Private ruling: Compensation payment
Date of advice: 30 July 2024
Published: 9 September 2024
Ruling period: For the income year ended DD MM YYYY
Date scheme commenced: DD MM YYYY

Ruling: Q1: Is the interest component of your compensation payment assessable as ordinary income? | A1: Yes. | Q2: Is the remainder component of your compensation payment assessable as ordinary income? | A2: No. | Q3: Is any capital gain or loss you made due to receiving the remainder component disregarded? | A3: Yes.

Relevant facts and circumstances: From DD MM YYYY until DD MM YYYY you held a member account (member number: X / Product: X) in accumulation phase with The Trustee for XXX Superannuation Fund (ABN XXX). On DD MM YYYY you were notified of upcoming changes to the fund as a result of a merger with other superannuation funds as of DD MM YYYY and the following year on DD MM YYYY you superannuation account was closed and the balance rolled over into the new fund. As a result of inappropriate financial advice you received during YYYY and YYYY regarding your superannuation investment decisions in the fund before the merger and it was concluded your fund had incurred a financial loss due to the incorrect advice. The outcome would be to place you in the financial position you would have been in had you not experienced the financial loss within your superannuation account, and you were offered a compensation amount of $X. You accepted the deed of settlement and release offer and received the compensation into your bank account on DD MM YYYY. The total compensation of $X comprised of $X for interest and $X for the net financial loss in the superannuation fund.

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 102-5 | Income Tax Assessment Act 1997 subsection 104-25(1) | Income Tax Assessment Act 1997 paragraph 108-5(1)(b) | Income Tax Assessment Act 1997 section 118-305

Reasons for decision: Summary: Question 1 The interest component is assessable as ordinary income. | Detailed Reasoning - Detailed reasoning: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts, which is called ordinary income. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers an argument raised that interest in relation to compensation is not interest that is ordinary income; rather the claim is that the interest represents a capital amount which is simply part of the compensation, and which effectively represents part of the consideration received on the disposal of either the underlying asset or the right to seek compensation, as the case may be. However, TR 95/35 did not accept this view and discusses the following: 237. Interest has been described as 'payment by time for the use of money' (Rowlatt J in Bennett v. Ogston (1930) 15 TC 374 at 379). In economic terms, interest is the return or compensation for the use or retention by one person of a sum of money belonging or owed to another. Court rules allow the Court to include in compensation interest on the whole or part of the amount for the whole or part of the period to which the judgment relates. 238. Any interest awarded as part of compensation is interest within the general meaning of that term. It represents assessable income of the taxpayer even when the judgment provides only for a single lump sum which would otherwise be a capital receipt ( Federal Wharf Co Ltd v. DFC of T (1930) 44 CLR 24; 1 ATD 70 and Riches v. Westminster Bank Ltd [1947] AC 390). 246. It is a question of fact to be determined in each case whether any part of the compensation received by the taxpayer is in the nature of interest. We consider that any amount which is in the nature of interest, and which can be identified as interest, and whether paid as part of the compensation or separately, constitutes assessable income of the taxpayer under the general income provisions. Consequently, the interest component you received of $X is assessable as ordinary income under section 6-5 of the ITAA 1997. | Summary: The remainder component is not assessable as ordinary income and is considered to be capital in nature. | Detailed Reasoning - Detailed reasoning: Section 6-5 of the ITAA 1997 does not provide specific guidance on the meaning of income according to ordinary concepts (ordinary income), however likely characteristics of ordinary income that have evolved from case law include receipts that: • are periodical, regular or recurrent; • are relied upon by the recipient for their regular expenditure and paid to them for that purpose; and • are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient. Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The remainder component you received is not assessable as ordinary income for these reasons: • the amount is a one-off receipt and therefore does not have any elements of periodicity, regularity or recurrence. • the amount does not relate to your employment, or services rendered by you. Consequently, the remainder component you received of $X for the net financial loss in your superannuation fund is not assessable as ordinary income under section 6-5 of the ITAA 1997. The amount is considered to be capital in nature. | Summary: The remainder component of $X is a capital gain which may be disregarded due to an exemption for being a right to a capital amount payable out of a superannuation fund. | Detailed Reasoning - Detailed reasoning: 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. Paragraph 108-5(1)(b) of the ITAA 1997 specifically includes a legal or equitable right within the definition of a CGT asset. A taxpayer's right to seek compensation is therefore classified as an intangible CGT asset. Why the remainder component was made is an important factor in determining whether an asset has been disposed of for capital gains tax purposes. TR 95/35 discusses the various scenarios, including: • disposal of the underlying asset, • compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and • disposal of the right to seek compensation. The transaction which generated your receipt of the compensation payment was a result of the inappropriate advice provided to you which resulted in a financial loss in your superannuation account. The relevant CGT asset is the disposal of the right to seek compensation. The right to compensation lay with the superannuation fund and is an intangible CGT asset (acquired at the time the fund made the financial loss due to the superannuation fund being provided the incorrect advice). However the amount paid to you as the individual member are in satisfaction of its right to seek compensation. While the amount is not received from a superannuation fund they are, nevertheless, received in relation to the taxpayer's interest in a superannuation fund. To put it another way, taxpayer's are only entitled to the amounts because of the interest in the superannuation fund. CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being released or cancelled (subsection 104-25(1) of the ITAA 1997). Your ownership of the intangible CGT asset ended when you accepted the compensation payment to settle your claim. In your case, the remainder component are capital proceeds for your CGT C2 event. | Detailed Reasoning - Capital gain disregarded: An exemption is provided under section 118-305 of the ITAA 1997 for any capital gain or loss made from a CGT event happening in relation to a right to an allowance, annuity or capital amount payable out of a superannuation fund or an asset of a superannuation fund. In your case, it is considered that the remainder component of $X is a capital gain which may be disregarded due to the exemption contained in section 118-305 of the ITAA 1997.