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Ruling

Subject: Compensation - loss on investment - incorrect investment allocation - interest

Question 1

Is the interest payment you received assessable as ordinary income?

Answer

Yes.

Question 2

Is the compensation payment you received assessable as ordinary income?

Answer

No.

Question 3

Is the compensation payment you received assessable as a capital gain?

Answer

No.

This ruling applies for the following period

1 July 2010 to 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You invested funds in a superannuation account through a financial advisor.

You became aware that company A had erroneously invested your money using an incorrect investment allocation. You removed your investments from company A and transferred them to company B.

As a result of the error your investment was disadvantaged by $X. This amount represented the difference between what was rolled over to company B and what should have been rolled over if company A had invested your funds correctly.

You lodged a claim for compensation.

You received a payment of $Z in full and final settlement of every entitlement, right or claim which you might have had in connection with the incorrect investment allocations with company A.

The compensation payment of $Z consisted of $X for the loss on your investment due to the incorrect investment allocation plus $Y interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-25

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

Reasons for decision

Summary

The interest payment you received is ordinary income and is included in your assessable income.

The compensation payment you received for the incorrect investment allocations is not included in your assessable income as either ordinary or statutory income.

Detailed reasoning

Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)). The legislation, however, does not define the expression income according to ordinary concepts. 

Ordinary income generally includes three categories, namely, income from rendering personal services, income from property, and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that:

o are earned

o are expected

o are relied upon, and

o have an element of periodicity, recurrence or regularity.

Interest is a form of property income and is therefore ordinary income.

In addition, Taxation Ruling TR 95/35 which provides the Commissioner's view on the taxation treatment of compensation receipts, states at paragraph 26 that interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions.

As such, the interest payment of $Y you received is included in your assessable income under section 6-5 of the ITAA 1997.

The compensation payment of $X that you received for the incorrect investment allocations is not income from rendering personal services, income from property or income from carrying on a business. The payment is also a once and for all payment and therefore does not have an element of recurrence or regularity. Additionally, the compensation payment is considered to be capital in nature.

Accordingly, the compensation payment of $X is not assessable income under section 6-5 of the ITAA 1997.

Your assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).

Section 10-5 of the ITAA 1997 lists those provisions about assessable income. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains.

TR 95/35 provides that settlement of a claim to seek compensation for a breach of contract or other compensable damage represents the disposal of an asset under the capital gains tax (CGT) provisions. The disposal of the right to seek compensation gives rise to a CGT event.

In your case, you lodged a claim for compensation due to company A investing your money using an incorrect investment allocation. A right to seek compensation is an asset for CGT purposes (paragraph 108-5(1)(b) of the ITAA 1997).

CGT event C2 happened when your ownership of that asset (the right to seek compensation) ended by the asset being satisfied or surrendered (section 104-25 of the ITAA 1997). This occurred when you disposed of your right to seek compensation from company A by signing the deed of release between yourself and company A.

The compensation amount of $X paid to you represents the capital proceeds from the disposal of that asset. The compensation payment was received in full and final settlement of every entitlement, right or claim which you might have had in connection with the incorrect investment allocations by company A.

In order to calculate whether you have made a capital gain or capital loss from the disposal of the asset it is necessary to consider the cost base of your right to seek compensation. TR 95/35 provides that a wide interpretation of the cost base is relevant where the right to seek compensation is relevant.

We consider that the losses suffered on your investment ($X) due to the incorrect investment allocations, which gave rise to your right to seek compensation, is included in the cost base of the asset. As the capital proceeds received for the disposal of your right to seek compensation is equal to the cost base of that right, you have not made a capital gain.

As such, the compensation payment you received is not included in your assessable income under any provision of the ITAA 1997.