Private ruling: Refund of overpaid interest and the interest paid for it
Date of advice: 21 May 2019
Published: July 2019
Ruling period: Year ended 30 June 2019
Date scheme commenced: 1 July 2004

Ruling: Q1: Are the refund payments received from Bank A an assessable receipt on capital account as the disposal of the right to compensation? | A1: No | Q2: Is the general 50% CGT discount available in respect of the disposal of the right to receive compensation? | A2: Not applicable as the payment was not on capital account

Relevant facts and circumstances: You commenced a margin lending investment strategy with Fund Manager A. This company was subsequently purchased by Bank A. Recently Bank A wrote to offer you a refund cheque valued at $XXX for transactions on your margin lending loan. This refund was composed of two elements – 1. A “Benefit Refund” of $YYY being a refund of overpaid interest for the period of time you were eligible for a discount on your margin loan due to your membership of a bank package, and 2. A “Compensatory Amount” of $ZZZ being interest on the overpaid interest on the margin loan. You have claimed the interest paid on your margin loan as a deduction in past years and intend to continue to claim such interest deductions in future years.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1997 subsection 20-20(2) | Income Tax Assessment Act 1936 Division 6

Reasons for decision: Summary: Generally an amount received would be assessable either as: ● ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) (whether received as regular payments or a lump sum) ● statutory income under section 15-30 of the ITAA 1997 (where a lump sum insurance payment is paid in lieu of regular, otherwise assessable payments and it is not itself ordinary income); and/or ● a capital gain as capital gains tax (CGT) event C2 will also happen, but any resulting capital gain is disregarded to the extent that it is assessed under another provision (section 118-20 of the ITAA 1997). | Detailed Reasoning - Assessable recoupment: The reimbursement of fees is not regarded as ordinary income. However Subdivision 20-A of the ITAA 1997 about assessable recoupments is relevant. Under subsection 20-20(2) of the ITAA 1997, an amount received as recoupment of a loss or outgoing is an assessable recoupment if you received the amount by way of insurance or indemnity and you have deducted or can deduct an amount for it for an earlier income year. Recoupment of a loss or outgoing includes any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery (subsection 20-25(1) of the ITAA 1997). An indemnity is not defined in the ITAA 1997, so takes its ordinary meaning. Indemnity is defined in the Macquarie Dictionary as being something paid by way of compensation for damage or loss sustained. An indemnity contemplates an obligation (whether by virtue of a contract, statute or a breach of some common law duty of care) to make good, or to compensate for, a loss ( Commercial Banking Company of Sydney Ltd v. FCT (1983) 14 ATR 142). In this case, the benefit refund is regarded as an amount received by way of indemnity. The margin loan interest charges were deductible expenses. As you were entitled to claim a deduction for the interest charges, the payment of $YYY from Bank A is an assessable recoupment under subsection 20-20(2) of the ITAA 1997 and should be included in your assessable income as ordinary income under subsection 6-5(2) of the ITAA 1997. | Detailed Reasoning - Capital gains: In this case you have been given a refund of overpaid interest. Acceptance of the lump sum is considered the ending of your right to seek compensation. This gives rise to CGT event C2. However as it has been also determined above that the payment that you will receive is assessable as ordinary income or statutory income, the anti-overlap provisions in section 118-20 of the ITAA 1997 will operate to reduce the capital gain arising as a result of CGT event C2 by the amount of the income assessed to you under either sections 6-5 or 15-30 of the ITAA 1997. The combined effect of sections 6-5, 15-30 and 118-20 of the ITAA 1997 is that the receipt will be assessed as ordinary income and the capital gain as a result of the CGT event will be reduced to nil. | Detailed Reasoning - Interest income: Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Interest income is regarded as ordinary assessable income. For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Any payment (for example compensation) to replace income is also considered to be income for ordinary concepts. Payments which substitute income have been held by the courts to be income under ordinary concepts ( Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433). If the compensation is paid for the loss of a capital asset then it will be regarded as a capital receipt and not ordinary income. The compensatory amount of $ZZZ is regarded as a compensation payment for the interest income that would otherwise have been received. As the interest payment received is for loss of interest income, the payment is assessable as ordinary income under subsection 6-5(2) of the ITAA 1997.