Private ruling: Compensation payment
Date of advice: 14 February 2019
Published: May 2019
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is the compensation payment you received assessable as ordinary income? | A1: No | Q2: Is the compensation payment you received assessable under the capital gains tax (CGT) provisions? | A2: Yes | Q3: Is the capital gain or loss on the compensation payment you received disregarded under section 118-305 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A3: Yes

Relevant facts and circumstances: You received inappropriate financial advice in relation to superannuation products which resulted in a loss to your investments. You accepted a Settlement Sum from the financial institution.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 102-5 | Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Section 118-305

Reasons for decision: Summary: The Settlement Sum is not assessable as ordinary income. The Settlement Sum is assessable under the capital gains tax provisions however the gain is disregarded under section 118-305(1) of the ITAA 1997. | Detailed Reasoning - Detailed Reasoning: A payment or other benefit received by a taxpayer is assessable income if it is: ● income in the ordinary sense of the word (ordinary income); or ● an amount or benefit that through the operation of the provisions of the tax law is included in assessable income (statutory income). | Detailed Reasoning - Ordinary income: Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). The legislation does not provide specific guidance on the meaning of income according to ordinary concepts, however, a substantial body of case law exists which identifies likely characteristics. 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 payment is not assessable as ordinary income in your hands as it is not a product in a real sense of any employment, services or business carried on by you and it does not have the characteristics normally associated with ordinary income such as periodicity and reliance on the payments to meet regular expenditure. We do not consider that the Settlement Sum relates to income and is capital in nature. | Detailed Reasoning - Statutory income – capital gains: Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes a net capital gain. A capital gain or loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset. A CGT asset is defined in paragraph 108-5(1)(b) of the ITAA 1997 as including a legal or equitable right that is not property. 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. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset for which the compensation has been received, it is often appropriate to adopt a ‘look-through’ approach to the transaction which generates the payment. 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. In your case, the relevant underlying asset is your right to a capital amount payable out of your superannuation fund. As a result of the inappropriate advice, there has been a permanent reduction in value to the underlying asset which gave right to the right to seek compensation from the person or entity that caused the loss in value to that asset. 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. However, 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 Settlement Sum you received is in relation to the permanent reduction in value of your right to a capital amount payable out of your superannuation fund. Therefore, any capital gain or loss you made is disregarded under section 118-305 of the ITAA 1997.