Edited version of private ruling

Authorisation Number: 1011696168796

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Ruling

Subject: lump sum due to negligence

Question

Are you assessable on lump sum received for negligent financial advice?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

Previously you engaged the services of a financial advisor to provide you with professional financial investment advice. Relying on that advice you borrowed a sum of money and invested it.

You paid fees to the financial advisors for their advice and incurred interest expenses in relation to the loan.

The value of the portfolio decreased significantly.

It is unlikely that your investments will ever recover from their current position.

You engaged an unrelated financial advisor to review your investment portfolio and the advice and recommendations of advisors you had originally retained.

The review brought to your attention a number of issues which indicated that your portfolio was exposed to a higher level of risk than the investment strategy you instructed you wished to adopt.

You contend that the advice from the financial advisors was negligent in that they

· did not recommend that you diversify your investment portfolio; and

· failed to advise you of the risks associated with a non-diversified investment portfolio.

You engaged the services of a law firm in order to seek compensation for your loss

You entered into Deed of Release and Settlement with Focused Life Solutions. You received a sum of $25,000 in settlement of your claim.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Reasons for decision

Sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income and statutory income derived directly or indirectly from all sources during the income year. Generally, if an amount received is not considered ordinary income or statutory income, it is not included in assessable income.

Ordinary income

The term ordinary income is not defined in the income tax legislation. However the courts have identified a number of factors which indicate whether the amount has the character of income, according to ordinary concepts. These factors include:

· Whether the payment is the result of any employment, services rendered, or any business or business like activity carried on; and 

· The form of the receipt, that is, whether the payment is received periodically or as a lump sum.

Ordinary income therefore frequently contains the elements of periodicity, recurrence and regularity. Consequently, payments regularly and periodically received in connection with services provided by a person are considered to be income.

Statutory income

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 and are also included in assessable income.

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

In your case, the lump sum is for financial loss or loss of earnings.

The lump sum compensation amount you are seeking is a payment for loss of income and so is fully assessable when received, under subsection 6-5(2) of the ITAA 1997.

As the compensation payment is assessable income, any legal expenses incurred in earning that income are deductible under section 8-1 of the ITAA 1997.

There are no specific provisions within the legislation that assess a payment made in relation to negligent financial advice. Therefore, it is only necessary to consider if the payment should be included as `ordinary income'.

In your case the payment you received is a once off lump sum payment. It is not a reward for any employment services, nor is it connected with any business activity of yours. In these circumstances none of the factors which would be associated with `ordinary income' are present, and as such no part of the payment will be included in your assessable income.

Please note,

There may be CGT consequences associated with the payment, for example, cost base adjustments of the portfolio assets. The CGT consequences have not been addressed in this ruling.