Private ruling: Compensation - other
Published: February 2015
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Is the compensation payment you received for the settlement of a class action brought against X Company, included in your assessable income as ordinary income or a net capital gain? | A1: No | Q2: Should the cost base of the shares in question be reduced by the amount of compensation received for paying excessive consideration for the shares? | A2: Yes | Q3: Should the capital loss you incurred on the disposal of the shares for the 20XX-XX financial year be reduced by the amount of compensation received in respect of the shares? | A3: Yes

Relevant facts and circumstances: In 20XX, a proceeding against X Company 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 Company shareholders who acquired an interest in X Company securities between 20XX to 20XX (inclusive) and who suffered loss as a result of the alleged misconduct. You were a shareholder as described above and a participant in a class action taken against X Company. You purchased X shares in X Company in 20XX The statement of claim in relation to the proceeding stated that you suffered loss and damage by the artificially inflated trading price. As a consequence of X Company's conduct the trading price of its shares on the ASX was artificially inflated during the Relevant Period and that persons who purchased X Company shares during this period suffered loss and damage A settlement was approved by the court in 20XX. As a result you received a compensation payment of $X. You sold your shares in 20XX. As a result of the sale of your shares in X Company, you made a capital loss in the 20XX-XX financial year.

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

Reasons for decision: Summary: The compensation payment you received is considered a capital receipt and not ordinary income. This is because the compensation payment was paid in relation to a capital asset, and was not to compensate for a loss of income. We consider that the payment is compensation for paying an excessive amount for an asset (the shares). Therefore, the compensation payment is treated as a recoupment of the cost base of the shares. | 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 • 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 Company. 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. As you have already disposed of the x Company shares in the 20XX-XX financial year and reported a capital loss on the disposal of the shares, you will need to adjust the amount of capital losses you have available to carry forward for future years.