Edited version of your written advice

Authorisation Number: 1051356546556

Date of advice: 3 April 2018

Ruling

Subject: Compensation payment

Question 1

Is the compensation amount payable to you for lost opportunity cost assessable under the capital gains tax provisions?

Answer

No.

Question 2

Is the compensation amount payable to you for lost opportunity cost assessable as ordinary income?

Answer

Yes.

Question 3

Is the compensation amount payable to you for the forfeited deposit assessable under the capital gains tax provisions?

Answer

Yes.

Question 4

Is the compensation amount payable to you for other costs previously paid out and expensed an assessable recoupment?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Individuals received financial advice to establish a SMSF and that the SMSF purchase a property.

Funds from their individual retail superannuation funds were rolled into the SMSF and a property fitting their investment criteria was sought.

The SMSF entered into a contract to purchase a property and a deposit was paid.

Finance was unable to be secured on the property and the deposit was forfeited.

A complaint was lodged with the Credit & Investments Ombudsman regarding the advice provided.

The ombudsman recommended the SMSF receive a compensation payment in full and final settlement of the complaint comprising of the lost opportunity cost to members on consolidating their superannuation money into the SMSF, and the capital and other costs paid out by the SMSF.

A Settlement and Release Deed was entered into which states that each party agrees to settle, and agrees that the Deed creates and constitutes a full and final settlement of, any claim by that party against the other party which that party has or may have at any time arising out of or in relation to or in connection with the Dispute.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Paragraph 104-25(1)(d)

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 20-20(2)

Reasons for decision

Questions 1&2

Section 102-5 of the Income Tax Assessment Act 1997 (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 to a CGT asset. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

Generally, when a taxpayer receives a compensation payment, a taxpayer has disposed of the right to seek compensation and a capital gain will usually arise. However, in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts, the Commissioner provides for an administrative practice in which a taxpayer can look through the ending of the right to seek compensation to an underlying asset of the taxpayer and the reasons for the compensation payment.

This is known as the ‘look-through’ approach, and is described in paragraph 3 of TR 95/35 as 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.

Right to seek compensation

The right to seek compensation is the right arising at law or in equity that vests in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. A right to seek compensation is an asset for the purposes of capital gains tax. The right to seek compensation is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged. This disposal triggers a CGT event C2.

In your case, you received a payment for the lost opportunity cost following the ombudsman recommendation that the advice to establish an SMSF was not appropriate. By entering into the Settlement and Release Deed you surrendered your right to seek compensation in relation to the inappropriate advice to set up an SMSF. Therefore, CGT event C2 occurred when you entered into the Settlement and Release Deed.

However, applying the underlying asset approach in TR 95/35, this component of the compensation relates specifically to the lost opportunity cost on consolidating your superannuation monies from your retail superannuation funds into the SMSF. The amount of compensation represents the difference between the performance of your actual SMSF and the performance of your previous retail superannuation funds.

This component of the compensation therefore adds to the balance of the monies in your SMSF. As the compensation replaces an amount that would have been assessable as ordinary income to the SMSF trustee if it had been earnt directly by the SMSF, it is treated as assessable income. This is because compensation payments acquire the same character as the amount they substitute (Commissioner of Taxation (NSW) v Meeks (1915) 19 CLR 568).

On the basis that this component of the compensation is assessable as ordinary income of the SMSF, the anti-overlap provision in section 118-20 of the ITAA 1997 reduces any capital gain by amounts that are otherwise assessable as a result of the event.

Therefore, section 118-20 of the ITAA 1997 will reduce the amount of the capital gain to nil. The amount received for inappropriate advice to establish an SMSF is assessable as ordinary income.

Question 3

Taxation Ruling TR 1999/19 Income tax capital gains: treatment of forfeited deposits details the tax treatment of forfeited deposits. It notes that when an individual signs a contract to purchase property, they acquire a CGT asset in the form of a contractual right to a transfer of the asset (the contractual right).

When a contract for the sale of real property does not proceed and a deposit is forfeited by a defaulting purchaser, TR 1999/19 specifies CGT event C2 happens as your ownership of an intangible CGT asset (being the contractual rights) ends. The time of the event is when you enter into a contract that results in the asset ending or, if there is no contract, when the asset ends. There are a number of ways such an asset can end, including being abandoned, surrendered or forfeited.

Consequently, CGT event C2 occurred when your contract to purchase the property was terminated and your ownership of the contractual right to the transfer of the property ended. This would have been the time that you were unable to proceed with settlement and forfeited the deposit.

Cost base

When a CGT event happens to a CGT asset you own, you make a capital gain or loss depending on whether or not the capital proceeds are more or less than the cost base or reduced cost base of the CGT asset. If the capital proceeds exceed the cost base of the asset, a capital gain is made. When the capital proceeds are less than the reduced cost base of the asset, a capital loss arises.

There are five elements that can make up the cost base of a CGT asset. These are:

● The first element: money or property given for the asset.

● The second element: incidental costs of acquiring the asset or that relate to the CGT event.

● The third element: costs of owning the asset.

● The fourth element: capital costs to increase or preserve the value of your asset or to install or move it.

● The fifth element: capital costs of establishing, preserving or defending your ownership of or rights to the asset.

Except for the third element, the reduced cost base of a CGT asset has the same five elements as the cost base. The third element of the reduced cost base relates to balancing adjustments which do not apply to contractual rights.

Generally, the capital proceeds from a CGT event is either the money, or the market value of property, you receive, or are entitled to receive from the event happening.

In your case, you received compensation for forfeiting the deposit on the property. Therefore, the compensation amount will be treated as the capital proceeds for the happening of the CGT event C2 at the time of forfeiture. As the amount of compensation on this point is exactly equal to the deposit lost, the cost base will match the capital proceeds. Consequently there will be a nil outcome and there will be no capital gain or loss associated with the amount received for the forfeiture of the deposit.

Question 4

The residual amount is the remainder of the payment after deducting the compensation for the forfeiture of the deposit.

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income also includes statutory income. Statutory income is amounts that are not ordinary income but are included in assessable income by another provision. One such provision is section 20-20 of the ITAA 1997 which deals with assessable recoupments.

Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss or 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 for an earlier income year, under any provision of this Act.

The word "indemnity" is not defined in the ITAA 1997 and so it must take its ordinary meaning. In Denmark Community Windfarm Ltd v FC of T [2017] FCA 478, Mckerracher J expressed the view that an indemnity may include a sum of money paid to a person in respect of an outgoing incurred by the person. Butterworths Concise Australian Legal Dictionary (3rd ed, LexisNexis, 2005) defines indemnity as 'a sum of money paid to compensate a person for liability, loss or expense incurred by the person'. The Macquarie Dictionary (online), defines indemnity as compensation for damage or loss sustained

Alternatively, an amount could be an assessable recoupment under section 20-20(3) if you have or can deduct an amount for the loss or outgoing under a provision listed in the tables in section 20-30.

In your case, your compensation payment included an amount for other costs incurred by the SMSF. You have provided an example of professional fees. Consequently, the amount was paid to you as compensation for expenses you have incurred. Depending on the nature of the costs paid and expensed by the SMSF, you have received an amount of compensation as a recoupment of a loss or outgoing, either by way of indemnity or under a provision listed in section 20-30 of the ITAA 1997.

As you have received a recoupment for a loss or outgoing that you have claimed or can claim a deduction for, we consider that the payment you received for costs previously paid out and expensed is an assessable recoupment under section 20-20 of the ITAA 1997.