Edited version of your private ruling

Authorisation Number: 1012433394191

Ruling

Subject: Capital gains tax implications on a compensation payment

Question 1

Should a reasonable apportionment of the compensation payment received be treated as additional capital proceeds for the units already disposed of in the 2XXX financial year?

Answer:

Yes

Question 2

Should a reasonable apportionment of the compensation payment received be treated as additional capital proceeds for the units already disposed of in the relevant financial year?

Answer:

Yes

Question 3

Should a reasonable apportionment of the compensation payment received be treated as a recoupment of the cost base of the units, for those units that you still hold?

Answer:

Yes

Question 4

Will an amendment to your 2XXX income tax return be required if the treatment of the compensation payment as additional capital proceeds results in a net capital gain, or an increased net capital gain, in the 2XXX financial year?

Answer:

Yes

This ruling applies for the following period

Year ending 30 June 2013

Year ended 30 June 2012

Year ended 30 June 2011

Year ended 30 June 2010

Year ended 30 June 2009

The scheme commenced on

1 July 2008

Relevant facts and circumstances

You and your spouse sought investment advice from a financial advisor.

You undertook a range of investments following advice from your financial advisor and derived assessable income from your investment portfolio.

During 2YYY you were advised to further increase your level of borrowing. Following this advice your margin loan was increased.

The additional loan funds from 2YYY were invested in a fund and used to purchase additional units in X at various times after the loan drawdown and to meet interest payments on the investment loans.

As a result of the severe impact of the global financial crisis, investments were sold during late 2ZZZ and proceeds were used to reduce the margin loan. You realised capital losses, which were reported in your income tax return for the 2XXX financial year.

In late 2ZZZ, there were a number of X units sold which resulted in a capital loss. The units were acquired in the 2YYY calendar year.

You have carried forward capital losses for the three financial years.

You acquired further X units, some of which you sold during the relevant financial year.

You registered a complaint with the financial advisor in respect of the advice received.

After negotiations with the financial planner, they have offered to compensate you and your spouse for a portion of the losses that they attribute to the loan increases.

The advisor has calculated a percentage of your losses as being attributable to the advice.

You have accepted the offer.

You state that the various managed funds that you had invested in prior to the 2ZZZ advice were all sold during 2ZZZ to 2XXX. Therefore you state that the borrowed funds can be reasonably attributed to the new X units.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-10

Reasons for decision

Detailed reasoning

Compensation payment - Vanguard units as the underlying asset

Capital gains tax (CGT) is the tax you pay on certain gains you make. Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you make a capital gain or capital loss as a result of a CGT event happening. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset. Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property; or a legal or equitable right that is not property.

Taxation Ruling TR 95/35 discusses the capital gains tax implications for compensation receipts. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt.

The 'look-through' approach is defined in paragraph 3 of TR 95/35 to be:

The 'look-through' approach is the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related. It is also referred to in this Ruling as the underlying asset approach.

'Underlying asset' is also defined in paragraph 3 of TR 95/35 as:

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

The transaction which generated the compensation receipt is the alleged inappropriate advice that caused you to increase your gearing by taking additional loans to purchase further investments through your investment fund. With these additional loans you state you acquired X units (and paid interest payments on your investment loans). You later sold these X units to comply with a margin call, which resulted in a capital loss. Applying the 'look-through' approach, the most relevant asset to which the compensation most directly relates is the X units. The compensation amount received was calculated based on the losses attributable to the additional loans acquired in 2ZZZ, which you state you used to purchase the X units.

Treatment of compensation if a CGT event occurs (disposal of the asset)

Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. units) is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs.

Paragraph 4 of TR 95/35 states that:

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation.

In some cases, you may receive additional 'capital proceeds' after the CGT event has occurred, including in a later financial year. For example, compensation may be offered and accepted after the CGT event has occurred, or litigation may result in compensation for losses arising from an investor's former investments. In this situation, your receipts from compensation payments can reasonably be treated as additional 'capital proceeds' for the previous redemption of your investments. This means that the capital gain or capital loss made for the previous CGT event needs to be recalculated. The calculation will be for the CGT event that occurred in that tax year and not the year of income the extra proceeds were obtained in.

In your case, you have disposed of a CGT asset (some X units) in late 2YYY and again in late 2VVV. Therefore CGT event A1 has happened in the 2XXX financial year and the relevant financial year. In addition, you still retain ownership of some of the X units.

Accordingly, you will need to apportion the amount received as compensation between the units sold, both in 2XXX and relevant financial years, and the remaining units.

The amounts apportioned to the sale of the units in late 2ZZZ will need to be included as additional capital proceeds in the 2XXX financial year. Likewise, the amounts apportioned to the sale of the units in late 2VVV will need to be included as additional capital proceeds in the relevant financial year.

As you have advised that a capital loss occurred on the disposal of the units in the 2XXX financial year, you will need to adjust the amount of capital losses you have available to carry forward for future years.

Treatment of compensation if a CGT event has not occurred

If a CGT event hasn't occurred for a particular investment asset - for example, an investment is still held - any compensation amounts you received are still taken into account for capital gains tax purposes. This will be the case even if the asset is of no current value.

If the compensation can be reasonably related to investment assets, the cost bases of the relevant assets are reduced by the amount of compensation received. The receipt of the compensation does not create a CGT event for the investment assets.

In your case, you still hold some of the relevant assets (the units).

Accordingly, the amount of the compensation payment that you have apportioned to the units still held, will be considered amounts related to the recoupment of the cost base of the assets and therefore the cost base of the asset (the units) should be reduced by the amount received as compensation.

No CGT event will occur for these remaining units until they are sold.

Is an amendment required to your 2XXX income tax return?

You should request an amendment for the year in which you disposed of your units if you:

· had a net capital gain in that year, or 

· will have a net capital gain in that year after you adjust the capital gain or capital loss to include the compensation received as additional proceeds

If you have a net capital loss for the year in which you disposed of your units, you will need to adjust the net capital loss you recorded for that year after recalculating the capital gain or capital loss on your units. You will also need to:

· adjust your tax records for later years to show the correct amount of net capital losses carried forward, and

· where you have made a net capital gain or have an increased net capital gain in a later income year as a result of the adjustment to your net capital losses you should request an amendment for that year.

You don't need to inform the Tax Office about an adjustment to net capital losses carried forward unless it results in a net capital gain or increases a net capital gain in a return you have lodged. This is because the calculation of a net capital loss does not form part of the making of an assessment. Therefore any potential change to a capital loss in a particular income year does not involve the amendment of an assessment. This means that a taxpayer who has a net capital loss in an income year and wishes to recalculate the quantum of the loss to correct an error, or change in circumstances, can do so without requiring an amendment of an assessment.

You have advised that a capital loss occurred on the disposal of the units in the 2XXX financial year.

As discussed above the amount of compensation received should be apportioned between the units that were sold in the 2XXX and relevant financial years, and those units that you still hold.

If the amount apportioned to the 2XXX financial year as additional capital proceeds does not cause your net capital loss to become a net capital gain, there will be no requirement to amend your return. You should, however, keep a record of the reduction in the capital loss (as a result of the compensation received) to ensure that the correct amount of capital losses are carried forward to any future years.