Edited version of your private ruling

Authorisation Number: 1051598300389

Date of advice: 25 October 2019

Ruling

Subject: Compensation for inappropriate financial advice

Question 1

Is your share of the settlement amounts that are interest, or amounts in the nature of interest, included in your assessable income?

Answer

Yes.

Question 2

Is your share of the settlement amounts that relate to capital losses made on the investment which you acquired as a result of following the inappropriate advice and have since sold treated as 'additional capital proceeds' for the disposal of the investment?

Answer

Yes.

Question 3

Is your share of the settlement amounts that is compensation for interest costs you incurred as a result of following the inappropriate advice included in your assessable income?

Answer

Yes.

Question 4

Is your share of the settlement amounts that is for the difference in net investment gain on the actual asset allocations and the net investment gain on appropriate asset allocations in relation to the investment that has been disposed of treated as 'additional capital proceeds' for the disposal of the investment?

Answer

Yes.

Question 5

Is your share of any capital gain made on the amount received for stress and inconvenience disregarded?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2018

The scheme commenced in

2008

Relevant facts

Financial advice

You and your spouse obtained financial advice from individual A while they worked for two separate businesses.

Complaint to entity B

You lodged a complaint with entity B alleging that the advice you received from individual A was inadequate and that as a result you had suffered loss.

Entity B reviewed the advice and calculated your loss during the period individual A worked for them.

In full and final settlement of your complaint with entity B you entered into a Deed of Settlement for a payment.

You claimed deductions for your interest costs which were included in the above calculations by entity B.

Entity C Customer Advice Review

In a letter, entity C advised you that they had conducted a review of financial advice given to you by individual A while they acted as a representative. Entity C concluded that some of the financial advice given to you during that period was inappropriate for your situation at the time and offered you compensation in relation to inappropriate asset allocations in a joint investment.

In calculating the compensation amounts entity C compared your actual position (based upon you following the inappropriate advice) to the position you would have been in had you received appropriate advice.

Entity C calculated the amount of compensation by comparing the net investment gain on the actual asset allocations and the net investment gain on appropriate asset allocations (counterfactual) which resulted in a difference of $xxx. Entity C then calculated an interest amount by applying the applicable home loan interest rate for the relevant period to the difference. Entity C then rounded this amount up.

You raised some concerns with entity C's findings and entity C subsequently offered you an additional amount as a goodwill gesture in recognition of the stress and inconvenience you experienced.

In a Deed of Settlement and Release, you and your spouse settled your claims against entity C.

You and your spouse disposed of your investment in 2018.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 102-20

Reasons for decision

Ordinary income

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)).

Ordinary income has generally been held to include 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.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

Statutory income

Amounts that are not ordinary income, but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997).

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list are Subdivision 20-A (recoupment) and section 102-5 (capital gains).

Assessable recoupments

Subdivision 20-A of the ITAA 1997 provides that certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Subsection 20-20(1) of the ITAA 1997 provides that an amount is not an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside of Subdivision 20-A.

An amount received by way of insurance or indemnity is an assessable recoupment if it is paid for a deductible expense and the deduction can be claimed in the current year or in an earlier income year (subsection 20-20(2) of the ITAA 1997). [Current year means the income year for which you are working out your assessable income and deductions].

Capital gains tax

You make a capital gain or capital loss as a result of a capital gains tax (CGT) event happening (section 102-20 of the ITAA 1997). For most CGT events, your capital gain or loss is the difference between your capital proceeds and the cost base or reduced cost base of your CGT asset.

The capital proceeds from a CGT event include the money you have received, or are entitled to receive, in respect of the event happening (subsection 116-20(1) of the ITAA 1997).

Treatment of settlement amounts if a CGT event happens (disposal of the asset)

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt.

The 'look-through' approach is defined in paragraph 3 of TR 95/35 as follows:

The 'look-through' approach is 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. It is also referred to in this Ruling as the underlying asset approach.

'Underlying asset' is also defined in paragraph 3 of TR 95/35 as follows:

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

Where the underlying asset for which the compensation relates has been disposed of, the compensation is considered to be additional capital proceeds for the disposal.

Capital gains tax exemption - compensation for personal wrong

A capital gain you make from a CGT event relating directly to compensation or damages you receive for any wrong you suffer personally is disregarded (subparagraph 118-37(1)(a)(ii) of the ITAA 1997).

Application to your circumstances

Compensation from entity B

No part of the settlement amount you received from entity B is ordinary income.

Assessable recoupment

Entity B calculated the compensation amount by taking into account your interest costs and reduced the amount by the tax benefits you had received. It is considered that the tax benefits you received were in relation to the deductions you claimed for the interest costs not the capital loss you made.

As you have been compensated for your interest costs, and you claimed a deduction for them in earlier income years this amount is an assessable recoupment and is included in your assessable income in the financial year ended 30 June 2018.

Capital gains tax - capital losses

Applying the 'look-through' approach, the most relevant asset to which the portion of the settlement amount that was for capital losses most directly relates is the investment.

Entity B calculated your capital losses on the investment. This amount is considered to be additional capital proceeds for the CGT event that happened when the investment was disposed of in 2018.

As the investment was held jointly your 50% share of this amount is $xxx. You will need to recalculate your capital gain and loss amounts for the year ended 30 June 2018 and may need to amend your tax return if there is now a capital gain, or there is an increased capital gain.

Compensation from entity C

Ordinary income - interest

The compensation amount from entity C included an amount of interest. Interest, or amounts received that are in the nature of interest are ordinary income. As the investment was owned jointly with your spouse your 50% share of this amount is included in your assessable income in the financial year ended 30 June 2018.

Capital gains tax - Difference between the actual and counterfactual asset allocations

Applying the 'look-through' approach, the most relevant asset to which this amount most directly relates is the investment.

As the investment was held jointly your 50% share of this amount is $xxx. You will need to recalculate your capital gain and loss amounts for the year ended 30 June 2018 and may need to amend your tax return if there is now a capital gain, or there is an increased capital gain.

Capital gains tax - goodwill gesture - stress and inconvenience

The capital gain you made on your 50% share of this amount is disregarded under section 118-37 of the ITAA 1997.