Private ruling: Compensation - Investment
Date of advice: 29 August 2017
Published: December 2017
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the whole amount of compensation received tax exempt? | A1: No | Q2: Is the investment compensation and excess management fee compensation assessable as ordinary income? | A2: No | Q3: Is there any capital gains tax (CGT) consequences as a result of the investment compensation and excess management fee compensation? | A3: No | Q4: Is the investment interest compensation and the excess management fee interest compensation assessable as ordinary income? | A4: Yes

Relevant facts and circumstances: In late 200X you had recently retired and sought advice from Commonwealth Financial Planning (CFP) on low to medium risk options to invest your retirement funds, which would preserve your capital and provide reasonable income in your retirement. You entered into an agreement with CFP on DDMMYY and rolled your super account and invested your cash holdings into an allocated pension with a relevant Fund. The fund was tax free investment as you were over 60 years of age. You believed the advice provided by CFP did not meet the agreed investment expectations resulting in a substantial loss. As a result you closed the allocated pension account in early 201X and transferred funds to a bank term deposit account. You sought compensation from the Bank (XYZ) for your losses through the Financial Ombudsman Service. The XYZ offered you an ex-gratia payment in full and final resolution of the complaint. You accepted the XYZ offer. The payment consisted of the following components: ● Investment compensation ● Interest compensation ● Excess Management fee (MER) compensation ● Excess Management fee (MER) interest

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 118-305

Reasons for decision: Summary: The investment compensation and excess management fees compensation you received in respect of your complaint surrounding the loss incurred by your superannuation fund is not regarded as ordinary income. Additionally, as the compensation payments were made in respect of the permanent reduction in value of your right to a capital amount payable from your superannuation fund, any capital gain or loss made from the payment is disregarded. The interest components of the compensation payments are regarded as ordinary income. Therefore, the interest payments you received as part of your compensation is assessable income in the year of receipt. | Detailed Reasoning - Ordinary Income: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Based on case law, it can be said that ordinary income generally includes receipts that: ● are earned ● are expected ● are relied upon, and ● have an element of periodicity, recurrence or regularity. Paragraph 26 of Taxation Ruling TR 95/35 deals with the treatment of interest awarded as a part of a compensation amount. It states: Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions. If the taxpayer receives a dissected lump sum compensation amount and the interest cannot be separately identified and segregated out of that receipt, no part of that receipt can be said to represent interest. In your case, you received compensation due to inappropriate financial advice. There are amounts separately identified as interest. These amounts are assessable as ordinary income in the year of receipt. The investment compensation and excess management fee compensation payments that you received are in respect of a review conducted by XYZ because they had provided inappropriate advice which caused your allocated pension account not to perform as well as it should have. The payments were not earned by you as it does not relate to services performed. The payments were a one off payment and don’t not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from a relationship to personal services performed. Accordingly, the investment and excess management fee compensation payments are not ordinary income and are therefore not assessable under section 6-5 of the ITAA 1997. Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997. | Detailed Reasoning - Capital gains: Taxation Ruling TR 95/35 considers the treatment of compensation payments and the capital gains tax (CGT) consequences for the recipient. In your case, the underlying CGT asset is your right to a capital amount payable out of a superannuation fund in the form of your allocated pension. As a result of the actions of your financial advisor, there was a reduction in the value of your allocated pension account. Therefore, it is considered that there has been a permanent reduction in value of your right to a capital amount payable out of your superannuation fund. Subsection 118-305(1) of the ITAA 1997 disregards any capital gain or loss if you make it from a CGT event in relation to any of the following; ● a right to an allowance, annuity or capital amount payable out of a superannuation fund ● a right to an asset of such a fund ● a right to any part of such an allowance, annuity, capital amount or asset. The investment and excess management fee compensation you received was in relation to the permanent reduction in value of your right to a capital amount payable out of a superannuation fund. Therefore, any capital gain or loss you made is disregarded under section 118-305 of the ITAA 1997. These amounts are not assessable under any other provision.