With the Hayne Royal Commission into the financial services industry in full swing, exposing significant misfeasance in the Banking, insurance, financial advice and superannuation sectors, there is much talk of the compensation being paid or accelerated. With this in mind, on 8 October 2018, the ATO posted an advice page, on its website, about how any compensation might be taxed.

Introduction

Addressing the reader, it says: ‘You need to consider the tax consequences if you have personally received compensation from a financial institution because you:

  • received advice from them that was found to be inappropriate
  • paid for advice that you did not receive.

The tax treatment of the compensation depends on what the compensation is being paid for and how you hold (or held) the investments. Your compensation payment can include some or all of:

  • compensation for loss on an investment
  • a refund or reimbursement of fees
  • interest.

The compensation may relate to multiple investments, with different amounts of compensation granted against each one. You must consider the tax consequences of each compensation amount separately.

You may need to contact us for advice if:

  • you held the investments on revenue account
  • you held the investments on trust
  • the compensation related to a superannuation account or self-managed super fund.

Compensation for loss on an investment

You may receive compensation for a loss amount if the value of your investments is lower than it would have been if you had received appropriate advice.

Compensation for investments you have disposed of

When you disposed of the relevant investment, capital gains tax (CGT) event A1 happened. Capital gains or losses made from a CGT event are reported in the financial year you disposed of the asset.

The compensation can be treated as additional capital proceeds relating to the disposal of those investments. If you had more than one investment, you will need to apportion the additional capital proceeds to each disposal.

If you are an Australian resident for tax purposes and the compensation relates to investments you held for at least 12 months, you may be entitled to the 50% CGT discount where you disposed of your investments for a capital gain.

You may need to request an amendment to your tax return to reflect the additional capital proceeds if the compensation relates to CGT events that happened in a previous financial year.

Compensation in relation to existing investments

If you have been compensated for investments you still own, you need to reduce either the cost base or the reduced cost base by the compensation amount you received, depending on whether you make a loss or gain when you dispose of the investments.

You will need to apportion the compensation amount where it relates to more than one investment.

Refund or reimbursement of adviser fees

Your compensation payment may include an amount that is a refund or reimbursement of adviser fees. The tax treatment of this amount depends on whether you claimed a deduction for the adviser fees in your tax returns.

Deduction claimed for adviser fees

If you claimed a deduction for the adviser fees in a tax return, the amount you received as a refund or reimbursement will form part of your assessable income in the year you receive it.

[I don’t think the law is as simple as this. The Commissioner is right, if the recoupment is by way of ‘insurance or indemnity’ (s20-20(2) of the ITAA97). But, if the compensation is not ‘by way of insurance or indemnity’, then it is only recoupments of specified types of outgoings, under specified provisions of the ITAA97 or ITAA36 that are assessable (s20-20(3) & s20-30 of the ITAA97.]

Deduction not claimed for adviser fees

If you did not claim a deduction for the adviser fees, the refund or reimbursement does not form part of your assessable income. This is a product of there being no SubDiv 20-A ‘assessable recoupment’ and no capital gain – broadly because the right to compensation, disposed of by receiving that compensation, had an adequate cost base, established by the monetary outlay, in paying for the unsatisfactory or non-existent advice – see TR 95/35).

However, where the adviser fees were included in the cost base or reduced cost base of any investments you made, you must reduce the cost base and reduced cost base by the amount of the refund or reimbursement. [s110-45(3) of the ITAA97]

You do not need to report any change of cost base and reduced cost base to us. The cost base and reduced cost base are used to calculate your capital gain or loss when you dispose of the investment. Report your capital gain or loss to us in the tax return for the year in which you dispose of the investment.

If you have disposed of these investments and have returned any resulting capital gain or loss in a previous income year, you may need to amend your tax return for that year.

Interest component

The interest component is assessable as ordinary income and should be included in your return in the financial year you receive it.

FJM 12.10.18

[ATO website: Taxation of Compensation post; LTN 193, 8.10.18; Tax Month – October 2018]

CPD questions (answers available)

  1. Was the prompt for this advice, bad conduct in the financial services industry exposed by the Hayne Royal Commission?
  2. Is the correct treatment, for compensation on an investment, that you still have, as recoupment of cost base?
  3. Is the position the same for an investment you’ve already sold?
  4. Is there any assessable income on compensation for investment advice, where no deduction has been claimed?
  5. Is the position the same for advice you have deducted?
  6. Is the position the same for advice that is part of the cost base for an investment?

[Answers:1.yes;2.yes;3.no(additionalSalesProceeds);4.no;5.no(thereMayBeAnAssessableRecoupment);

6.no(seeCompensationForInvestments)]

 

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