Edited version of your written advice

Authorisation Number: 1051233931944

Date of advice: 9 June 2017

Ruling

Subject: Income tax - Compensation - interest

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.

Relevant facts

‘A’ and ‘B’ obtained financial advice from (‘C’) in relation to investing $X.

The advice received was to invest the $X into an investment portfolio (investment portfolio) and also to contribute $X per month personally as well as take out a $X per month margin loan to add to the investment portfolio.

A’ and ‘B’ followed the advice and made the investment.

Subsequent to that initial investment, A’ and ‘B’ made a further investment of $X on the advice of ‘C’.

The investment portfolio resulted in substantial losses and A’ and ‘B’ decided to redeem their investment in 2003. A’ and ‘B’ received $X and $X from the redemption. A total of $X was received.

A’ and ‘B’ suffered a total loss of $X not including interest expenses and bank charges they incurred from the margin loan.

A’ and ‘B’, through another financial advisor (‘D’) negotiated a compensation payment from C’s financial services licensee, (‘E’) for compensation for the capital loss. ‘E’ paid A’ and ‘B’ $X for their loss (first compensation amount)

‘B’ passed away in 2012.

‘D’ sought further compensation on behalf of A’ and ‘B’ estate in 2015 resulting in a further compensation payment of $X (second compensation amount) the payment was paid in 2015.

The ‘E’ initiated a review program in 2014.

In early 2016, ‘D’ began liaising with ‘E’ in relation to the financial advice received by A’ and ‘B’.

‘E’ agreed to pay A’ and ‘B’s estate a further sum of $X (third compensation payment).

The third compensation payment included payments described as opportunity cost and interest.

You have provided a number of documents that forms part of and should be read in conjunction with this private ruling.

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 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, a review was undertaken in relation to the poor return on your investment. An investigation undertaken concluded that you had been provided inappropriate investment advice. As a result of the review, you were offered an amount of compensation which included amounts for opportunity cost and interest.

Therefore, the amount of the compensation (excluding the interest component) is assessable under the capital gains tax provisions.