Private ruling: Assessability of settlement sum
Published: July 2011
Ruling period: Year ending 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Is the settlement sum assessable to you as ordinary income? | A1:  | Q2: Does capital gains tax (CGT) apply to the settlement sum? | A2:  | Q3: Can you disregard the capital gain or capital loss arising from the CGT event? | A3: 

Relevant facts and circumstances: You sought compensation from Company X for losses suffered as a result of relying on advice they provided to you. Company X denied liability and has agreed to pay you an amount of money in settlement for the claims made on the condition you forgo any right to future claims against them.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1. Income Tax Assessment Act 1997 Section 102-20. Income Tax Assessment Act 1997 Subsection 104-25(1). Income Tax Assessment Act 1997 Subdivision 115-A.

Reasons for decision: Detailed Reasoning - Ordinary income: Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments that substitute for income have been held by the courts to be income under ordinary concepts. In your case, you will receive a lump sum amount in return for forgoing any right to future claims against Company X. This compensation is not replacing ordinary income and therefore the lump sum is also not ordinary income. Therefore, it must be considered whether the lump sum is assessable as statutory income under the capital gains tax provisions. | Detailed Reasoning - Capital gains tax (CGT): Section 102-20 of the ITAA 1997 states that you make a capital gain or capital loss if and only if a CGT event happens. CGT events are the different types of transactions or happenings which may result in a capital gain or a capital loss. CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited (subsection 104-25(1) of the ITAA 1997). In certain circumstances, an award of compensation or damages may result in the end of an asset in terms of CGT event C2, being the right to compensation. The Commissioner's view in regards to this issue is set out in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts . In regards to the disposal of the right to seek compensation, TR 95/35 states that 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. Accordingly, any capital gain arising on the disposal of that right is calculated using the cost base of that right. The following example is given in regards to the disposal of the right to seek compensation: 283. On 4 July 1989 Marty acquired a rental property. In January 1990 Marty decided to sell the property. On 15 March 1990 Waldo indicated to Marty that he was willing to buy the property for $200,000. On 20 March 1990 Marty engaged his solicitors, Legal Eagles, to act for him in the sale. Legal Eagles had also acted for Marty when he purchased the property. On 10 July 1990 contracts were exchanged with a requirement that the sale be settled one year later on 10 July 1991. The sale was not finalised on 10 July 1991 because of a delay in receiving a clearance from one of the local authorities. Waldo later exercised his right under the contract to repudiate the contract and claimed a refund of his deposit. 284. On 24 October 1991 Marty commenced legal action against Legal Eagles seeking damages for their negligence in not ensuring that the certificate was received by the proposed settlement date. On 20 December 1991 Legal Eagles advised Marty they were willing to negotiate a settlement. On 17 January 1992 Marty accepted and received compensation of $95,000 in settlement of his claim against Legal Eagles. At this date Marty had not sold the property. Note: no part of the $95,000 represents a repayment of the deposit paid by Waldo. 285. | Detailed Reasoning - Relevant asset:: The right to seek compensation. The property is not the relevant asset as it was neither permanently damaged nor was its value permanently reduced by the actions of Legal Eagles. | Detailed Reasoning - Acquired:: July 1991 (when Legal Eagle's negligent action became apparent) | Detailed Reasoning - Cost base:: Nil acquisition cost plus legal costs | Detailed Reasoning - Disposed of:: January 1992 | Detailed Reasoning - Consideration:: $95,000 | Detailed Reasoning - CGT consequences:: Marty will be assessed in the 1992 income tax year on the net capital gain Your case is similar to that of Marty in the example above. In your case you will receive a lump sum amount in return for settlement with Company X and for forgoing any future claim against them. CGT event C2 will happen when you accept the settlement offer. The relevant asset is the right to future claims against Company X. This right was acquired when it became apparent that you suffered loss as a result of relying on the advice of Company X. The cost base includes the legal costs. The consideration is the amount of the lump sum payment. You will be assessed on the net capital gain in the year in which you accepted the settlement offer. There is no exemption from capital gains tax provided for in the legislation in relation to this type of compensation receipt. 50% discount The 50% discount can be applied to a capital gain that an individual makes if the CGT event happened after 21 September 1999 and the CGT asset was owned by the individual for at least 12 months (Subdivision 115-A of the ITAA 1997). If it became apparent that you suffered loss as a result of relying on the advice of Company X after 21 September 1999 and more than 12 months before you accept the settlement offer, then you will be able to use the 50% discount.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.