Private ruling: Compensation payment
Date of advice: 13 November 2017
Published: March 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the compensation payment received assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Does the compensation payment received reduce the cost base of the underlying assets under the capital gains tax (CGT) provisions? | A2: Yes.

Relevant facts and circumstances: You invested your money following advice from a financial planner. The investment decreased in value. The financial planners advised that they had reviewed your case and determined that the advice you received was not appropriate for your circumstances. You were offered compensation based on their calculation on the financial position that you would have been in had you received financial advice appropriate for your circumstances. You still own the investment.

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

Reasons for decision: Summary: 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. Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation. 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. If an amount of compensation is received by a 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 that 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. Having regard to your full circumstances, it is accepted that the compensation payment relates to the diminished value of an underlying asset, being your investment portfolio, which you still hold. Consequently the compensation payment will not be assessable income under section 6-5 of the ITAA 1997 as the payment will be of a capital nature. As there is no disposal of the underlying asset the receipt will instead amount to a reduction of the cost base of the relevant investment. This will affect the capital gain or loss made when you sell the investment.

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