Edited version of private advice

Authorisation Number: 1051598342010

Date of advice: 26 November 2019

Ruling

Subject: Compensation - inappropriate 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 Company Y 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, to the extent that deductions were claimed for the interest.

Question 4

Is your share of the fees that were refunded by Company Z included in your assessable income?

Answer

Yes, to the extent that deductions were claimed for the fees.

This ruling applies for the following periods

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

Financial advice

You and your spouse obtained financial advice from Individual Z who was authorised to provide advice for two separate businesses:

• Company D from late 20XX until early 20XX, and
• Company B from early 20XX until early 20XX.

In a Statement of Advice (SOA) dated late 20XX Individual Z advised you and your spouse to:

• borrow $XXX,XXX
• invest the whole amount into a portfolio of Australian managed share funds using Company E, and
• use the proceeds from the investment strategy to pay down your mortgage.

You agreed to proceed with the advice as outlined in the SOA and commenced the investment strategy a short time after. Up until the time Individual Z ceased acting for Company D the overall investment strategy remained consistent.

In or around 20XX you engaged the services of Company C to investigate and review the soundness of the advice provided to you by Individual Z.

Company C considered your financial needs and objectives and your personal and financial circumstances at the time the advice was provided and concluded that the recommended strategies were not appropriate for you in your circumstances or for achieving your objectives.

Company C estimated that your financial losses as a result of the advice were $XXX,XXX.XX, which was calculated as follows:

Complaint to Company D

You lodged a complaint with Company D alleging that the advice you had been provided was inappropriate for your circumstances, claiming losses of $XXX,XXX.XX.

Company D reviewed the issues and concerns you raised in your complaint and without admission of any legal liability acknowledged that you suffered financial loss as a result of the financial advice provided by Individual Z.

Company D undertook their own calculation of the losses incurred from the recommended gearing strategy up until the end of the financial year ended 30 June 20XX, noting that Individual Z ceased acting for Company D early 20XX.

The losses calculated by Company D came to $XX,XXX.XX, calculated as follows:

In addition, Company D offered an additional $X,XXX for professional fees incurred in pursuit of your complaint.

In full and final settlement of your complaint with Company D you entered into a Deed of Settlement dated early 20XX for $XX,XXX.XX.

You claimed deductions for interest costs incurred on the loan(s) taken out to finance the investment.

Company Z Customer Advice Review

In a letter dated late 20XX Company Z advised you that they had conducted a review of financial advice given to you between early 20XX and early 20XX by Individual Z while he acted as a representative of Company B (part of the Company Z group). Company Z concluded that the financial advice you received during that period was appropriate for your situation at the time.

You disagreed with the findings in relation to the review and replied to Company Z outlining your reasons for disagreeing (letter to Company Z dated early 20XX which should have been early 20XX).

Company Z conducted an investigation into the issues raised by you and concluded that overall the advice you received was appropriate for your circumstances. However, in view of your dissatisfaction with the service you had received, Company Z offered you a refund of the adviser services you had paid as a goodwill gesture.

Company Z calculated the advisor service fees you paid over the period that Individual Z was licenced through Company B and applied interest to those amounts. They offered you a total compensation amount of $XX,XXX which was calculated as follows:

In a Deed of Settlement and Release made early 20XX you settled your claims against Company B for the above amounts.

You claimed deductions for management fees (which included advisor fees) incurred in relation to the investments.

You disposed of the Company Y investment in the financial year ended 20 June 20XX.

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 102-5

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 3 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

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).

The five elements of a CGT asset's cost base are acquisition costs, incidental costs, non-capital costs of ownership which are not deductible, capital expenditure to increase the value of the asset, and capital expenditure to establish, preserve or defend title to the asset or a right over the asset (section 110-25 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.

Application to your circumstances

Compensation from Company D

No part of the settlement amount you received from Company D is ordinary income.

Assessable recoupments

Company D calculated the compensation amount by taking into account your XX% share of the interest costs of $XX,XXX ($XX,XXX) and reduced the amount by the tax benefits you had received of $XX,XXX.XX. 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 of $XX,XXX.XX ($XX,XXX - $XX,XXX.XX) this amount is an assessable recoupment to the extent that you claimed deductions for the interest, and is included in your assessable income in the financial year ended 30 June 20XX.

You also received an amount of $X,XXX for professional fees incurred in pursuit of your complaint. As you have or can claim a deduction for these professional fees your XX% share of this amount is an assessable recoupment and is included in your assessable income in the financial year ended 30 June 20XX.

Your XX% share of this amount is also an assessable recoupment to the extent that deductions have been claimed for professional fees, and is included in your assessable income in the financial year ended 30 June 20XX.

Capital gains tax - capital losses of $XX,XXX.XX

Applying the 'look-through' approach, the most relevant asset to which the portion of the settlement amount that was for capital losses to early 20XX most directly relates is the Company Y investment.

Company D calculated your capital losses to June 20XX on the Company Y investment as being $XX,XXX.XX. This amount is considered to be additional capital proceeds for the CGT event that happened when the Company Y investment was disposed of in the financial year ended 30 June 20XX.

As the Company Y investment was held jointly your XX% share of this amount is $XX,XXX.XX.

Please note: The time period to amend your 20XX notice of assessment has expired. As such, you are not required to request an amendment to that notice of assessment.

While you are not be required to amend, you will need to recalculate your capital gain/loss amounts for that year for the purposes of reducing any carry forward capital losses you may have had and this may flow forward to affect income tax returns for more recent years.

Compensation from Company Z

Ordinary income

Your share of the compensation payment from Company Z includes interest on residual cash of $XXX and interest on compensation of $XXX.

Interest, or amounts received that are in the nature of interest, are ordinary income. As such, these amounts are included in your assessable income in the financial year ended 30 June 20XX.

Assessable recoupments

Your share of the amount received from Company Z includes a refund of adviser fees of $X,XXX. As you have received a refund of fees, this amount is an assessable recoupment to the extent that deductions were claimed for the fees, and is included in your assessable income in the financial year ended 30 June 20XX.