How should compensation received for inappropriate advice be taxed?
With the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry currently underway, many individuals may have received or may be about to receive compensation for inappropriate financial advice received from financial institutions (e.g. compensation for loss of investment, refund or reimbursement of fees or interest).
Such a compensation payment will be taxable in the hands of the recipient – and the amount of tax payable will depend on what the compensation was paid for and whether the investments were held on revenue or capital account.
For example, if compensation is received for the loss of an investment, the tax treatment of the compensation will depend on whether the individual taxpayer has disposed of the investment or not. Therefore, if the investment is
- disposed of, the compensation will form part of additional capital proceeds; or
- not disposed of, the compensation will reduce the cost base (or reduced cost base) of the investment.
Likewise, the tax treatment of a compensation payment received to refund or reimburse adviser fees will depend on whether the adviser fee was originally claimed as a tax deduction or included in the cost base of the investment. Accordingly, such compensation will either:
- be included in assessable income if the individual taxpayer claimed a tax deduction for the adviser fee;
- not be included in assessable income if the individual taxpayer did not claim a tax deduction for the adviser fee; or
- reduce the cost base of the investment by the amount of compensation received if the adviser fee was originally Included in the cost base of the investment.
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