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Edited version of your private ruling
Authorisation Number: 1012535750606
Ruling
Subject: compensation payment
Question 1
Is the interest you received of as part of the compensation payment assessable as ordinary income?
Answer
Yes.
Question 2
Is the remainder of the compensation payment assessable under the capital gains tax (CGT) provisions?
Answer
Yes.
This ruling applies for the following period
Year ended 30 June 2013
The scheme commences on
1 July 2012
Relevant facts and circumstances
The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:
· the application for private ruling, and
· the documents provided with the application for private ruling.
On the recommendation of your financial advisor, you invested your money in a investment product.
In 2011, you closed this account and made a complaint to your financial planner as the invested funds had decreased.
The review team considered your situation and found that the investment was not appropriate for your circumstances.
Further, they concluded that your funds should have been invested in different type of investment product.
You received an offer of compensation from the financial planner.
In calculating an appropriate compensation offer, the financial planner compared your actual investment portfolio with a reference portfolio.
The reference portfolio shows how your investment would have performed had your funds been invested appropriately.
You executed a Deed of Settlement and Release in full and final settlement of your complaint.
You were paid an amount of compensation. This amount included interest, the difference between your actual portfolio and the reference portfolio and a CGT gross up amount.
Relevant legislative provisions
Income Tax Assessment Act 1997 subsection 6-5(1)
Income Tax Assessment Act 1997 section 102-20
Income Tax Assessment Act 1997 section 104-25
Income Tax Assessment Act 1997 subsection 104-25(1)
Income Tax Assessment Act 1997 subparagraph 104-25(1)(b)
Income Tax Assessment Act 1997 paragraph 108-5(1)(b)
Reasons for decision
Question 1
Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts. This 'ordinary income' includes amongst other things, income from salary and wages and interest.
Taxation Ruling TR 95/35 deals with the tax treatment of compensation receipts. Paragraph 26 of this ruling specifically deals with the treatment of interest awarded as a part of a compensation amount:
Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions. If the taxpayer receives an undissected lump sum compensation amount and the interest cannot be separately identified and segregated out of that receipt, no part of that receipt can be said to represent interest.
In this case, you received compensation due to inappropriate financial advice. An amount of was separately identified as interest. Therefore, this amount is assessable as ordinary income.
Question 2
Capital gains tax (CGT) is the tax you pay on certain gains you make. Section 102-20 of the ITAA 1997 provides that you make a capital gain or capital loss as a result of a CGT event happening to an asset in which you have an ownership interest.
Paragraph 108-5(1)(b) of the ITAA 1997 states that a CGT asset includes legal and equitable rights that are not property. Legal and equitable rights are also intangible assets in terms of subsection 104-25(1) of the ITAA 1997. The right to seek compensation is an example of a legal or equitable right and is also an intangible asset.
TR 95/35 specifies a 'look through' approach to identify whether the compensation is in relation to an underlying asset. Where there is no relevant underlying asset, the ruling states that the compensation relates to the disposal by the taxpayer of the right to seek compensation.
Section 104-25 of the ITAA 1997 specifies that CGT event C2 will occur when an intangible asset is cancelled, surrendered or has a similar ending. Specifically, subparagraph 104-25(1)(b) of the ITAA 1997 states that CGT event C2 happens if ownership of an intangible CGT asset ends by being released, discharged or satisfied.
Application to your circumstances
In this case, you made a complaint to your financial planner in relation to the poor return on your investment. An investigation conducted by a review team concluded that you had been placed in an inappropriate investment. As a result of this investigation, you were offered an amount of compensation in full and final settlement of your complaint. We consider that upon settling your claim, you disposed of your right to seek compensation in relation to the inappropriate financial advice that was provided. CGT event C2 occurred on the date you executed the Deed of Settlement and Release.
Therefore, the amount of the compensation (excluding the interest component) is assessable under the capital gains tax provisions.