Private ruling: Compensation payment
Date of advice: 23 June 2017
Published: October 2017
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the compensation received assessable as ordinary income? | A1: No | Q2: Is the compensation received assessable under the Capital Gains tax provisions? | A2: Yes

Relevant facts and circumstances: You were given financial advice some time ago by the financial planning arm of a bank. As a result of poor performance, you changed superannuation funds. This year you received notification from the bank that it had identified concerns regarding the financial advice provided to you, and offering an amount of compensation in order to place you in the financial position you would have been in had you received financial advice appropriate for your circumstances. You signed and returned the deed of settlement and release to accept the offer, and the compensation funds were deposited into your bank account. By accepting the offer, you have foregone any future action against all parties, and the compensation paid is made for full and final settlement. At no point did you file a claim or seek any damages in regards to your situation, you were simply contacted and told that you were to receive the compensation payment into your personal bank account after you signed the deed of settlement and release. No breakdown of the payment was provided.

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 amount received is not regarded as ordinary assessable income. This amount 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 - 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: a) are periodical, regular or recurrent; b) are relied upon by the recipient for their regular expenditure and paid to them for that purpose; and c) 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. 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 seek compensation. In this case we consider that the compensation you received 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. CGT event C2 happened when you accepted the offer of compensation. Therefore the lump sum compensation payment is regarded as capital proceeds for your CGT C2 event and is included when calculating your assessable capital gain. Please note that as it has been 12 months or more since the previous underperforming advice has been received, then you can reduce the capital gain by 50%.