Edited version of private advice

Authorisation Number: 1052239264734

Date of advice: 18 April 2024

Ruling

Subject: Assessable income - compensation payment

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.

The remainder component is viewed as being capital in nature and will be assessed under the capital gains tax provisions.

Question 3

Is any capital gain or loss you made due to receiving the remainder component disregarded under section 118-305 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commenced on:

1 July 20XX.

Relevant facts and circumstances

The superannuation fund (the Fund) was wound up prior to the commencement of the ruling period.

At the time the Fund was wound up:

•         You, being Person A and Person B, were the members of the Fund; and

•         You were the directors of the corporate trustee of the Fund (the Trustee).

You did not personally claim any deduction/s for advisor fees arising in relation to the Fund, with deductions being claimed by the Fund.

A financial institution sent a letter to you as the representatives of the Trustee and the Fund indicating that a review had been undertaken on ongoing advisor services fees for which services may not have been provided during some service periods.

As a result of the review the financial institution paid an amount, the Compensation payment, which consisted of an amount of interest (the interest component), and the refund of the advice fees (the remainder component).

You received the Compensation payment in the ruling period, with it being paid into your personal joint bank account.

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 20-20

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Paragraph 104-25(1)(b)

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

Income Tax Assessment Act 1997 Section 118-305

Reasons for decision

Question 1: Is the interest component of your compensation payment assessable as ordinary income?

Assessable income

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.

Ordinary income has generally been held to include interest income and the general principle is that interest is derived when it is received or credited.

Taxation Ruling TR 95/35 'Income tax: capital gains: treatment of compensation receipts' 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.

Application to your situation

As a result of their review, the financial institution had determined that it had not been evidenced that all of the service periods for which the Fund had paid ongoing advisor fees had been serviced and as a result of their findings they would make the Compensation payment.

As the Fund had been wound up at that time, the Compensation payment was made to you personally.

The taxation provisions apply to the scenario that has occurred. Therefore, the treatment of the Compensation payment if it had been received by the Fund is not relevant in this situation as the Compensation payment was paid to you personally when the Fund no longer existed.

The Compensation payment included an identified interest amount, being the interest component. Therefore, in accordance with the principles contained in TR 95/35, the interest component amount of the Compensation payment is assessable income under section 6-5 of the ITAA 1997.

Question 2: Is the remainder component of your compensation payment assessable as ordinary income?

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.

Whether an amount is ordinary income is determined by its character in the hands of the recipient.

Application to your situation

The Compensation payment consisted of the interest component and the remainder component.

The remainder component of the Compensation payment you received is not assessable as ordinary income under section 6-5 of the ITAA 1997 for the following reasons:

•         The amount is a one-off receipt and therefore does not have the relevant characteristics, such as elements of periodicity, regularity or recurrence; and

•         The amount does not relate to employment, or services rendered by either or both of you, or any lost income.

Nor is the remainder component an assessable recoupment as you had not paid for the ongoing advisor fees or claimed deductions for those expenses.

Therefore, the remainder component of the Compensation payment is capital in nature assessable under the capital gains tax (CGT) provisions.

Question 3: Is any capital gain or loss you made due to receiving the remainder component disregarded under section 118-305 of the ITAA 1997?

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.

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. Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset, such as a taxpayer's right to seek compensation.

Subsection 116-20(a) of the ITAA 1997 provides that the capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, in respect of the event happening.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the capital gains tax implications for compensation receipts discusses various scenarios, such as receiving compensation from a right to seek compensation in relation to a personal jury or other compensable damage or injury. The right to seek compensation, being a CGT asset, is disposed of when it is satisfied, released, or discharged.

Under paragraph 104-25(1)(b) of the ITAA 1997 a CGT event C2 happens if your ownership of an intangible CGT asset ends when it is released, discharged or satisfied.

CGT exemption

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.

Application to your situation

The payment of the Compensation payment was generated due to the financial institution's review of overpaid advisor fees paid by the Fund for service periods where no service may have been provided.

The right to compensation lay with the Fund, however payment was made to you as the individual members of the Fund in satisfaction of the Fund's right to seek compensation.

CGT event C2 occurred when you accepted the Compensation payment with the remainder component being the capital proceeds for the CGT event C2 occurring to the Fund's right to seek compensation.

Therefore, it is viewed that the exemption provided under section 118-305 of the ITAA 1997 applies in your situation and you can disregard any capital gain or capital loss arising in relation to the remainder component of the Compensation payment.

Conclusion

It has been determined that:

•         The interest component of the Compensation payment is assessable income in the income year in which it was received. The interest should be apportioned between you in accordance with your membership holding in the Fund with your respective interest amount being reported in your individual income tax return; and

•         The remainder component of the Compensation payment is capital in nature. Any capital gain or capital loss arising in relation to this amount can be disregarded under section 118-305 of the ITAA 1997.