Edited version of private advice

Authorisation Number: 1051869309452

Date of advice: 19 July 2021

Ruling

Subject: Compensation - lump sum payment

Question 1

Will the Lump Sum Payment you receive be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the Lump Sum Payment you receive be treated as an ex-gratia payment?

Answer

No

Question 3

Will the Lump Sum Payment you receive be assessable as a capital gain?

Answer

Yes

Question 4

Will the capital gain made be disregarded under section 118-305 of the ITAA 1997?

Answer

No

Question 5

If the answer to Question 4 is 'No' will the capital gain be a discount capital gain under Division 115 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Years ended 30 June 2021 to 30 June 2022

The scheme commences on:

1 July 2019

Relevant facts and circumstances

You have been employed by a company for approximately XX years.

You are a member of the Super Fund

In or around XX/20XX, it was discovered that superannuation balances for a number of members of the Super Fund were miscalculated and incorrect due to administrative errors. The correctness of your superannuation benefit was confirmed in or around XX/20XX by the Trustee of the Super Fund.

On XX/XX/20XX, you were advised of an error and misrepresentation of your superannuation balance and your superannuation benefit.

You suffered financial detriment by having:

•        made financial decisions with respect to your retirement based on the erroneous and misrepresented balance of your superannuation benefits; and

•        lost the opportunity to increase the superannuation benefits to which you could have been entitled upon your retirement had you known the true balance of your superannuation benefits.

You and the Trustee will enter into a deed of settlement and release (Deed) to settle any claim you may have against the Trustee. The Trustee will determine to make a Lump Sum Payment, in consideration for resolving all matters arising with respect to the error, without admission of liability.

The Trustee has advised that it is not permitted to recoup the Lump Sum Payment out of the Super Fund.

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 104-25

Income Tax Assessment Act 1997 section 118-305

Income Tax Assessment Act 1997 division 115

Reasons for decision

Ordinary Income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

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.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

The Lump Sum Payment you will receive was not earned by you as it does not relate to services performed. The payment is not a revenue receipt directly related to your employment duties. The payment is not considered to be a payment solely for lost income. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the errors from your Super Fund leading to a misrepresentation of your superannuation balance.

Considering the full circumstances, the Lump Sum Payment will not be regarded as ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

Ex-gratia payment

An ex gratia payment is one that is given as a favour or gift. The term 'gift' is not defined in the ITAA 1997. Therefore, the word 'gift' takes its ordinary meaning. Rather than attempting to define a 'gift', the courts have described a gift as having the following characteristics and features:

•        There is a transfer of the beneficial interest in property

•        The transfer is made voluntarily

•        The transfer arises by way of benefaction, and

•        No material benefit or advantage is received by the giver by way of return.

Based on the information provided, the cause for the Lump Sum Payment is in relation to claims against your Super Fund. It is considered that the payment is not a true 'gift', but rather paid to you as compensation to settle your dispute with your Super Fund.

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 capital gains, section 102-5 of the ITAA 1997.

Capital gains tax (CGT) provisions and compensation

Your assessable income includes your net capital gain for the income year (section 102-5 of the ITAA 1997). Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens.

Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts.

Why the payment was made is an important factor in determining whether an asset has been disposed of for CGT purposes.

TR 95/35 discusses the various scenarios, including:

• disposal of the underlying asset,
• compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and
• disposal of the right to seek compensation.

The relevant CGT asset in your case is the right to seek compensation. The payment you will receive will be in full settlement of the claims made.

Your right to seek compensation is an intangible CGT asset and your ownership of that asset will end when you accept the Lump Sum Payment. At that time CGT event C2 happens. CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being released or cancelled (subsection 104-25(1) of the ITAA 1997). In your case, the Lump Sum Payment represents capital proceeds for your CGT C2 event.

Section 118-305 of the ITAA 1997

Section 118-305 of the ITAA 1997 is an exemption to the CGT provisions for amounts that are 'in relation to' a right to all or part of an allowance, annuity or capital amount payable out of a superannuation fund or an asset of the fund. Any capital gain or loss from an amount that falls within that exemption is disregarded.

In your case, the amount of the compensation does not have a sufficient connection with the rights you had in the Super Fund to fall within section 118-305 of the ITAA 1997. This is because the right you had in the Super Fund was only ever the amount held in your super account, not the overstated amount incorrectly included on the statement. That is, there was no loss in the Super Fund itself. As the compensation amount only relates to that excess amount, to which you had no legal right, the connection between the right to the payment and the interest in the Super Fund is indirect and too remote to meet the "in relation to" requirement in section 118-305 of the ITAA 1997. Therefore, the exemption does not apply.

Application of the CGT discount

A discount capital gain may be applied if certain conditions are met under Division 115 of the ITAA 1997.

As you acquired the right to seek compensation more than 12 months before the CGT event, you can apply the 50% general discount.