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Edited version of your written advice
Authorisation Number: 1012939850096
Date of advice: 21 January 2016
Ruling
Subject: Compensation payment
Question 1
Is the compensation receipt assessable as ordinary income?
Answer
No.
Question 2
Is an amount required to be included in your assessable income as a capital gain in relation to the compensation receipt?
Answer
No.
This ruling applies for the following period:
Year ended 30 June 2015
The scheme commenced on:
1 July 20XX
Relevant facts and circumstances
Your financial advisor misappropriated funds from you.
You lodged a claim for compensation with the financial advisor's employer.
The result of this claim was that you entered into a Deed of Release with the employer, agreeing to a full and final settlement payment of the amount of your financial loss.
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 104-25
Income Tax Assessment Act 1997 paragraph 108-5(1)(b)
Reasons for decision
Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)). The legislation, however, does not define the expression income according to ordinary concepts.
Ordinary income generally includes 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, and
• have an element of periodicity, recurrence or regularity
The compensation payment that you received for the financial loss due to the misappropriation of funds by your financial advisor is not income from rendering personal services, income from property or income from carrying on a business. The payment is also a once and for all payment and therefore does not have an element of recurrence or regularity. Accordingly, the compensation payment you received is not considered as ordinary income under s 6-5 of the ITAA 1997.
Your assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).
TR 95/35 provides that settlement of a claim to seek compensation for a breach of contract or other compensable damage represents the disposal of an asset under the capital gains tax (CGT) provisions. The disposal of the right to seek compensation gives rise to a CGT event.
In your case, you lodged a claim for compensation due to your financial advisor misappropriating funds. That right to seek compensation is an asset for CGT purposes (paragraph 108-5(1)(b) of the ITAA 1997).
CGT event C2 happened when your ownership of that asset (the right to seek compensation) ended by the asset being satisfied or surrendered (section 104-25 of the ITAA 1997). This occurred when you disposed of your right to seek compensation from the employer by signing the deed of release between yourself and the employer.
The compensation amount paid to you represents the capital proceeds from the disposal of that asset. The compensation payment was received in full and final settlement of every entitlement, right or claim which you might have had in connection with the financial loss caused by the actions of the financial advisor.
In order to calculate whether you have made a capital gain or capital loss from the disposal of the asset it is necessary to consider the cost base of your right to seek compensation.TR 95/35 provides direction on the calculation of such. It states at paragraph 104 that if the right to seek compensation arises in respect of a monetary loss of the taxpayer, the amount of that loss is included in the cost base of the right to seek compensation for that loss. Example 9 below is similar to your circumstances:
Example 9
286. The Newco Superannuation Fund, relying on advice from its legal advisers, B Co, has been lodging taxation returns on the basis that it is a complying fund. Due to certain irregularities in its accounting and taxation records, amended assessments are raised against the super fund which it pays in February 1994. In April 1994, the fund commences legal action against its advisers, seeking to recover the additional tax liability and penalties, being $60,000. In June 1994 the fund receives $60,000 plus an amount to cover the legal costs of the fund from B Co.
287.
Relevant asset: |
The right to seek compensation from the advisers |
Acquired: |
February 1994 |
Cost base: |
The amount of additional tax and penalties plus any legal costs incurred in pursuing the claim against the advisers |
Disposed of: |
June 1994 |
Consideration: |
$60,000 plus legal costs |
CGT consequences: |
There is no capital gain or loss |
We consider that the loss you suffered due to the misappropriation of funds by your financial advisor which gave rise to your right to seek compensation is included in the cost base of the asset. As the capital proceeds you received for the disposal of your right to seek compensation is equal to the cost base of that right, you have not made a capital gain.
As such, the compensation payment you received is not included in your assessable income under any provision of the ITAA 1997.