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Edited version of your written advice
Authorisation Number: 1012883833470
Date of advice: 25 September 2015
Ruling
Subject: Compensation
Question 1
Is the amount of the compensation payment received for the shortfall interest regarded as an assessable recoupment?
Answer
Yes.
Question 2
Is the compensation for the tax payable amount subject to the capital gains tax provisions?
Answer
Yes.
Question 3
Does the additional tax for which the compensation was paid form part of the cost base for capital gains tax purposes?
Answer
Yes.
This ruling applies for the following period:
Year ended 30 June 2016
The scheme commenced on
1 July 2015
Relevant facts
You amended your tax return to remove the deduction for your superannuation personal contribution.
The amendment was initiated because of an error made by your nominated superfund provider.
The superfund provider has advised that they will provide you with a compensation payment which is made up of the additional tax payable due to the amendment and shortfall interest charge imposed.
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 Subdivision 20-A
Income Tax Assessment Act 1997 Section 25-5
Income Tax Assessment Act 1997 Section 102-5
Income Tax Assessment Act 1997 Section 104-25
Reasons for decision
Ordinary income
Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.
For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).
On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.
Your compensation payment is not earned by you as it does not relate to services performed or from carrying on a business.
As the payments you received are not for loss of income, the payments are not assessable as ordinary income under subsection 6-5(2) of the ITAA 1997.
Statutory income
Amounts that are not ordinary income, but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997).
The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list are Subdivision 20-A of the ITAA 1997 (assessable recoupments) and section 102-5 of the ITAA 1997 (capital gains).
Assessable recoupment
Under subsection 20-20(3) of the ITAA 1997, an amount received as recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if it is paid to cover the cost of a deductible expense listed in section 20-30 of the ITAA 1997 and the deduction can be claimed in the current year or in an earlier income year. Section 25-5 of the ITAA 1997 is listed in section 20-30 which allows a deduction for tax-related expenses such the general interest charge or the shortfall interest charge (item 1.3 in the table in subsection 20-30(1) of the ITAA 1997).
Recoupment of a loss or outgoing includes any kind of recoupment, reimbursement, refund or recovery (subsection 20-25(1) of the ITAA 1997).
The shortfall interest charge imposed on your amended assessment is a deductible tax-related expense under paragraph 25-5(1)(c) of the ITAA 1997. As you are entitled to a deduction for the SIC, the payment of SIC from the superfund is an assessable recoupment.
Capital gains tax
Your assessable income includes your net capital gain for the income year (subsection 102-5(1) of the ITAA 1997). You make a capital gain (or loss) as a result of a CGT event happening (section 102-20 of the ITAA 1997).
CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being released or cancelled (subsection 104-25(1) of the ITAA 1997). The time of the event is when you enter into the contract that results in the asset ending, or if there is no contract, when the asset ends (subsection 104-25(2) of the ITAA 1997).
A CGT asset is any kind of property or a legal or equitable right that is not property (section 108-5 of the ITAA 1997).
Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation payments. Why the payment was made is an important factor in determining whether an asset has been disposed of for capital gains tax purposes.
In your case, your right to seek compensation is an intangible CGT asset (acquired at the time of the compensable wrong) and your ownership of that asset ended when you accepted the compensation from the superfund. At that time CGT event C2 happened.
The capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, in respect of the event happening, and the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event) (section 116-20 of the ITAA 1997).
In your case, the capital proceeds will include the compensation paid by the superfund to you for the tax payable on your amended assessment.
The cost base of the right to seek compensation is determined in accordance with the provisions of section 110-25 of the ITAA 1997.
The cost base of a CGT asset consist of 5 elements (subsection 110-25(1) of the ITAA 1997). The first element includes in the cost base any consideration in respect of the acquisition of the right to seek compensation (subsection 110-25(2) of the ITAA 1997).
If the right to seek compensation arises in respect of a monetary loss, the amount of that loss is included in the cost base of the right to seek compensation for that loss (paragraph 104 of TR 95/35).
As such, your cost base includes the amount of additional tax payable on your amended assessment as a result of the superfund's error.
Please note as the capital proceeds do not exceed the amount of compensation being sought, there is no capital gain.