Edited version of private advice

Authorisation Number: 1052086210468

Date of advice: 20 February 2023

Ruling

Subject: Compensation - loan not changed from interest only to principal and interest

Question

Does Subdivision 20-A of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the Compensation receipt paid by the lender?

Answer

No.

Question 2

Does section 104-25 of the ITAA 1997 apply to the Compensation receipt paid by the lender?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The deceased had a loan with a financial institution.

The interest only period on the loan had expired at which point the deceased had the option to extend the loan term and the repayments should have switched to principal and interest.

Due to an error by the financial institution this did not happen.

As the principal amount of the loan was not being reduced excess interest was paid.

The financial institution informed the estate of the error and offered a total compensation amount (Compensation receipt) which consisted of:

•         a refund of the excess interest that had been paid on the loan due to the error, and

•         an additional amount as compensation for the deceased not having use of the funds.

The estate accepted the Compensation receipt.

The estate did not claim deductions for any interest paid on the loan.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-25(1)

Reasons for decision

Assessable recoupments

Subdivision 20-A of the Income Tax Assessment Act 1997 (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 gain (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 C2 happens when your ownership of an intangible CGT asset ends by cancellation, surrender, or release or similar means (subsection 104-25(1) of the ITAA 1997. The right to seek compensation is an intangible CGT asset.

The capital proceeds from a CGT event include the money you have received, or are entitled to receive, in respect of the happening of the CGT event (subsection 116-20(1) of the ITAA 1997).

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).

Treatment of settlement amounts if a CGT event happens (disposal of the asset)

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts and provides that in certain circumstances, it may be appropriate to adopt a 'look-through' approach to the transaction or arrangement which generates the compensation receipt to determine the most relevant asset in respect of which the compensation has been received.

Where the compensation amount is not received in relation to any underlying asset the most relevant asset is the right to seek compensation.

Application to your circumstances

Assessable recoupments

The total compensation receipt included an amount for excess interest paid on the loan due to the error. The estate did not claim deductions for any interest paid on the loan. As such, no part of the total Compensation receipt is included in the estate's assessable income as an assessable recoupment under Subdivision 20-A of the ITAA 1997.

Capital gains

The total amount of the Compensation receipt paid to the estate relates to a failure by the financial institution, at the expiration of the interest only period of the loan, to provide the deceased with the opportunity to extend the term of the loan and ensure that the repayments switched to principal and interest. As such, the amount the deceased was entitled to receive was not in respect of any underlying asset and relates to the disposal of the right to seek compensation in relation to the financial institution's errors which resulted in the payment of excess interest.

The estate is considered to have disposed of this right to seek compensation in relation to the errors when the decision was made to accept the compensation payment. CGT event C2 happened at this time. The total Compensation receipt represents capital proceeds for the disposal of the right to seek compensation.