Edited version of your written advice

Authorisation Number: 1012913352737

Date of advice: 17 November 2015

Ruling

Subject: Compensation payment

Question 1

Is any part of the compensation payment being made to the trustee of a wound up superannuation fund (the Fund), which will then be directly paid to the beneficiaries of the Fund's deceased member, a superannuation death benefit?

Answer 1

No.

Question 2

Will the compensation payment be ordinary income?

Answer 2

No.

Question 3

Will the lump sum in arrears tax offset apply to the compensation payment?

Answer 3

No.

Question 4

Will the compensation payment be considered capital proceeds from CGT event C2?

Answer 4

Yes.

Question 5

Is any resulting capital gain a discount capital gain?

Answer 5

Yes.

Question 6

Will the beneficiaries of the deceased's estate be assessed on any resulting capital gain?

Answer 6

Yes, provided the beneficiaries are Australian residents at the end of the relevant income year and not under a legal disability.

Question 7

Will beneficiaries that are assessed on the capital gain be required to gross up the capital gain prior to applying the general discount?

Answer 7

Yes.

This ruling applies for the following period

Year ending 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts and circumstances

An entity (the Entity) provided advice to a self-managed superannuation fund (the Fund).

The Fund experienced significant losses during the global financial crisis.

The Fund had a corporate trustee.

The director of the corporate trustee and the only member of the Fund passed away.

The Fund was subsequently wound up and the deceased's Estate was fully administered.

A beneficiary of the deceased Estate approached a solicitor for action against the Entity.

The Entity had written to the executors and advised they had conducted a review of the account of the Fund, and offered a settlement in full and final satisfaction of all claims against the Entity.

The Entity advised the executors that the payment would have to be made to the Fund's trustee and that the corporate trustee, which at the time was deregistered, would have to be reinstated.

The executors of the deceased's estate have now reinstated the corporate trustee.

The corporate trustee has been reinstated solely for the purpose of receiving the compensation payment from the Entity.

The applicant for the private ruling has advised that the proceeds from the Entity will be distributed according to the deceased's Estate.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Section 102UY

Income Tax Assessment Act 1936 Subdivision AB

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 102-30

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Paragraph 108-5(1)(b)

Income Tax Assessment Act 1997 Section 115-210

Income Tax Assessment Act 1997 Section 115-215

Income Tax Assessment Act 1997 Division 302

Income Tax Assessment Act 1997 Subsection 307-5(1)

Reasons for decision

Summary

The compensation payment (the payment) is not a superannuation death benefit as the payment is not from as superannuation fund.

As the one-off payment made to each beneficiary is made in full and final satisfaction of all claims against the Entity, it will not be earned or expected, and is therefore not considered ordinary income.

The payment is assessable under the capital gains tax provisions.As the beneficiaries will immediately receive the payment, they will be presently entitled to a share of the capital gain.

Detailed reasoning

Superannuation death benefits

A superannuation death benefit from a superannuation fund is described in the table in subsection 307-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as follows:

On the basis of the information provided, the Commissioner considers the compensation payment is not a superannuation death benefit as the payment will not go to any of the beneficiaries as a payment from a superannuation fund.

Accordingly, Division 302 of the ITAA 1997 which sets out the tax treatment of superannuation death benefits will not apply to the compensation payment.

Ordinary income

Section 6-5 and section 6-10 of the ITAA 1997 provides that the assessable income of a taxpayer includes ordinary and statutory income derived directly and indirectly from all sources 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.

Other characteristics of income that have evolved from case law include receipts that:

• are earned

• are expected

• are relied upon

• have an element of periodicity, recurrence or regularity.

In this case the payment is a one-off payment that is being paid in full and final satisfaction of all claims against the Entity. The payment will not be earned or expected and is therefore not considered ordinary income.

Lump sum in arrears tax offset

A lump sum payment in arrears is a payment received in one tax year that includes income that accrued in previous tax years. The lump sum is assessable in the year of receipt. However, you may be eligible for a tax offset to reduce the amount of tax they have to pay (subdivision AB of the Income Tax Assessment Act 1936 (ITAA 1936)).

As discussed below, we consider that the compensation payment in this case relates to the disposal of the right to seek compensation; the payment does not relate to income that accrued in previous years. Accordingly, the lump sum in arrears tax offset is not relevant in this case.

Capital gains tax

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.

Taxation Ruling 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.

In this case, a review was conducted by an entity in relation to the services and advice they had previously provided to the SMSF. As a result of this review, an amount of compensation has been offered in full and final settlement of all claims against an entity in relation to the advice provided to the SMSF. We consider that upon settling the claim against an entity, the right to seek compensation was disposed of in relation to alleged inappropriate financial advice that was provided. CGT event C2 will occur on the date that a settlement agreement is entered into.

The right to seek compensation arises at the time of the compensable wrong. We consider that the wrong occurred prior to the deceased's death and the right to seek compensation therefore formed part of the deceased's estate. As this will be more than 12 months before the CGT event, any capital gain that arises from CGT event C2 will be a discountable gain.

Although the payment will be made to the corporate trustee, we consider that this is purely for administrative purposes required by the Entity. The corporate trustee is not the beneficial recipient of the payment and we consider that the corporate trustee is receiving the payment as agent for the deceased's Estate.

Therefore, the amount of the compensation is assessable under the capital gains tax provisions and will be included in the income of the deceased's estate.

Beneficiaries

Section 97 of the ITAA 1936 provides that the assessable income of a beneficiary who is not under a legal disability shall include:

i. the share of the net income of the trust estate, attributable to a period when the beneficiary was a resident; and

ii. the share of the net income of the trust estate, attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia.

Section 115-215 of the ITAA 1997 provides that appropriate amounts of the trust estate's net income attributable to the trust estate's capital gains are treated as a beneficiary's capital gains when assessing the beneficiary, so:

(a) the beneficiary can apply capital losses against gains; and

(b) the beneficiary can apply the appropriate discount percentage (if any) to gains.

Section 102UY of the ITAA 1936 adjusts the amount otherwise included in a beneficiary's assessable income, under section 97 of the ITAA 1936, by effectively ignoring any capital gains that are brought to tax under section 115-215 of the ITAA 1997. Its purpose is to avoid double taxation of capital gains by adjusting the amount included in a beneficiary's assessable income under section 97 of the ITAA 1936.

As the beneficiaries will immediately receive the compensation payment, they will be presently entitled to a share of the capital gain. The beneficiary will be treated as having made an additional capital gain of double the amount of the beneficiary's share of the trust's net income that is attributable to a capital gain that has benefited from the 50% discount (section 115-215 of the ITAA 1997).

The beneficiary can then apply any of their personal capital losses to the gain and apply the appropriate discount percentage to the capital gain.