Edited version of private advice

Authorisation Number: 1052153694790

Date of advice: 21 August 2023

Ruling

Subject: Compensation

Question 1

Is the interest component of your compensation payment assessable as ordinary income?

Answer

Yes.

Question 2

Is the remainder component of your compensation payment assessable as ordinary income?

Answer

No.

Question 3

Is any capital gain or loss you made due to receiving the remainder component disregarded?

Answer

Yes.

This ruling applies for the following period:

Year ended DD MM 20XX

The scheme commenced on:

DD MM 20XX

Relevant facts and circumstances

You and your spouse established a self-managed superannuation fund.

As a result of inappropriate financial advice you received, the incurred financial loss due to the real estate investment/s that were purchased.

You accepted a compensation payment on DD MM 20XX consisting of an interest component and a remainder component of in satisfaction of the right to seek compensation.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 102-5

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

Income Tax Assessment Act 1997 paragraph 108-5(1)(b)

Income Tax Assessment Act 1997 section 118-305

Reasons for decision

Detailed reasoning

Summary

The interest component of the compensation payment is assessable income. The remainder component of your compensation payment is not assessable as ordinary income and the capital gain is disregarded.

Interest component

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts, which is called ordinary income.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considered an argument raised that interest in relation to compensation is not interest that is ordinary income; rather the claim is that the interest represents a capital amount which is simply part of the compensation, and which effectively represents part of the consideration received on the disposal of either the underlying asset or the right to seek compensation, as the case may be.

However, TR 95/35 did not accept this view. It states:

237. Interest has been described as 'payment by time for the use of money' (Rowlatt J in Bennett v. Ogston (1930) 15 TC 374 at 379). In economic terms, interest is the return or compensation for the use or retention by one person of a sum of money belonging or owed to another. Court rules allow the Court to include in compensation interest on the whole or part of the amount for the whole or part of the period to which the judgment relates.

238. Any interest awarded as part of compensation is interest within the general meaning of that term. It represents assessable income of the taxpayer even when the judgment provides only for a single lump sum which would otherwise be a capital receipt (Federal Wharf Co Ltd v. DFC of T (1930) 44 CLR 24; 1 ATD 70 and Riches v. Westminster Bank Ltd [1947] AC 390).

246. It is a question of fact to be determined in each case whether any part of the compensation received by the taxpayer is in the nature of interest. We consider that 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.

Consequently, the interest component of your compensation payment is assessable as ordinary income under section 6-5 of the ITAA 1997.

Remainder component

Ordinary income

Section 6-5 of the ITAA 1997 does not provide specific guidance on the meaning of income according to ordinary concepts (ordinary income), however likely characteristics of ordinary income that have evolved from case law include receipts that:

•                     are periodical, regular or recurrent;

•                     are relied upon by the recipient for their regular expenditure and paid to them for that purpose; and

•                     are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

In your case, the remainder component (apart from the interest component) was calculated based on the difference between the actual fund balance of your superannuation product at the end of the compensation period and what the balance would have been at that time if you had received appropriate advice.

The remainder component you and your spouse received is not assessable as ordinary income for these reasons:

•                     the amount is a one-off receipt and therefore does not have any elements of periodicity, regularity or recurrence.

•                     the amount does not relate to your employment, or services rendered by either you or your spouse.

Consequently, the remainder component is not assessable as ordinary income under section 6-5 of the ITAA 1997. The amount is considered to be capital in nature.

Statutory income - capital gains

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset. A taxpayer's right to seek compensation is therefore classified as an intangible CGT asset.

Why the remainder component was made is an important factor in determining whether an asset has been disposed of for capital gains tax 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 transaction which generated your receipt of the compensation payment was a result of the inappropriate advice provided to you which resulted in a financial loss in the SMSF. The relevant CGT asset in your case is the disposal of the right to seek compensation.

The right to seek compensation is an intangible CGT asset (acquired at the time the SMSF made a financial loss due to the superannuation fund providing the incorrect advice) and your ownership of that asset ended when you accepted the compensation payment to settle your claim.

The right to compensation lay with the SMSF however the amounts paid to you as the individual members are in satisfaction of its right to seek compensation.

At that time CGT event C2 happened. 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 remainder component are capital proceeds for your CGT C2 event.

Capital gain disregarded

An exemption is provided under section 118-305 of the ITAA 1997 for any capital gain or loss made from a CGT event happening in relation to a right to an allowance, annuity or capital amount payable out of a superannuation fund or an asset of a superannuation fund.

In your case, it is considered that the remainder component is a capital gain which may be disregarded due to section 118-305 of the ITAA 1997 applying.

Conclusion

The interest component is assessable in the income year you and your spouse accepted the compensation officer and should be apportioned based on each members entitlement in the SMSF.