Edited version of your written advice

Authorisation Number: 1051302639500

Date of advice: 2 November 2017

Ruling

Subject: Lump sum compensation payment

Questions

1. Is the compensation payment received by a person (Your Client) from a financial institution (the Payer) a superannuation member benefit for the purposes of subsection 307-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Is the interest component of the compensation payment assessable as ordinary income?

3. Is the remainder of the compensation payment assessable under the capital gains tax (CGT) provisions?

Answers

1. No.

2. Yes.

3. Yes.

This ruling applies for the following period:

Income year ended 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

In the 2016-17 income year, Your Client received a specified amount (the Compensation Payment) from the Payer in full and final settlement of the potential negative impact in relation to advice provided by the Payer during a specific period.

The Compensation Payment comprised the following components:

● losses on investment performance

● interest on losses on investment performance

● reimbursement of advice fees

● interest on reimbursement of advice fees

● reimbursement of advice fees

● interest on advice fees

The Payer has also agreed to pay compensation amounts (yet to be determined or finalised), for additional taxation on the Compensation Payment and any associated additional future taxation.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Section 102-5

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

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Subsection 112-20(1)

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Division 115

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

All references are to the ITAA 1997 unless otherwise indicated.

Reasons for decision

Summary

The Compensation Payment is not a superannuation member benefit for the purposes of subsection 307-5(1).

The interest component of the Compensation Payment is assessable as ordinary income.

The remainder of the Compensation Payment is assessable under the CGT provisions.

Detailed reasoning

Question 1

Item.1, Column 2 of subsection 307-5(1) provides that a superannuation member benefit is a payment to you from a superannuation fund because you are a fund member.

In this case, the Compensation Payment was paid to Your Client by the Payer, which was not a superannuation fund. Accordingly, the Compensation Payment is not a superannuation member benefit for the purposes of subsection 307-5(1).

Question 2

Subsection 6-5(1) 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 Income tax: capital gains: treatment of compensation receipts (TR 95/35) deals with the tax treatment of compensation receipts. Paragraph 26 of TR 95/35 specifically deals with the treatment of interest awarded as a part of a compensation amount:

26. 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, Your Client received an amount of compensation in relation to potentially inappropriate advice. The amount received was not an undissected lump sum as the Payer provided a detailed methodology showing the various components of the Compensation Payment and how this was calculated. Amounts were also separately identified as being interest payments. Therefore, these amounts are assessable as ordinary income.

Question 3

Section 102-5 provides that a taxpayer's assessable income includes a net capital gain (if any) for the income year. 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) as including a legal or equitable right that is not property.

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 sue on the settlement of a legal dispute (See Re Coshott and FCT [2014] AATA 622).

In this case, we consider the compensation Your Client received relates to the disposal of their right to seek compensation. The right to seek compensation was acquired at the time of the first compensable wrong or injury, and includes all the rights arising during the process of pursuing the compensation claim.

CGT event C2 happened when Your Client accepted the offer of compensation.

Further Information for you to consider

Working out the capital gain

The capital gain for the disposal of the right to seek compensation will be the difference between the capital proceeds Your Client received as compensation and the cost base of the right to seek compensation.

The cost base of the right to seek compensation is determined in accordance with the provisions of section 110-25. The consideration in respect of the acquisition of the right to seek compensation includes incidental costs of acquiring the right to seek compensation or relate to the disposal of the right. This would include any legal expenses incurred in respect of pursuing your right to seek compensation, that is, legal expenses that relate specifically to the settlement. Subsection 112-20(1) does not apply to deem a market value cost base for the right to seek compensation.

Section 118-20 will reduce the capital gain made from the CGT event where a provision of the Act outside of Part 3-1 includes an amount in your assessable income. In this case, the interest amounts are included in Your Client’s assessable income as ordinary income and Your Client will reduce their capital gain by these amounts.

As Your Client is an individual that acquired their asset after 11.45am on 21 September 1997 and held the asset (right to seek compensation) for more than 12 months, Your Client can reduce their capital gain by 50% using the discount method (Division 115).

Future Compensation for Taxation Amounts

You have advised that the Payer has agreed to pay compensation amounts for additional taxation on the Compensation Payment and any additional future taxation. The form of these payments and the sum has not been determined.

If the compensation for potential CGT liability is considered to be an indemnity and part of the original settlement, paragraphs 254 - 261 of TR 95/35 detail the taxation treatment of such receipts.

Where there is an ongoing obligation to pay a number of future payments, the treatment is similar to the treatment outlined in TR 2007/D10 Income tax: capital gains: capital gains tax consequences of earnout arrangements (withdrawn).

Once the form of the additional compensation payments is agreed upon between Your Client and the Payer, you may wish to apply for a private ruling in relation to its taxation treatment.