Edited version of your written advice

Authorisation Number: 1051223238412

Date of advice: 10 May 2017

Ruling

Subject: Compensation income

Questions

1. Is the interest received assessable as ordinary income?

2. Are the amounts received as refund of fees an assessable recoupment?

3. Are the amounts received which represent the underperformance of your investments assessable under the Capital Gains tax provisions?

Answers

1. Yes

2. Yes

3. Yes.

This ruling applies for the following period

Year ending 30 June 2016

The scheme commences on

1 July 2015

Relevant facts and circumstances

Some years ago under the advice of your financial advisor, you borrowed some money and invested in an investment account through your bank, which continued to be managed by your financial advisor.

Your financial advisor recently left your bank abruptly and a new financial advisor took control of your account.

The new advisor noticed that the portfolio appeared to have significantly underperformed against expectations in the general market and requested a review of the advice provided by the original advisor.

Upon review it was noted that your portfolio was poorly managed and as a consequence had underperformed.

A compensation payment was arranged to be paid to you.

At no point did you file a claim or seek any damages in regards to your situation, you were simply contacted and told that you were to receive a compensation payment.

You signed for and were paid X amount.

By signing the acknowledgement and acceptance form you released the bank and its agents from any future claims by you to seek compensation.

A breakdown of the payment was provided, and included:

● A refund of the ongoing adviser fees that were paid from your account.

● A refund to you of the difference in administration fees that were charged as a result of you not being offered the opportunity to transfer to another type of investment account.

Payments representing the calculation of the underperformance of your portfolio against the growth benchmark for your agreed risk profile.

Later the remaining assets within your portfolio were disposed of and the balance of the account monies was withdrawn.

You did not seek damages for the underperformed investment; you were unaware that your portfolio was being poorly managed nor underperforming against the general market. The receipt of compensation was completely unexpected.

You have claimed a deduction for your adviser and administration fees.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 subsection 20-20

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 108-5

Reasons for decision

Summary

The the amounts received which represent the underperformance of your investments are not regarded as ordinary assessable income. These amounts are considered to be capital in nature and assessable under the capital gains tax provisions as capital proceeds from your right to seek compensation.

The amounts received as refunds of your adviser and administration fees are an assessable recoupment.

The interest received is assessable as ordinary income.

Detailed Reasoning

A payment or other benefit received by a taxpayer is assessable income if it is:

a) income in the ordinary sense of the word (ordinary income); or

b) an amount or benefit that through the operation of the provisions of the tax law is included in assessable income (statutory income).

Ordinary income

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). The legislation does not provide specific guidance on the meaning of income according to ordinary concepts, however, a substantial body of case law exists which identifies likely characteristics. Characteristics of ordinary income that have evolved from case law include receipts that:

a) are periodical, regular or recurrent;

b) are relied upon by the recipient for their regular expenditure and paid to them for that purpose; and

c) are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The payment is not assessable as ordinary income in your hands as it is not a product in a real sense of any employment, services or business carried on by you and it does not have the characteristics normally associated with ordinary income such as periodicity and reliance on the payments to meet regular expenditure.

Interest received

Interest income is regarded as ordinary income and therefore assessable under subsection 6-5(2) of the ITAA 1997.

Compensation payments which substitute income are regarded as ordinary income.

Therefore the compensation for lost interest is regarded as ordinary assessable income.

The refund of fees and the payment representing the underperformance of your portfolio are not regarded as ordinary income under section 6-5 of the ITAA 1997.

Recoupment

Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss of outgoing is an assessable recoupment if:

● you received the amount by way of insurance or indemnity, and

● you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act.

In your case you received amounts for the refund of the advisor and administration fees you had incurred and previously claimed as deductions. You are therefore required to include these as an assessable recoupment.

Statutory income – capital gains

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes a net capital gain. A capital gain or loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

A CGT asset is defined in paragraph 108-5(1)(b) of the ITAA 1997 as including a legal or equitable right that is not property. Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation.

Paragraph 70 of TR 95/35 provides that in determining the most relevant asset for which the compensation has been received, it is often appropriate to adopt a ‘look-through’ approach to the transaction which generates the payment.

The ‘look-through’ approach is defined in paragraph 3 of TR 95/35 to be 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.

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. A C2 event can apply where there is a release or discharge of a right to seek compensation.

In this case we consider that the amounts received which represent the underperformances of your investments relate to the disposal of your right to seek compensation. The right to seek compensation was acquired at the time of the compensable wrong or injury. CGT event C2 happened when you accepted the offer of compensation.

Please note that if it has been 12 months or more since the previous underperforming advice has been received, then you may be able to reduce the capital gain by 50%.