Edited version of private advice

Authorisation Number: 1052369456082

Date of advice: 25 March 2025

Ruling

Subject: Compensation payment - lump Sum

Question 1

Is your share of compensatory interest A assessable to you as ordinary income when you received it?

Answer

Yes.

Question 2

Is any capital gain or loss you make due to receiving financial loss component A disregarded?

Answer

Yes.

Question 3

Will the amounts which are taxable be included in the Tax return for the financial year the payments were received.

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX XXXX 20XX

Relevant facts and circumstances

Person A was at the time of all advice a licenced advisor with bank A.

From XX XXXX 20XX to XX XXXX 20XX, you and your partner had a self-managed super fund (SMSF) which incurred financial loss due to the inappropriate financial advice from person A on investing the SMSF's assets.

Your SMSF reported the loss at the time and paid tax on income from the investments during this period, including reinvesting the income during the periods.

Prior to XX XXXX 20XX, the SMSF was closed.

On XX XXXX 20XX, you and your partner received a letter from bank A offering a compensation amount due to inadequate financial advice for a loss in investments under its Customer Advice Review (CAR) program.

The letter contains details about the assessment of the financial advice received from person A. The outcome of the assessment was that advice provided was likely inappropriate.

As part of the CAR, you and your partner received a compensation offer relating to your SMSF investment, which encompassed the following amounts:

•                     Compensatory interest A.

•                     Financial loss component A.

The compensation aimed to place you in the financial position you would have been in if the advice given was appropriate.

You and your partner did not seek an independent assessment of bank A's CAR outcome.

On XX XXXX 20XX, you and your partner received payment of the total compensation offer to your personal bank accounts.

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 102-5

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 subsection 108-5(b)

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 118-305

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Based on case law, it can be said that ordinary income generally includes 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.

The payment that you received is in respect of a review conducted by bank A because they had provided inappropriate financial planning advice which caused your SMSF account to not perform as well as it should have. The payment was not earned by you as it does not relate to services performed. The payment is also a one-off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from a relationship to personal services performed.

Accordingly, the compensation payment is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

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.

Capital gains

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

When an individual receives a compensation amount, there are CGT consequences. Under section 104-35 of the ITAA 1997, a CGT event D1 happens when the taxpayer suffers the wrong and a right to seek compensation is created.

Under section 104-25 of the ITAA 1997, CGT event C2 happens when the right comes to an end. The amount of compensation received by the individual is all or part of the capital proceeds for the ending of the right. As the right has no or a limited cost base, there will be a capital gain for the individual.

Exemption under section 118-305 of the ITAA 1997

The capital gain under CGT event C2 can be disregarded if a CGT exemption such as section 118-305 of the ITAA 1997 applies.

Subsection 118-305(1) of the ITAA 1997 disregards any capital gain or loss if you make it from a CGT event in relation to any of the following;

•                     a right to an allowance, annuity or capital amount payable out of a superannuation fund

•                     a right to an asset of such a fund

•                     a right to any part of such an allowance, annuity, capital amount or asset.

If you are an Australian resident for tax purposes and the compensation relates to investments you held for at least 12 months, you may be able to claim the 50% CGT discount. This occurs where you disposed of your investments for a capital gain.

Interest

Paragraphs 26, 237, 238 and of Taxation Ruling TR 95/35 deals with the treatment of interest awarded as a part of a compensation amount. It states:

[26] Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions. If the taxpayer receives an undissected lump sum compensation amount and the interest cannot be separately identified and segregated out of that receipt, no part of that receipt can be said to represent interest.

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 a 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 circumstances

Question 1

In your case, you and your partner received compensation due to inappropriate financial advice provided to your SMSF. An amount is separately identified as interest. Therefore, this amount is assessable as ordinary income in the year of receipt under section 6-5 of the ITAA 1997.

Question 2

In your case, the right to seek compensation is an intangible CGT asset (acquired at the time the SMSF made a financial loss due to the incorrect advice) and your ownership of that asset ended when you accepted the compensation payment to settle your claim. As a result of the actions of your financial advisor, there was a reduction in the value of your SMSF account.

At that time, CGT event C2 happened. 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. In your case, this component is capital proceeds for your CGT event C2.

However, under section 118-305 of the ITAA 1997, your share of the capital gain is disregarded.

Question 3

Your share of the interest you received is assessable as ordinary income in the year of receipt under section 6-5 of the ITAA 1997.