Edited version of private advice

Authorisation Number: 1051893441454

Date of advice: 31 August 2021

Ruling

Subject: Compensation - lump sum payment

Question 1

Is the Settlement Amount classified as a superannuation benefit under section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the Settlement Amount assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer

No

Question 3

Is the Settlement Amount assessable as a capital gain?

Answer

Yes

Question 4

If the answer to Question 4 is 'Yes' will the capital gain be a discount capital gain under Division 115 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are a member of a Super Fund.

In XX/20XX the trustee of your superannuation fund advised you they were reviewing the member information held for you on the basis that it was concerned an error had been made in the calculation of your benefits. You were subsequently advised in this initial review they did not identify any discrepancy in your 30 June 20XX superannuation benefit. This process caused you great stress and anxiety.

On XX/XX/20XX you received a letter from the trustee of your superannuation fund in relation to your benefit in the Super Plan. The trustee of your superannuation fund did not correctly account for your transfer from weekly to monthly payroll. As a result, benefits were calculated incorrectly between a period. The balance was incorrectly displayed during this period and should be decreased. The trustee of your superannuation fund provided you could lodge a complaint and were entitled to be covered for reasonable costs, including seeking advice.

You had been making financial decisions and commitments based on the balance including the timing of your pending retirement and your family's lifestyle during retirement.

The calculations provided by the trustee of your superannuation fund amounted to $XXX,XXX less in superannuation benefits. The error had been made in a formula in 20XX and had resulted in your member's balance being consistently wrongly overstated from that time forward. You agreed the difference in balance was the result of a calculation error by the trustee of your superannuation fund and the restated balance was correct.

You have suffered tremendous stress and anxiety throughout the process as a result of the misreporting by the trustee of your superannuation fund and the impact it has had on your pre-retirement decision making and retirement planning. During the year you had constant meetings and phone calls with the trustee of your superannuation fund to find some form of agreement for this error which was a huge emotional and mentally draining experience.

You have made several major financial decisions, as well as day-to-day decisions, based on the superannuation balances prior to identification of the error, including:

•         the retirement of your spouse from the workforce;

•         the planned timing of your own impending retirement;

•         renovations on your own house;

•         purchase of new assets;

•         commitment to provide children funds for deposits of their future own homes; and

•         the sale of a previous investment property with the intention of purchasing another.

You entered a Deed of Release dated XX/XX/20XX with the trustee of your superannuation fund showing you had made a complaint against the Trustee in connection with your benefit (Claim) and the Trustee and you wished to settle the Claim. The Trustee agreed to pay the following amounts in full and final settlement of the Claim (Settlement Amount):

a)    a single lump sum payment of $XXX,XXX (First Payment);

b)    the lesser of any tax and Medicare Levy, if any, incurred in connection with the First Payment and $XXX,XXX (Taxation Adjustment); and

c)    a lump sum payment of $XX,XXX (as two payments of $XX,XXX) for reasonable costs of obtaining legal, financial and tax advice in connection with settling the Claim (Professional Fees Recouped).

The Deed of Release is silent on the reason for, and the nature of, the payment.

The First Payment was the difference between the superannuation balance that was advised and the actual balance.

The Trustee has advised that it is not permitted to recoup the Settlement Amount 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 - division 115

Income Tax Assessment Act 1997 - section 307-5

Reasons for decision

Superannuation Benefit

Superannuation benefits are defined in section 307-5 of the ITAA 1997. In accordance with Item 1 of the table in subsection 307-5(1) of the ITAA 1997 a superannuation member benefit is a payment to you from a superannuation fund because you are a fund member.

Subsection 307 5(2) of the ITAA 1997 further clarifies that a payment described in column 2 of the table in subsection 307 5(1) is a superannuation member benefit.

Based on the information you provided to us the lump sum payment under the Deed was not made by the superannuation fund, but rather by the entity that is the trustee of the superannuation fund.

As this payment was not made from the Super Fund but rather by the trustee of the Super Fund, the payment you received is not a superannuation benefit in accordance with section 307-5 of the ITAA 1997. This is because the payment received by you is not a category of superannuation payment mentioned in subsection 307-5(1) of the ITAA 1997.

Ordinary Income

Subsection 6-5(2) of the 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 the trustee of your superannuation 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

Although you have not requested a ruling on the question, we note your application included consideration the settlement be an 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 the trustee of your superannuation fund. It is considered that the payment is not a true 'gift', but rather paid to you as compensation to settle your dispute with the trustee of your superannuation 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 Settlement Amount. 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).

Taxation adjustments - additional capital proceeds

A taxation adjustment is any additional amount of compensation (for example, a 'top-up') calculated to cover any income tax liability (including CGT) that may arise in respect of a compensation receipt. This amount may be determined and received at the time of the compensation receipt or at any other time (paragraph 3 of TR 95/35).

Taxation adjustments are considered to be additional amounts received as a result of or in respect of the disposal of an asset (paragraph 27 of TR 95/35).

You are entitled to receive under the Deed an amount for a 'taxation adjustment' as an additional amount of compensation to cover any personal income tax liability that may arise in respect of the First Payment. This amount would be treated as additional capital proceeds for the disposal of your right to seek compensation.

In your case, the First Payment and Taxation Adjustment represent capital proceeds for your CGT C2 event.

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.