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Ruling

Subject: Assessability of income

A society has paid a sum to the estate being interest for a period of time spaning several income tax years. The interest component is considered to be assessable under section 6-5 of ITAA 1997 as it falls within the meaning of interest by way of recompense for loss of the use of capital during a period of time in which it would earn income.

Whilst the payment was for interest income owing to the taxpayer it was related to earlier income tax years; the interest is assessable upon the association having made its final decision thus giving the estate the right to claim both the principle and the interest components.

Question 1

Is the sum of interest paid by the society to the estate assessable as income?

Answer

Yes

Question 2

Is the sum of interest paid to the estate assessable in the income tax years the payment was associated with?

Answer

No

Question 3

Is the sum of interest paid to the estate assessable in the income year liability was admitted?

Answer

Yes

This ruling applies for the following periods:

30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The applicant became the executor of the estate upon the death of a taxpayer who passed away a few years ago.

The taxpayer acquired investments upon the death of a relative a number of years earlier. The scheme was run by the relative's legal advisor; the taxpayer maintained the investment and invested further funds.

A few years later, the legal advisor was deregistered.

After the taxpayer's death, the applicant lodged a claim against a fidelity fund for the money owed to the taxpayer.

The society accepted the claim against the fidelity fund and agreed to pay a sum of money comprising of principle and interest.

A few months later the society wrote a cheque which the applicant banked into the estate bank account on the same day.

The fidelity fund paid interest from the time the legal advisor was deregistered. The nominal rate of interest was a specified percentage per annum across the life of the investment.

To date, whilst the applicant has lodged income tax returns for the estate, the applicant has not declared any income from the fidelity fund as the monies had not been received during those financial years nor was it certain that the fidelity fund would accept the applicant's claim.

The applicant provided a detailed spreadsheet showing details of each investment, the periods of interest due and payable and the amounts of interest received.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1936 Section 19 and

Income Tax Assessment Act 1936 Section 25.

Reasons for decision

Is the sum of interest paid by the society assessable income?

The general income provisions are set out in section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). Subsection 6-5(2) of ITAA1997 states:

"If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year."

Paragraph 26 of Taxation Ruling TR 95/35 states that interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions.

Payments that represent compensation for a loss suffered by investors or for a right which investors surrender are generally determined by applying the primary test for distinguishing between income and capital.

Interest is not specifically defined under the provisions of the ITAA 1997. The meaning of interest has been discussed in many cases:

In Federal Wharf Co Ltd v DCT (SA) (1930) 44 CLR 24; 1 ATD 70, the taxpayer's property was acquired under legislation which provided that interest was to be added to compensation for the acquisition. Such interest is to be computed from the time when the minister entered into occupation to the time when compensation was paid. The taxpayer contended that the amount so received was not income but formed part of the compensation intended to put it pecuniarily in the same position, as it would have been if its land had not been acquired. The High Court held that it was income. Rich J said at CLR 28:

'In my opinion, the character of the interest payable ... is that of recompense for loss of the use of capital during a period of time in which it would earn income. It represents the annual value of capital. It has been paid because the owner has been deprived of a capital asset which he had and has not received the fund which is to be substituted for the capital asset. The interest is the flow of that fund.'

In Westminster Bank Ltd v Riches [1947] AC 390; (1947) 28 TC 159, it was held that an award of "interest" on a debt is nevertheless "interest of money" chargeable to tax. Even though it is awarded as compensation to the injured party and may, therefore be described and justified as being interest "by way of or in the nature of damages".

In this case, the society, has admitted liability to pay compensation to investors who had suffered pecuniary loss because of the deregistration of the legal advisor.

The society has paid a sum of money being interest income for a specified period spaning several income tax years. The interest component is considered to be assessable under section 6-5 of ITAA 1997 as it falls within the meaning of interest by way of recompense for loss of the use of capital during a period of time in which it would earn income.

Is the sum of interest paid by the society assessable for the periods intended for or on the relevant income year?

The assessable income of a resident of Australia includes income derived directly or indirectly from all sources whether in or out of Australia. [section 25 of the Income Tax Assessment Act 1936 (ITAA 1936) and section 6-5 of the ITAA 1997].

The income is deemed to have been derived by a person as soon as it is applied or dealt with in any way on his behalf or as he directs. [section 19 of the ITAA 1936 and section 6-5 of the ITAA 1997].

Interest credited as a fixed term deposit and added to capital is deemed to have been derived when credited.

Therefore, the interest the applicant received on behalf of the estate, whilst the payment for interest income owing to the taxpayer was related to several income tax; the interest is assessable upon the society having made it's final decision thus giving the estate rights to claim the sum of capital and interest income.