Private ruling: Compensation payment for financial loss
Date of advice: 22 November 2022
Published: 23 January 2023
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is a compensation payment to be treated as non-assessable income for income tax purposes? | A1: No.

Relevant facts and circumstances: You receive a pension as part of your superannuation scheme. You have previously been discharged from your employer. During the 20XX FY the tax withheld from your benefit payments was miscalculated. You had several conversations with your superannuation fund to determine whether the tax withheld was correct. The superannuation fund continued to assert the tax withheld was correct. However, upon further investigations it was determined the amount withheld was incorrect. You relied on the information when making financial decisions and ultimately suffered financial loss due to the incorrect advice regarding the tax withheld. You received a letter of offer from the superannuation fund in which they proposed settlement on your claim for compensation of $XXX. You emailed the fund a response to their offer in which you highlighted the impact the incorrect treatment had influenced your approach to important financial decisions. The superannuation fund has conceded that your explanation is valid and reasonable in the circumstances. The superannuation fund consequently decided to remove the discount applied in their first offer calculation of loss and have provided additional compensation of the financial loss you have incurred because of their misstatement. The fund sent you an amended offer. Settlement offer In the interests of resolving your complaint, an amended settlement amount of $XXX gross was offered on a 'Without prejudice' basis and on the following terms: 1. The fund accepts no liability for any financial loss you may have suffered. 2. Your claim against the fund is fully resolved upon payment. 3. The payment is a gross amount and you are personally responsible for any tax liabilities that may occur. The offer was accepted prior to the due date and time.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 104-25 | 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 118-37 | Income Tax Assessment Act 1997 paragraph 118-37(1)(a) | Income Tax Assessment Act 1997 section 118-305 | Income Tax Assessment Act 1997 subparagraph 118-37(1)(a)(ii) | Income Tax Assessment Act 1936 subsection 160ZB(1)

Reasons for decision: Detailed Reasoning - Ordinary income: Section 6-5 of the 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, expected, relied upon, and have an element of periodicity, recurrence or regularity. In your situation you have accepted a settlement payment as a result of incorrect information being provided to you by your superannuation fund. The payment is not earned by you as it does not relate to services performed or to your employment duties with your employer. The payment is also a one-off payment and thus it does not have an element of recurrence or regularity. Considering the full circumstances, the payment is not regarded as ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997. | Detailed Reasoning - Capital proceeds: 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. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the capital gains tax implications for compensation receipts. The purpose of the payment is an important factor in determining whether an asset has been disposed of for capital gains tax purposes. TR 95/35 discusses 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 compensation receipt is as a result of the actions undertaken by the superannuation fund, who provided negligent financial advice. The relevant CGT asset in your case is the right to seek compensation. The payment received was in full settlement of the claims made. Your right to seek compensation is an intangible CGT asset (acquired at the time you made a financial loss due to the superannuation fund providing the incorrect advice) and your ownership of that asset ended when you accepted the lump sum to settle your claim. At that time CGT event C2 happened. 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). In your case, the lump sum payment represents capital proceeds for your CGT C2 event. | Detailed Reasoning - CGT exemptions: The CGT exemptions that require consideration in this case are those provided by paragraph 118-37(1)(a) and section 118-305 of the ITAA 1997. Under paragraph 118-37(1)(a) of the ITAA 1997 a capital gain is disregarded if it is compensation or damages you receive for: (i) any wrong or injury you suffer in your occupation; or (ii) any wrong, injury or illness you or your relative suffers personally. | Detailed Reasoning - Wrong you suffer personally: Subsection 160ZB(1) of the Income Tax Assessment Act 1936 (ITAA 1936) which was re-written as paragraph 118-37(1)(a) of the ITAA 1997 sheds light on what is meant by a wrong you suffer personally. Subsection 160ZB(1) of the ITAA 1936 stated: A capital gain shall not be taken to have accrued to a taxpayer by reason of the taxpayer having obtained a sum by way of compensation or damages for any wrong or injury suffered by the taxpayer to his or her person or in his or her profession or vocation and no such wrong or injury, or proceeding instituted or other act done or transaction entered into by the taxpayer in respect of such a wrong or injury, shall be taken to have resulted in the taxpayer having incurred a capital loss. (emphasis added) Subsection 1-3(2) of the ITAA 1997 states that where the 1936 Act expressed an idea in a particular form of words and the 1997 Act appears to have expressed the same idea in a different form of words in order to use a clearer or simpler style, the ideas are not be taken to be different just because different forms of words were used. There is nothing in an Explanatory Memorandum or any other extrinsic material in relation to the remaking of subsection 160ZB(1) of the ITAA 1936 into paragraph 118-37(1)(a) of the ITAA 1997 that indicates that the meaning or effect of the new provision was to be any different to the old provision. Therefore, it is considered that a wrong suffered personally by a taxpayer means a wrong suffered 'to his or her person'. The following principles of statutory interpretation are also relevant in considering the meaning of a wrong suffered personally: • The noscitur a sociis rule states that a meaning of a word is derived from its context. For example, in the expression 'house, office, room or place' the word 'place' does not include a public lane. • The ejusdem generis rule states that general matters are constrained by reference to specific matters. For example, 'a railway, road, pipeline or other facility' does not include a storage facility ( Canwan Coals Pty Ltd v. Federal Commissioner of Taxation (1974) 1 NSWLR 728). Negligence is a tort so is a legal wrong. It is a failure to take reasonable care to avoid causing injury or loss to another person. Therefore, it could be argued that the negligence by your superannuation fund in providing incorrect information was a wrong that you suffered personally. However, the meaning of 'wrong' must be considered in the context of the words around it which are 'injury' and 'illness' in relation to paragraph 118-37(1)(a) of the ITAA 1997 and 'injury suffered by the taxpayer to his or her person' in relation to subsection 160ZB(1) of the ITAA 1936. Taking into account this context, it is considered a wrong suffered personally for the purposes of paragraph 118-37(1)(a) of the ITAA 1997 would include, for example, defamation, as this is a wrong suffered by the taxpayer to his or her person but would not include negligence that causes financial loss as unlike defamation, injury or illness, it is not a wrong suffered by a taxpayer to his or her person. This interpretation is supported by TR 95/35 which contains two examples that deal with compensation for negligence that resulted in financial loss (examples 8 and 28). In example 8, the taxpayer was assessed on the compensation as a capital gain on the disposal of their right to seek compensation and no CGT exemptions (including subsection 160ZB(1) of the ITAA 1936/paragraph 118-37(1)(a) of the ITAA 1997) were considered to apply. In example 28, the end result was that there was no capital gain but this was because of reasons other than the wrong suffered personally exemption provided for by subsection 160ZB(1) of the ITAA 1936/paragraph 118-37(1)(a) of the ITAA 1997. In that example it states that if any amount of the compensation had been for inconvenience or personal suffering then that amount would be exempt from CGT under the wrong suffered personally exemption. However, as the whole amount of the compensation was for a financial loss caused by negligence the wrong suffered personally exemption did not apply. Therefore, it is not considered that the negligence by your superannuation fund that caused you financial loss is a wrong you suffered personally for the purposes of exemption under subparagraph 118-37(1)(a)(ii) of the ITAA 1997. | Detailed Reasoning - Wrong you suffer in your occupation: The Commissioner states in TR 95/35 that the exemption under subsection 160ZB(1) of the ITAA 1936/paragraph 118-37(1)(a) of the ITAA 1997 will only apply where an individual receives compensation for a wrong or injury suffered to his or her person or in his or his occupation, profession or vocation. Whilst at paragraph 214 of TR 95/35 it states that the terms 'to his or her person' and 'in his or her vocation' should be read as widely as possible, the intention of the 'wide' interpretation was to cover the full range of employment and professional type claims; for example to include claims for discrimination, harassment, victimisation, wrongful dismissal, and defamation as well as personal injury or illness. The negligent provision of incorrect information by your superannuation fund that you suffered is very different to wrongs such as discrimination, harassment, victimisation, wrongful dismissal and defamation which a person can suffer 'in' their occupation, profession or vocation. Although there is an indirect connection to your occupation, it is considered that the negligent provision of incorrect information by your superannuation fund is not a wrong that you suffered 'in' your occupation. | Detailed Reasoning - Superannuation: Section 118-305 of the ITAA 1997 provides an exemption for CGT events that happen in relation to: (a) a right to an allowance, annuity or capital amount payable out of a *superannuation fund or *approved deposit fund; (b) a right to an asset of such a fund; (c) a right to any part of such an allowance, annuity, capital amount or asset. Part of the settlement amount took into account the fact that due to the superannuation fund's negligent advice, you did not have the opportunity to increase your entitlements. However, this does not mean that you had a right to any amount payable out of your superannuation fund. This is supported by the fact that the settlement amount was not paid out of your superannuation fund but rather by the trustee of the superannuation fund. Therefore, it is not considered that section 118-305 of the ITAA 1997 applies in your case. | Detailed Reasoning - Additional information: As the CGT event (your disposal of the right to seek compensation) happened less than 12 months after you acquired that right (at the time you suffered a financial loss), you are not able to apply the 50% general discount.