Private ruling: Compensation for inadequate financial advice
Date of advice: 11 October 2017
Published: March 2018
Ruling period: Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the lump sum payment you received for compensation on the superannuation component assessable as ordinary income? | A1: No | Q2: Are there any capital gains tax (CGT) consequences as a result of the lump sum payment on the superannuation component you received? | A2: No | Q3: Is the payment you received for interest compensation on the superannuation component assessable as ordinary income? | A3: Yes


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 118-305

Reasons for decision: Summary: The lump sum payment you received in respect of the review surrounding the loss incurred by your superannuation fund is not ordinary assessable income. Additionally, as the lump sum payment was made in respect of the permanent reduction in value of your right to a capital amount payable from your superannuation fund, any capital gain or loss made from the payment is disregarded. However the interest component is assessable as ordinary income. | Detailed Reasoning - Detailed Reasoning: 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). Based on case law, it can be said that ordinary income generally includes receipts that: ● are earned ● are expected ● are relied upon, and ● have an element of periodicity, recurrence or regularity. In your situation the payment that you will receive is in respect of a review conducted by your bank because they had provided inappropriate financial planning advice which caused your superannuation account to not perform as well as it should have. The payment was not earned by you 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 does not arise from a relationship to personal services performed. Accordingly, the super compensation payment is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997. 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. | Detailed Reasoning - Capital gains: Taxation Ruling TR 95/35 considers the treatment of compensation payments and the capital gains tax (CGT) consequences for the recipient. 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 section 104-155 of the ITAA 1997. In determining which the most relevant asset is, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt. Paragraph 3 of TR 95/35 provides definitions for some of the key terms used in the ruling. The definitions provide that 'permanent damage or reduction in value' does not mean everlasting damage or reduced value, but refers to damage or reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right. 'Underlying asset' is defined 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 (TR 95/35). Paragraphs 6 to 9 of TR 95/35 provide the following guidelines on the treatment of compensation for permanent damage to or permanent reduction in the value of the underlying asset: If an amount of compensation is received by the taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of the underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset. Accordingly, the total acquisition costs of the post-CGT asset should be reduced in terms of section 110-25 of the ITAA 1997 by the amount of the compensation. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset. The adjustment of the total acquisition costs effectively reduces those costs by the amount of the recoupment as if those costs had not been incurred. Compensation received by a taxpayer has no CGT consequences if the underlying asset which has suffered permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985 or is any other exempt CGT asset. In your case, the underlying asset is your right to a capital amount payable out of a superannuation fund. As a result of the actions of your financial advisor, there was a reduction in the value of your superannuation account. Therefore, it is considered that there has been a permanent reduction in value of your right to a capital amount payable out of your superannuation fund. Subsection 118-305(1) of the ITAA 1997 disregards any capital gain or loss if you make it from a CGT event in relation to any of the following; ● a right to an allowance, annuity or capital amount payable out of a superannuation fund ● a right to an asset of such a fund ● a right to any part of such an allowance, annuity, capital amount or asset. The compensation you will receive is in relation to the permanent reduction in value of your right to a capital amount payable out of a superannuation fund. Therefore, any capital gain or loss you made is disregarded under section 118-305 of the ITAA 1997. | Detailed Reasoning - Interest: Paragraph 26 of Taxation Ruling TR 95/35 deals with the treatment of interest awarded as a part of a compensation amount. It states: Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions. If the taxpayer receives an undissected lump sum compensation amount and the interest cannot be separately identified and segregated out of that receipt, no part of that receipt can be said to represent interest. In this case, you will receive compensation due to inappropriate financial advice. An amount is separately identified as interest. Therefore, this amount is assessable as ordinary income in the year of receipt under section 6-5 of the ITAA 1997.

Relevant facts: You received a letter from your bank offering a compensation amount due to inadequate financial advice for a loss in investments as well as loss on your superannuation account, including interest. | You are not seeking a ruling on the compensation received in relation to your loss in investments, but only for the compensation and interest received regarding your superannuation fund. | The offer contains superannuation compensation and an interest component. | The letter contains details about the assessment of the financial advice received from a representative of your banks financial planning arm. | The financial advice was given to you but the assets in question were owned by your superannuation fund. | The outcome of the assessment was that advice provided was likely inappropriate. As a result of this, the offer of compensation was made. | The compensation aims to place you in the financial position you would have been in if the advice given was appropriate. | You were sent a Deed of Settlement and Release which was signed by you.