Edited version of private advice

Authorisation Number: 1051600192088

Date of advice: 31 October 2019

Ruling

Subject: Compensation - inappropriate financial advice

Question

Will the compensation payable to you be assessable income in the financial year it will be received?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commences on:

1 July 2008

Relevant facts and circumstances

In 2008, you invested a significant amount of money in a project following the advice of a financial planner who is an authorised representative of Company A.

A couple of years later, you invested more money in the same project following the advice of the same financial planner.

You alleged that you made a loss from these investments. Company A and the financial planner denied your claim and as a result you lodged a complaint with the relevant authority. You provided a copy from the relevant authority letter.

Company A has agreed to settle the complaint without admission of liability with the payment of compensation.

You provided a copy of the draft Deed confirming the nature and amount of each component of the payments.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 15-30

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 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).

Interest

Interest income is regarded as ordinary income and therefore assessable under subsection 6-5(2) of the ITAA 1997.

Paragraph 26 of Taxation Ruling TR 95/35 deals with the treatment of interest awarded as a part of a compensation amount. It states:

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.

Recoupment

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

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 is section 102-5 (capital gains).

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).

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for a taxpayer in receipt of compensation and whether the amount should be included in the assessable income of the recipient under the CGT provisions.

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 (paragraph 70 of TR 95/35).

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 (paragraph 3 of TR 95/35).

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 (paragraph 3 of TR 95/35).

Treatment of compensation if a CGT event happens (disposal of the asset):

CGT event A1 happens when you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997). The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs (subsection 104-10(3) of the ITAA 1997).

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset of the taxpayer, the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation (paragraph 4 of TR 95/35).

The compensation may form part of or all of the consideration in respect of the disposal of the underlying asset, and may be received by the taxpayer before or after the actual disposal of the underlying asset (paragraph 144 of TR 95/35). For example, litigation may result in compensation for losses arising from an investor's former investments.

Application to your circumstances

In your case, you will receive a payment made of components which are assessable income as either ordinary or statutory income. The payment is therefore assessable in the financial year you will receive it, and no exemptions will apply.