Private ruling: assessability of compensation payment
Published: September 2012
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Questions and answers: | Will the lump sum settlement amount or any portion thereof to be paid to you, be assessable as ordinary income? | No. | Will any capital gain arising from your share of the lump sum settlement amount be disregarded? | No.

Relevant facts and circumstances: A few years ago your financial advisors, developed a wealth plan for you and your spouse. This plan advised you to amalgamate moneys from several sources in to a single superannuation account: Your contributions Your spouse's contributions Super Fund #1 $X Super Fund #4 $X Super Fund #2 $X Compensation payment $X Super Fund #3 $X Long service leave $X You invested all these moneys with Super Fund #5 in an account in your name solely. Super Fund #5 would pay you an allocated pension. You accepted the plan believing your financial advisors were experts in this field. You paid for their advice. You depended on their advice as you are unable to understand the law in relation to taxation and superannuation. You understanding was that that the plan would consolidate yours and your spouse's superannuation you would save on fees and charges. You received a notice of assessment for the year ended 30 June 2010 in which you were assessed for excess non-concessional contributions of $X. You were charged excess non-concessional tax of $X. You have signed sent a deed of release to your superannuation fund to withdraw the money to pay the ATO You and your spouse lodged a dispute with the financial advisors alleging that you were provided inappropriate advice by them regarding contributions made to your superannuation fund resulting you being liable for excess contribution tax. All parties have agreed to settle their claims. You and your spouse have received a deed of settlement offering a settlement sum of $X in exchange for releasing your financial advisors from all claims against them.

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 104-25 | Income Tax Assessment Act 1997 Section 104-155

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 an Australian resident taxpayer includes the ordinary income they derive directly or indirectly from all sources, whether in or out of Australia, during an income year. Ordinary income is defined in subsection 6-5(1) of the ITAA 1997 to mean income according to ordinary concepts, however, the legislation does not provide any specific guidance on what is meant by income according to ordinary concepts. The courts have identified a number of factors which indicate whether an amount has the character of income according to ordinary concepts. These include amounts that: · are earned · are expected · are relied upon, and · have an element of periodicity, recurrence or regularity. In your case, the undissected lump sum payment that you and your spouse will receive from your financial advisors was not earned as it does not relate to services performed. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from investment advice you received, rather than from a relationship to personal services performed. Accordingly, the lump sum compensation payment that you and you spouse have received from your financial advisors is not considered to be ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Statutory income: Section 6-10 of the ITAA 1997 looks at amounts that are not ordinary income but are included in assessable income by another provision. These amounts are called statutory income and are also included in assessable income. The general capital gains tax (CGT) provisions are set out in Part 3-1 of the ITAA 1997. Under the CGT provisions a taxpayer will make a capital gain or loss only if a CGT event happens to a CGT asset. To determine if a CGT event happens in respect of a compensation payment it is necessary to consider the nature of the asset to which the compensation payment relates. The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts Taxation Ruling TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be: · an underlying asset · a right to seek compensation, or · a notional asset in terms of subsection 160M(7) - (section 104-155 of the ITAA 1997). In determining which is the most relevant asset, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt. In TR 95/35 the term 'underlying asset' is used. The underlying asset is defined in TR 95/35 as: the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity. If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset. The right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. A right to seek compensation is an asset for the purposes of Part 3-1. The right to seek compensation is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged. This disposal triggers a CGT event C2. In your situation, the lump sum compensation payment will be made to compensate you and your spouse for the failure of the financial advisors to properly fulfil her obligations of providing investment advice appropriate to you and your spouse's particular circumstances. As the payment is not in relation to any loss incurred by the payment of the excess non-concessional contributions tax, rather the failure of you and your spouse's financial advisor failing to fulfil her obligations, it is viewed as being consideration received for the disposal of you and your spouse's right to seek compensation. You and your spouse will dispose of your right to seek compensation when you and your spouse enter into a Deed of Release. This triggered CGT event C2. Accordingly, the lump sum payment that you and your spouse received from your financial advisors is assessable under Section 6-10 of the ITAA 1997. You will make a capital gain if your share of the capital proceeds from the ending of your right to seek compensation are more than the cost base of the asset under subsection 104-25(3) of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.