Tax Consequences Of Compensation From Financial Institutions

The Royal Commission into misconduct tin the banking, superannuation and financial services industry has revealed some major deficiencies in terms of financial advice provided to consumers. Even though the Commission itself cannot fix or award compensation or make orders to require parties to a dispute to take or not take any action, the media exposure from the hearings have spurred many financial institutions to compensate their customers who received less than stellar treatment.

The tax treatment of this compensation depends on what the compensation is being paid for and how the investment was held. 

A compensation amount from a financial institution could include a combination of loss on an investment, refund or reimbursement of fees, and/or interest.  Compensation may also relate to multiple investments, with different amounts granted against each one. Therefore, if you receive compensation in this form, the tax consequences of each amount must be carefully considered.

If you receive compensation for loss on an investment (i.e. the value of your investments is lower than it would have been if you had received appropriate advice) and you have subsequently disposed of the relevant investment. The compensation received will most likely be treated as additional capital proceeds related to disposing the investments if you held the investment on capital account.

For example, if you dispose of an investment, CGT event A1 occurs and any capital gains or losses are reported in the financial year you disposed of the asset. If you’re an Australian resident and have held the investment for at least 12 months, remember you may be entitled to the 50% CGT discount if you disposed of your investments for a capital gain. Where the compensation amount relates to more than one investment, you will need to apportion the additional capital proceeds to each disposal. An amendment to a prior year tax return may need to be requested where the disposal of investment and receipt of compensation happens in different financial years.

In relation to compensation for existing investments that you have not sold, you may need to reduce the cost base of the investment by the compensation amount you receive (for investments held on capital account). Again, apportionment is required where the compensation relates to more than one investment.

The compensation payment received may include an amount that is a refund or reimbursement of adviser fees, the tax treatment of which depends on whether you claimed a deduction for the adviser fees in your tax return. If you claimed a deduction for adviser fees, the refund or reimbursement will be assessable income in the year you receive it. If you did not claim a deduction for the adviser fees, you do not need to include the amount as your assessable income. However, if you included the adviser fees in the cost base of the investment, that must be reduced accordingly.

If you receive compensation which has an interest component, it is assessable as ordinary income and should be included in your tax return in the financial year it is received. Note that the tax treatment of compensation may differ if you held investments on revenue account, on trust, or the compensation relates to a superannuation account or a SMSF account.

Need more guidance?

Have you received a compensation amount and don’t know how to dissect it into the relevant parts? Or perhaps the compensation amount received relates to investments that were not held on capital account (i.e. revenue, on trust, or superannuation related)? Whatever your issue may be, we have the expertise to help, contact us today.