Edited version of private advice

Authorisation Number: 2935012683585

Date of advice: 3 December 2019

Ruling

Subject: Compensation

Question 1

Is the interest component of the payment you received from Bank A included in your assessable income?

Answer

Yes.

Question 2

Is the component of the payment you received from Bank A that is compensation for the interest costs you incurred as a result of following the potentially inappropriate advice included in your assessable income?

Answer

Yes.

Question 3

Are the components of the payment you received from Bank A for:

·         geared remediation (minus the amount received for interest costs)

·         ungeared remediation, and

·         personal tax implications of the offer amount

treated as additional capital proceeds for the disposal of the investment?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June YYYY to year ended 30 June YYYY

The scheme commenced on

1 July YYYY

Relevant facts

You obtained financial advice from a financial adviser.

Bank A reviewed the financial advice provided to you by the adviser and determined that the financial advice was potentially inappropriate and offered you a payment in respect of that advice.

Bank A offered you a payment of $X. This amount represents Bank A's calculation of the potential negative financial impact of the advice given to you due to gearing recommendations that were potentially inappropriate given your circumstances at the time. This amount consisted of:

·         $X for geared remediation which represents the amount of remediation calculated in relation to losses incurred on the gearing component of your investment and includes the interest paid on the loan of $X

·         $X for ungeared remediation which represents the amount of remediation calculated in relation to losses incurred on the potentially inappropriate asset allocation of your own contributed capital, and

·         Interest on these amounts of $X.

You claimed deductions the interest paid on the loan which was included in the calculation of the geared remediation.

You accepted the offer from Bank A subject to resolution of the personal tax implications from receiving the payment.

Your accountant assessed the personal tax implications of the offer amount to be $X.

Bank A subsequently offered you a further payment of $X in full and final settlement of any personal tax implications of the offer amount. You accepted the offer.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 Division 116

Income Tax Assessment Act 1997 subsection 118-20(1)

Income Tax Assessment Act 1997 subsection 118-20(1A)

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).

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 (paragraph 246 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35)).

Statutory income

Amounts that are not ordinary income, but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997).

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list are Subdivision 20-A (recoupment) and section 102-5 (capital gains).

Assessable recoupments

Subdivision 20-A of the 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 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.

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997).

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.

Taxation adjustments

A taxation adjustment is any additional amount of compensation (for example, a 'top-up') calculated to cover any income tax liability (including CGT) that may arise in respect of a compensation receipt. This amount may be determined and received at the time of the compensation receipt or at any other time (paragraph of TR 95/35).

Taxation adjustments are considered to be additional amounts received as a result of or in respect of the disposal of an asset (paragraph 27 of TR 95/35).

Anti-overlap provisions - 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 this part) 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).

Application to your circumstances

Ordinary income - interest

The compensation you received included an amount of interest of $X.

Interest, or amounts received that are in the nature of interest, are ordinary income. As such, this amount is included in your assessable income in the financial year ended 30 June XXXX.

Assessable recoupment

Bank A calculated the compensation amount for geared remediation by taking into account your interest costs of $X.

As you have been compensated for your interest costs, and you claimed a deduction for them in earlier income years this amount is an assessable recoupment and is included in your assessable income in the financial year ended 30 June XXXX.

Capital gains

Applying the 'look-through' approach, the most relevant asset to which the compensation amount (including the geared remediation, ungeared remediation, interest and the additional amount for personal tax implications) most directly relates is the investment itself.

The full amount of the compensation payment you received constitutes additional capital proceeds from the disposal of your investment (which triggered CGT event A1). However, subsections

118-20(1) and 118-20(1A) of the ITAA 1997 will operate to reduce any capital gain to the extent that the payment is assessable as ordinary income (interest) and as an assessable recoupment (interest costs).

As such, the remaining components of the compensation payment:

·         $X for geared remediation (minus the amount received for interest costs)

·         $X for ungeared remediation, and

·         $X for the personal tax implications of the offer amount

are additional capital proceeds for the CGT event (A1) that happened when you disposed of your investment.