CSLR) to the self-managed superannuation fund (the Fund), treated as concessional or non-concessional contributions under sections 291-25 and 292-95 of the Income Tax assessment Act 1997 (ITAA 1997) respectively?

Answer 1

No.

Issue 2

Question 2

Is the determination amount of the compensation payment assessable as ordinary income?

Answer 2

No.

Question 3

Is the determination amount of the compensation payment subject to CGT?

Answer 3

Yes.

Question 4

Does the exemption provided under section 118-305 of the ITAA 1997 apply?

Answer 4

No.

This ruling applies for the following period:

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

From DDMMYYYY, Member A and Member B were the trustees and members of their self-managed superannuation fund ('the Fund').

The Fund was a client of a financial advisor ('the Financial Firm') from MMYYYY to DDMMYYYY.

The Fund sought compensation for poor financial advice received for the period MMYYYY to DDMMYYYY by complaining to the Australian Financial Complaints Authority (AFCA).

On DDMMYYYY, AFCA issued a determination letter, which states that the financial advice was not appropriate and outlined the required compensation for poor advice received.

AFCA considered that appropriate advice would have led to greater investment diversification providing lower exposure to market volatility and lower risk of capital loss.

AFCA calculated the loss for each member separately for the period DDMMYYYY to DDMMYYYY using a 'but for' analysis to determine how much better off each member would have been if appropriate advice had been received. They compared the actual value of the net assets of the Fund at the end date to what the value of the net assets of the Fund would have been at the end date if appropriate advice had been provided. They ordered the financial firm to pay compensation to the Fund.

Member B's loss was AU $X.

Member A's loss was AU $X.

The Financial Firm did not pay any compensation to the Fund.

The Fund applied for compensation through the Compensation Scheme of Last Resort (CSLR).

CSLR offers compensation payments where complainants have been unable to obtain compensation from the financial firm. Compensation payments from CSLR are capped at $150,000.00 per individual.

On DDMMYYYY, Member A received a letter of offer from CSLR, consisting of a determination amount and an interest component as follows:

AU $X determination amount

AU $X interest component

AU $X total compensation amount

The interest component was calculated for period DDMMYYYY to DDMMYYYY. The interest amount paid by CSLR to the Fund increased between the letter date and payment date, so the total compensation amount was as follows:

AU $X was paid directly to the Fund on DDMMYYYY.

On DDMMYYYY, Member B received a letter of offer from CSLR, consisting of a determination amount and an interest component as follows:

AU $X determination amount

AU $X interest amount

AU $X total compensation amount

The money was paid directly to the Fund on DDMMYYYY.

Assumptions

The Fund did not claim deductions in their Self-Managed Super Fund Annual Reports for the inappropriate advice.

The Fund does not still own any investments from when they received inappropriate advice.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 291-25

Income Tax Assessment Act 1997 section 292-90

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 118-305

Income Tax Assessment Act 1997 paragraph 118-305(2)(a)

Reasons for decision

Issue 1

Question 1

Are the determination amounts and interest components of the compensation payment made under the Compensation Scheme of Last Resort (CSLR) to the self-managed superannuation fund (the Fund), treated as concessional or non-concessional contributions under sections 291-25 and 292-95 of the Income Tax assessment Act 1997 (ITAA 1997) respectively?

Summary

The determination amounts and interest components of the compensation payment made to the Fund are neither concessional nor non-concessional contributions. The compensation payment does not count towards the Members' contribution caps.

Detailed reasoning

1.              An amount that is received into a superannuation fund will typically be either from income that has not yet been taxed, which are concessional contributions under section 291-25 of the ITAA 1997, or from income that has already been taxed, which are non-concessional contributions under section 292-90 of the ITAA 1997.

2.              The compensation payment is neither a concessional contribution nor a non-concessional contribution.

3.              In paragraph 4 Taxation Ruling TR 2010/1DC2 - Income tax: superannuation contributions (TR 2010/1DC2), the ATO defines the ordinary meaning of contribution in the context of superannuation, 'a contribution is anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund or all of the members in general.'

4.              The compensation payment did not increase the capital of the Fund as the payment replaced earnings that would have existed within the Fund if the fund had received appropriate financial advice.

5.              In paragraph 133 of TR 2010/1DC2, 'we consider that an increase in the fund's capital due to income, profits and gains arising from the use of the fund's existing capital will not, generally, be derived from someone whose purpose is to benefit one or more members of the fund.'

6.              The determination letter from AFCA states that it was the Fund that engaged the financial firm's services, not the trustees at an individual level.

7.              As the Fund held the contract with the Financial Firm, any compensation payable was payable to the Fund because it was the entity that suffered the loss after receiving inappropriate financial advice under the contract.

8.              In paragraph 136 of TR 2010/1DC2, the ATO considers 'a company pays a dividend to provide a return to its shareholders, not to benefit the members of a particular shareholder that happens to be a superannuation provider'

9.              The compensation payment was received directly from the CSLR to the Fund and it is not a contribution. The CSLR's purpose was not to benefit one or more members; the purpose was to compensate the Fund.

ATO view documents

Taxation Ruling TR 2010/1DC2 Income tax: superannuation contributions

Issue 2

Questions

Question 2

Is the determination amount of the compensation payment assessable as ordinary income?

Question 3

Is the determination amount of the compensation payment subject to CGT?

Question 4

Does the exemption provided under section 118-305 of the Income Tax Assessment Act 1997 apply?

Summary

The determination amount of the compensation payment is not assessable as ordinary income, however the determination amount of the compensation payment is subject to capital gains tax. An exemption from CGT does not apply in this circumstance.

Detailed reasoning

An amount received that is ordinary income is included in assessable income under section 6-5 of the ITAA 1997 whereas an amount that is capital in nature is generally subject to CGT under Part 3-1 of the ITAA 1997.

The ATO's view on when a lump sum compensation payment is assessable as ordinary income is contained in Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? For compensation payments that are capital, rather than income, in nature, the CGT consequences are discussed in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts.

The ATO has applied the general principles set out in those 2 documents to the situation where a super fund receives compensation for deficient financial advice. The ATO's position on that situation is set out in our fact sheet Deficient financial advice which can be accessed on our webpage ato.gov.au by searching for 'QC 59708'. It advises that:

•                The compensation is subject to CGT rather than being assessable as ordinary income.

•                If the compensation received relates to a loss of value on an investment in respect of a capital asset that the super fund still owns, the super fund must reduce either its cost base or reduced cost base by the amount of compensation.

•                If the compensation amount relates to a loss of value on an investment in respect of a capital asset that the super fund has disposed of, the payment of compensation to the super fund would constitute additional capital proceeds in respect of the relevant CGT event. The super fund would need to amend its income tax return where the disposal happened in a previous income year.

•                If the trustee determines that the compensation amount cannot be attributed to any particular asset(s) of the fund, the compensation amount will be capital proceeds for the ending of the right to seek compensation.

•                The super fund may be eligible to apply the CGT discount if the asset has been held for 12 months or longer.

Having regard to the above for this case, the determination amount is subject to CGT rather than being assessable as ordinary income.

Although in this case the compensation was paid by CSLR rather than the financial service provider due to the super fund not being able to obtain payment from the financial service provider, this is not considered to alter the tax consequences.

Section 118-305 exemption

Section 118-305 of the ITAA 1997 provides a CGT exemption to disregard a capital gain or loss for a CGT event happening in relation to superannuation in certain circumstances.

However, paragraph 118-305(2)(a) of the ITAA 1997 states that the exemption is not available to the trustee of a super fund where the CGT event happens in relation to a CGT asset of the fund.

In this case, the compensation was received by the trustees of the super fund for deficient advice provided to the fund in relation to investments held by the fund. From the documentation provided it is not completely clear whether the compensation can be attributed to any particular asset(s) that the fund held or alternatively, the relevant CGT asset was the fund's right to seek compensation. In any case, the CGT event would happen to a CGT asset of the fund whether it was particular investment assets or the right to seek compensation. Consequently, paragraph 118-305(2)(a) of the ITAA 1997 applies to deny an exemption under section 118-305 of the ITAA 1997 in this case.

ATO view documents

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable?

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts.

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