Edited version of private ruling

Authorisation Number: 1011863300955

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Ruling

Subject: Lump sum payment - CGT event C2 - disposal of a right to seek compensation

Question 1:

Is the payment to you from the financial institution as a gesture of goodwill and without admission of any liability assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

Question 2:

Is the payment to you from the financial institution as a gesture of goodwill and without admission of any liability assessable as a capital gain under Parts 3-1 or 3-3 of the ITAA 1997?

Answer:

Yes.

This ruling applies for the following period:

1 July 2010 to 30 June 2011.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

You carry on a business. The business involves the sale of items. You sell a number of items over the internet and this includes via agents. The agents can be paid commissions.

You set up a facility with a financial institution to enable payment by credit card. There were numerous Terms and Conditions that accompanied the facility.

You had an agent overseas and you had sold several items. The payments had been made by credit cards and the financial institution had approved the transactions so you then shipped the items.

After some time the financial institution contacted you to say that the credit card details for one transaction provided by the agent overseas were from a stolen card. You advised that if that was the case then it may also be so for all of the transactions from overseas.

The financial institution then removed an amount from your account to cover the amounts charged to stolen credit cards.

You then made allegations to the financial institution that they had failed to warn you of the risks of internet transaction

After exhausting all channels with the financial institution you approached the Financial Ombudsman Service (FOS). The FOS advised both you and the financial institution that the financial institution had a case to answer.

During the 2010-11 financial year, the financial institution made an offer that acknowledged that merchant fraud could be very distressing. Without admission of any liability of the allegations made by you in your letter or the FOS complaint, the financial institution advised that they would make a one-off payment to you.

There were conditions of accepting the offer including the withdrawal of your complaint from FOS and the signing of a deed of release prepared by the financial institution.

As you did not want a lengthy legal dispute, you accepted the offer in the 2010-11 financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 paragraph 108-5(1)(b)

Income Tax Assessment Act 1997 Subdivision 110-A

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Summary

A capital gain will be included in your return for the year in which the CGT event occurred. The capital gain will be calculated by subtracting the cost base from the consideration received from the event.

Ordinary income

Subsection 6-5(1) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of ordinary income in income tax legislation, it is necessary to apply principles developed by the courts to the facts of a particular case.

Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

Characteristics of ordinary income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation, (1990) 170 CLR 124; (1990) 21 ATR 1; 90 ATC 4413 the Full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipients purpose in engaging in the transaction, venture or business.

Subsection 6-5(2) of the ITAA 1997 states that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. It does not operate to include in a taxpayer's assessable income amounts of a capital nature.

The payment is not assessable as ordinary income in your hands as it is not a product in a real sense of any employment, services or business carried on by you and it does not have the characteristics normally associated with ordinary income such as periodicity and reliance on the payments to meet regular expenditure.

The receipt of the payment is for you to cease any further action in relation to your claim that you were "falsely led to believe that the ………. approval of transactions meant they were safe". We consider this is a compensation payment and it was not related to the income lost but rather for you to withdraw your actions.

Accordingly, the payment received by you from the financial institution is capital in nature and does not constitute assessable income under section 6-5 of the ITAA 1997.

Capital gain

Taxation Ruling TR 95/35 deals with the tax treatment of compensation receipts, and recommends a look through approach in identifying the most relevant asset in respect of which compensation has been received. Where there is no relevant underlying asset, the ruling advocates considering whether a capital gains tax (CGT) event happened to the right to seek compensation.

You had no relevant underlying asset in respect of which the compensation was received. The compensation payment arose for the withdrawal of your complaints against the financial institution and the signing of a deed of release. Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right with the definition of a CGT asset. Your right to seek compensation is therefore a CGT asset.

CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. When an undissected lump sum compensation payment is received TR 95/35 provides that the whole amount is treated as consideration for the disposal of the right to seek compensation.

In your case you received an amount for the disposal of the right to seek compensation. This amount is taken to be the consideration for the CGT event.

Cost base

The cost base of the right to seek compensation is determined in accordance with the provisions of Subdivision 110-A of the ITAA 1997. Expenditure or an outgoing forms part of the cost base of a right to seek compensation if there is a direct and substantial link between the expenditure or outgoing and the arising of the right to seek compensation. Any legal fees or expenses you incurred in obtaining the lump sum payment can be included in the cost base.

Time of disposal

A right to seek compensation will be disposed of when the right is settled between the parties or is finally determined by a court, as there would then be a cancellation, release, discharge, or satisfaction, of the asset constituted by the right of action, that is, when CGT event C2 under section 104-25 of the ITAA 1997 happens.