Edited version of your written advice

Authorisation Number: 1051285180388

Date of advice: 25 September 2017

Ruling

Subject: Compensation payment

Questions

1. Is the compensation received assessable as ordinary income?

2. Is the compensation received assessable under the Capital Gains tax provisions?

Answers

1. No

2. Yes

This ruling applies for the following period

Financial year ending 30 June 2018

The scheme commences on

1 July 2017

Relevant facts and circumstances

You have received an offer of compensation from a bank for financial advice you received in 20XX for your superannuation fund which was considered inappropriate.

You have been made the offer of compensation in your own names.

If you accept the terms of the offer of compensation, you agree that there is no further liability on the bank and that you release and discharge the institution from any other possible course of future action.

The settlement sum being offered under the Deed of Settlement and Release is for the investment loss and any associated interest.

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 108-5

Reasons for decision

Summary

The compensation payment is not regarded as ordinary assessable income.

The compensation payment received is considered to be capital in nature and assessable under the capital gains tax provisions as capital proceeds from your right to seek compensation.

Detailed Reasoning

A payment or other benefit received by a taxpayer is assessable income if it is:

a) income in the ordinary sense of the word (ordinary income); or

b) an amount or benefit that through the operation of the provisions of the tax law is included in assessable income (statutory income).

Ordinary income

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). The legislation does not provide specific guidance on the meaning of income according to ordinary concepts, however, a substantial body of case law exists which identifies likely characteristics.

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. The payment is not assessable as ordinary income in your hands as it is not a product in a real sense of any employment, services or business carried on by you and it does not have the characteristics normally associated with ordinary income such as periodicity and reliance on the payments to meet regular expenditure.

The acceptance of the offer of compensation will resolve the dispute between the bank and you. You will agree to release the bank in consideration of the compensation. We consider this to be compensation not related to income lost but paid in consideration of the releases contained in the offer of compensation.

Accordingly, the compensation received by you will be capital in nature and does not constitute ordinary income under subsection 6-5(1) of the ITAA 1997

Statutory income – capital gains

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes a net capital gain. A capital gain or loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

A CGT asset is defined in paragraph 108-5(1)(b) of the ITAA 1997 as including a legal or equitable right that is not property. Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation.

Paragraph 70 of TR 95/35 provides that in determining the most relevant asset for which the compensation has been received, it is often appropriate to adopt a ‘look-through’ approach to the transaction which generates the payment.

The ‘look-through’ approach is defined in paragraph 3 of TR 95/35 to be 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.

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. A C2 event can apply where there is a release or discharge of a right to sue on the settlement of a legal dispute (See Re Coshott and FCT [2014] AATA 622).

In this case we consider that the compensation you have been offered relates to the disposal of your right to seek compensation. The right to seek compensation was acquired at the time of the compensable wrong or injury and includes all the rights arising during the process of pursuing the compensation claim. CGT event C2 will happen when you accept the offer of compensation.

Please note that as it has been 12 months or more since the previous underperforming advice has been received, you may be entitled to a 50% discount under Division 115 of the ITAA 1997.

Your share of the capital gain is included in your assessable income.

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