Private ruling: Compensation payment
Date of advice: 6 October 2017
Published: February 2018
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the interest component assessable as ordinary income? | A1: Yes | Q2: Is the payment for compensation made in relation to the agreement be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No | Q3: Does the compensation payment reduce the cost base of the underlying assets under the Capital Gains Tax provisions? | A3: Yes.

Relevant facts and circumstances: You raised concerns over the appropriateness of the advice you received from an investment arm of a bank and subsequent investment returns. It was then determined that the advice given was inappropriate for you and compensation was paid by the bank, along with interest on the compensation for the period of the investment. The financial planner had determined the offer of compensation based on the following components: ● an amount representing interest compensation; ● an amount representing the disadvantage you experienced as a result of being invested differently from your agreed risk profile. In order to receive the compensation payment you signed and returned the required documentation. You have not sold the investment products.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5. | Income Tax Assessment Act 1997 section 102-5

Reasons for decision: Summary: 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) (Interest received) Interest income is regarded as ordinary income and therefore assessable under subsection 6-5(1) of the ITAA 1997. Compensation payments which substitute income are regarded as ordinary income. Therefore the compensation for lost interest is regarded as ordinary assessable income. However the investment compensation received by you is 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. 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 an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset. Having regard to your full circumstances, it is accepted that the compensation payment relates to the diminished value of an underlying asset, being your investment portfolio, which you still hold. Consequently the compensation payment will not be assessable income under section 6-5 of the ITAA 1997 as the payment will be of a capital nature. As there is no disposal of the underlying asset the receipt will instead amount to a reduction of the cost base of the relevant investments.