Edited version of private advice

Authorisation Number: 1051622602125

Date of advice: 4 February 2020

Ruling

Subject: Compensation - potentially inappropriate advice - interest - assessable recoupment - additional capital proceeds

Question 1

Is the interest component of the payment you received from Bank A included in your assessable income?

Answer

Yes

Question 2

Is the dividend component of the payment you received from Bank A treated as additional capital proceeds for the disposal of the investment?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2014 to year ended 30 June 2019

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You obtained financial advice from an adviser while they were an authorised representative of Bank A. You had investments with a Financial Group.

The Financial Group reviewed the financial advice provided to you and identified issues with the advice that required remediation in relation to having dividends paid to cash rather than being reinvested in respect to your portfolio (investment).

The Financial Group offered you a payment of $Z for losses due to new issues with your advice which consisted of:

·   $Y which represents payment for having dividends paid to cash rather than being reinvested (dividend component), and

·   $X in interest on this amount.

You accepted the offer from the Financial Group and received payment on or about DDMMYYYY.

You disposed of your investment in the financial year ended 30 June YYYY.

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 104-10(1)

Income Tax Assessment Act 1997 Division 116

Income Tax Assessment Act 1997 subsection 118-20(1)

Income Tax Assessment Act 1997 subsection 118-20(1A)

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 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.

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997). 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)

TR 95/35 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.

Reducing capital gains if amount otherwise assessable - preventing double taxation

A capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act (outside of Part 3.1) includes an amount (for any income year) in your assessable income or exempt income (subsection 118-20(1) of the ITAA 1997).

Subsection 118-20(1) of the ITAA 1997 applies to an amount that, under a provision of this Act (outside of part 3.1), is included in your assessable income or exempt income in relation to a CGT asset as if it were so included because of the CGT event referred to in that subsection if the amount would also be taken into account in working out the amount of a capital gain you make (subsection 118-20(1A) of the ITAA 1997).

Application to your circumstances

Ordinary income - interest

The payment you received included an amount of interest of $X.

Interest, or amounts received that are in the nature of interest, are ordinary income. As such, this amount is included in your assessable income in the financial year ended 30 June XXXX.

Capital gains

Applying the 'look-through' approach, the most relevant asset to which the compensation amount (including the geared remediation, ungeared remediation, interest and the additional amount for personal tax implications) most directly relates is the investment itself.

The full amount of the compensation payment you received constitutes additional capital proceeds from the disposal of your investment which triggered CGT event A1. However, subsections

118-20(1) and 118-20(1A) of the ITAA 1997 will operate to reduce any capital gain to the extent that the payment is assessable as ordinary income (interest).

The remaining component of the dividend component ($Y) is additional capital proceeds received for the CGT event (A1) that happened when you disposed of your investment.