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Ruling

Subject: capital gains tax - compensation receipt - interest - income vs. capital

Question 1: Will the compensation amount be included in your assessable income in the 2011-12 income year?

Answer: No.

Question 2: Will the interest amount be included in your assessable income in the 2011-12 income year?

Answer: Yes.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You acquired parcels of shares in Company B on different dates after 20 September 1985, which you continue to own.

A class action on behalf of investors in Company B and its successor entity Company C who had acquired shares in either company during a specific period.

A deed of settlement with Company C was executed, with the Federal Court of Australia approving the class action settlement.

The deed of settlement provided that the proceedings between the Applicants and the Respondent, including the Applicant's and Group Member's claims for damages, compensation, interest and legal and administrative costs and disbursements, past and future, is fully and finally settled.

As a result of the deed of settlement, you received a dissected compensation payment which consisted of a compensation amount and an amount of interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-15

Income Tax Assessment Act 1997 Section 102-5

Reasons for decision

Treatment of compensation receipts

Compensation amount

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that your assessable income includes income according to ordinary concepts, which is called ordinary income. 

Taxation Ruling TR 95/35 (TR 95/35) outlines the Commissioner's view on the capital gains tax (CGT) treatment of compensation payment. In TR 95/35 the Commissioner adopts an underlying asset approach, also known as a look-through approach, to determine the asset to which the compensation amount is most directly related.

TR 95/35 provides that on a look-through approach a compensation payment inherits the characteristics of the item for which the payment is made. Accordingly, it is necessary to establish what you are being compensated for in order to determine whether the payment will form part of your assessable income. For example, if the compensation is paid in respect of a capital asset or amount then it is regarded as a capital receipt and not ordinary income.

Under this approach, the initial question is whether there is an underlying asset to which the compensation has a direct and substantial link. This requires that there be an asset which has been disposed of or which has been permanently reduced in value.

If there is no disposal of the underlying asset, but it has been permanently damaged or permanently reduced in value, the Commissioner will treat the compensation as a recoupment of all or part of the total acquisition costs of the asset. In this context, the Commissioner considers that permanent does not mean everlasting, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to repair it, or put it right. Compensation received by the purchaser of an asset because excessive consideration was paid is also treated by the Commissioner as a recoupment of the acquisition costs.

The effect of the above is that the total acquisition costs of the underlying asset are reduced by the amount of the compensation. No capital gain or capital loss arises in respect of the asset until the taxpayer actually disposes of it. If the compensation amount exceeds the total unindexed acquisition costs, there are no CGT consequences in respect of that excess and on the future disposal of the asset, its cost base will be nil.

The adjustment of the total acquisition costs effectively reduces those costs by the amount of the recoupment as if those costs had not been incurred.

In your case, you received a compensation amount as a result of the settlement of a class action. In accordance with the guidance provided in TR 95/35, the look-through approach provides that the payment relates to your OZ Minerals shares, which are the capital assets that have suffered the permanent reduction in value. As there has been no disposal of the shares by you, the payment represents recoupment of your acquisition costs of the shares and is inherently regarded as a capital receipt.

Therefore, the compensation amount will not be included in your assessable income in the 2010-11 financial year. The payment will be apportioned in relation to the cost base of your Company C shares, with the apportioned amount reducing the cost base of each Company C share. The recalculated cost base of each Company C share will be used when determining whether you have made a capital gain or capital loss on the disposal of your Company C shares in the future.

Interest amount

Paragraph 26 of TR 95/35 outlines that interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions if the compensation payment is dissected and the amount of interest can be separately identified and segregated out of that payment.

In your case, you received an interest amount in relation to your compensation payment. As the interest amount can be identified, in accordance with TR 95/35 the interest amount will be included in your assessable income in the 2010-11 financial year under the income tax provisions.