Edited version of private advice

Authorisation Number: 1052305932545

Date of advice: 19 September 2024

Ruling

Subject: Assessable income

Question 1

Will the proposed compensation interest amount of relating to the Fund Z be assessable to you as ordinary income?

Answer 1

Yes

Question 2

Will the proposed compensation amount for inconvenience caused be assessable as ordinary income?

Answer 2

No.

Question 3

Will the proposed compensation amount in relation to the Fund Z account be assessable to you as ordinary income?

Answer 3

No.

Question 4

Will the proposed compensation amount in relation to your personal investments as reinvested income be assessable income?

Answer 4

Yes.

Question 5

Will the CGT event associated with the receipt of amounts you receive from the financial institution?

Answer 5

Yes.

Question 6

Will the 50% discount apply to reduce the capital gain in the year it is received?

Answer 6

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You have not yet reached preservation age for superannuation purposes.

You previously engaged a financial advisor for the purpose of investing both personally and for superannuation.

Based on the advice provided, you invested during a period of several years, and ultimately realised losses on both the personal and superannuation portfolios.

You made investments using the following accounts:

•                     Investment Account Z

The investments were made over a number of years.

All investments were in shares and made in your name.

•                     Account Y

Investments were made over a number of years.

The account was held by you as a fund member.

The funds in this account were withdrawn as a lump sum and rolled over into another fund.

You received a letter from the financial institution to inform you that they had proactively reviewed the advice provided and deemed it to be inappropriate based on your risk profile.

The letter offered you a compensation payment.

Following multiple written exchanges between the financial institution and you, they ultimately responded with a revised offer for all losses incurred across the period.

The updated offer comprised amounts:

•                     for losses associated with inappropriate advice

•                     for the initial advice fee

•                     for the additional professional fees incurred during this review process

•                     non-financial loss as a gesture of goodwill for the inconvenience caused.

Entity description further detail

1. You compensation amount

2. You compensatory interest

3. Fund compensation amount

4. Fund further compensation

5. Fund compensatory interest

6. Fund compensation amount relating to the initial advice fee

7. Fund further compensation relating to the initial advice fee

8. Fund compensatory interest relating to the initial advice fee

9. Not specified professional fees incurred relating to offers with them

10. Not specified goodwill gesture for inconvenience caused

11. Mix rounding amounts rounded up to the next $100

The Compensation Amount #1 relates to personal investments made by you pursuant to the financial advice that were disposed of at a loss. The Compensation Amount is calculated by comparing to the net return that would have been achieved based on an alternative appropriate investment of the funds. That is that instead of making a capital loss on these share investments (market performance loss and fees), you would have made a profit (market performance and reinvested income).

The Compensation Amounts #3 and #6 relate to the losses that were suffered by you in relation to your investments when you transferred your account balance from the Fund Z to another fund. The amount is an estimate of how much larger your lump sum would have been if there had been suitable investments made. There was also a refund of the initial adviser fee.

The Further Compensation Amounts (#4 and #7) relate to the further losses that were suffered by you in relation to your investments. This is calculated using fund based investments chosen by the financial institution as being suitable for your risk profile

These compensation payments relate to losses suffered as a result of advice provided regarding investments made personally by you, and advice regarding investments made through your account.

You did not claim a deduction for overcharged fees in relation to the account in the relevant tax returns.

The total amount will be paid to you.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 116-20

Reasons for decision

Ordinary income

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

Ordinary income has generally been held to include 3 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.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

Capital gains

You make a capital gain or capital loss as a result of a capital gains tax (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.

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

The five elements of a CGT asset's cost base are acquisition costs, incidental costs, non-capital costs of ownership which are not deductible, capital expenditure to increase the value of the asset, and capital expenditure to establish, preserve or defend title to the asset or a right over the asset (section 110-25 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. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt.

The 'look-through' approach is defined in paragraph 3 of TR 95/35 as follows:

The 'look-through' approach is the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related. It is also referred to in this Ruling as the underlying asset approach.

'Underlying asset' is also defined in paragraph 3 of TR 95/35 as follows:

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

Where the underlying asset for which the compensation relates has been disposed of, the compensation is considered to be additional capital proceeds for the disposal.

Application to your circumstances

1.            The proposed interest amounts are assessable income as per Section 6-5 of the ITAA 1997.

2.            The proposed compensation for inconvenience is not assessable income as this does not meet the definition of ordinary income.

3.            The proposed compensation amounts relating to the Fund Z account are not assessable income.

These amounts are capital in nature and relate to the Fund Z account.

The right to sue is the CGT asset because the amount cannot be linked specific to shares as underlying assets.

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 fund or an asset of a fund.

Any CGT will be exempt on the Fund Z account relating to the proposed amounts.

4.            The proposed amount in relation to your personal investments as reinvested income will be assessable as this amount has been reinvested and are treated as any other invested amount.

5.            There will be a CGT event when you receive the proposed amount from the financial institution.

6.            This event will occur in the year you receive the payment and the 50% discount will apply to reduce any capital gain.