Edited version of private advice

Authorisation Number: 1051616341588

Date of advice: 3 December 2019

Ruling

Subject: Compensation - inappropriate advice

Question 1

Is the interest component of the payment you received, and other amounts that are in the nature of interest, included in your assessable income?

Answer

Yes.

Question 2

Is the amount you received as reimbursement of the premiums paid for insurance cover that was potentially inappropriate included in your assessable income?

Answer

Yes, to the extent that deductions were claimed for the insurance premiums.

Question 3

Is the amount you received as reimbursement of the premiums paid for insurance cover that was potentially inappropriate treated as a reduction of the cost base of investments you acquired as a result of following the potentially inappropriate advice?

Answer

Yes, to the extent that the insurance premiums were included in the cost base.

Question 4

Is the amount you received as compensation for net interest paid and received on loans taken out as a result of following the potentially inappropriate advice included in your assessable income?

Answer

Yes, to the extent that deductions were claimed for the interest (apportioned as explained in the reasons for decision below).

Question 5

Is the amount you received as compensation for fees charged for the potentially inappropriate advice included in your assessable income?

Answer

Yes, to the extent that deductions were claimed for the fees (apportioned as explained in the reasons for decision below).

This ruling applies for the following periods

Year ended 30 June 20XX to year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

You obtained financial advice.

You were advised to borrow money and invest in a specific investment product.

The financial advice provided to you was reviewed and it was determined that the financial advice was potentially inappropriate and offered you a payment in respect of that advice.

You were offered a payment of $XX,XXX. This amount represents the calculation of the potential negative financial impact of the advice given to you, and was made up of the following components:

·         Insurance - $XX,XXX

·         Gearing - $XX,XXX, and

·         Interest - $X,XXX.

Insurance

This amount is reimbursement for the premiums paid for insurance cover that was potentially inappropriate at the time. The premiums were paid in relation Insurance policies you took out to cover your increased risk as a result of taking out the investment loans.

Gearing

This amount is payment for losses due to gearing recommendations that were potentially inappropriate given your circumstances at the time. This amount was calculated as follows:

Interest

This amount represents the interest calculated on the amounts above.

You accepted the offer and received payment in or around July 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 102-20

Income Tax Assessment Act 1997 subsection 110-45(3)

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).

Any amount which is in the nature of interest, and which can be identified as interest, and whether paid as part of the compensation or separately, constitutes assessable income of the taxpayer under the general income provisions (paragraph 246 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35)).

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).

However, expenditure does not form any element of the cost base to the extent of any amount you have received as recoupment of it, except so far as the amount is included in your assessable income (subsection 110-45(3) of the ITAA 1997).

Treatment of compensation where a CGT event has not happened

If a CGT event hasn't happened for a particular investment asset, for example an investment is still held, any compensation amounts are still taken into account for capital gains tax purposes. This will be the case even if the asset is of no current value.

Where the compensation amounts can be reasonably related to an investment asset, the cost base of the relevant asset is reduced by the amount of the compensation received. The receipt of the compensation does not create a CGT event for the investment assets.

Application to your circumstances

Ordinary income - interest and amounts in the nature of interest

The compensation you received included an amount of interest of $X,XXX and an amount of $X,XXX for the 'time value of money'.

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

The compensation amounts received to reimburse you for interest, fees and insurance premiums are considered to be assessable recoupments to the extent that deductions were claimed for the interest, fees and insurance premiums.

The compensation amount was calculated for gearing by taking into account your share of the net interest paid and received on loans of $XX,XXX and fees charged of $XX,XXX, which when added together give a total amount of $XXX,XXX.

When broken down into percentages:

·         XX% of the $XXX,XXX relates to net interest paid and received on loans; and

·         XX% relates to fees charged.

However, the compensation amount has been reduced by the gain made on your investment of $XX,XXX. It is considered that this amount should be apportioned to reduce the net interest paid and received and the fees charged based on the percentages calculated above.

Therefore:

·         $XX,XXX - $XX,XXX (XX% x $XX,XXX) = $XX,XXX, is included in your assessable income for the reimbursement of net interest received and paid; and

·         $XX,XXX - $XX,XXX (XX% x $XX,XXX) = $XX,XXX, is included in your assessable income for the reimbursement of fees charged

in the year ended 30 June 20XX to the extent that deductions were claimed for these expenses.

Similarly, the amount of $XX,XXX received for the reimbursement of insurance premiums will also be included in your assessable income in the year ended 30 June 20XX to the extent that deductions were claimed for the insurance premiums that were reimbursed.

Capital gains tax

The amount of $XX,XXX received for the reimbursement of insurance premiums is treated as a reduction in the cost base of your investment to the extent that the insurance premiums have been included in the cost base.