Private ruling: Class action settlement
Published: November 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Is the compensation payment you received for the settlement of a class action brought against X, assessable as ordinary income? | A1: No | Q2: Should the cost base of the shares in question be reduced by the amount of compensation received? | A2: Yes

Relevant facts and circumstances: A proceeding against X was filed seeking to recover losses suffered by shareholders as a result of alleged material non-disclosures and misleading conduct. The proceeding was brought on behalf of X shareholders who acquired an interest in X securities between a specified period. You were a shareholder as described above and a participant in a class action taken against X. A settlement was reached and approved by the court. As a result you received a compensation payment during the relevant financial year. You still hold your shares in X.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Subsection 110-45(3)

Reasons for decision: 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). Ordinary income has generally been held to include 3 categories, namely income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: · are earned; · are expected; · are relied upon; and · have an element of periodicity, recurrence or regularity. The compensation you received was not income from rendering personal services, income from property or income from carrying on a business. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. You received compensation for the acquisition of the shares at an inflated price. The compensation was paid in relation to a capital asset and accordingly, it is regarded as a capital receipt and not ordinary income. Therefore, the compensation payment is not assessable ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Capital gains tax provisions: Taxation Ruling TR 95/35 discusses the capital gains tax implications for compensation receipts. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt. 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. The transaction which generated the compensation receipt is the acquisition of the shares. Applying the 'look-through' approach to the acquisition of shares, the most relevant asset to which the compensation most directly relates is the shares in X. The compensation was for the acquisition of the shares at an inflated price. Paragraph 10 of TR 95/35 provides that: If a taxpayer is compensated for having paid excessive consideration to acquire an asset, the amount referable to the overpayment represents a recoupment of all or part of the total acquisition costs of the asset. Therefore, the cost base of the shares should be reduced by the amount of the compensation on an apportionment basis. No capital gain or loss arises in respect of that asset until you actually dispose of the underlying asset.