‘Adverse’ tax outcomes flagged with misconduct compensation

In recent months, ASIC has initiated court actions against both NAB and AMP in relation to advice or superannuation related compliance failures, with both banks already promising refunds for affected customers.

The royal commission also exposed extensive examples of misconduct relating to insurance in super across both retail and industry funds.

DBA Lawyers director Daniel Butler said financial advisers who are not aware of the tax rules at play need to be very careful as there are income tax, CGT, GST and other possible taxes that could apply.

“The agreement or settlement deed needs to be carefully examined to make sure there are no adverse tax implications and the communications arriving at any settlement sum need to be mindful of the eventual tax ramifications,” Mr Butler warned.

In an online update, the ATO explained that if an individual receives compensation from a financial institution because they received advice from them that was found to be inappropriate or paid for advice that they did not receive, they will need to consider the tax consequences.

The ATO stated that the tax treatment of the compensation depends on what the compensation is being paid for and how the individual held the investments.

“Your compensation payment can include compensation for loss on an investment, a refund or reimbursement of fees or interest,” it said.

“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.”

The ATO said there is different tax treatment depending on whether the compensation relates to investments that an individual has disposed of or existing investment.

“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 ATO explained.

“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 the taxpayer is an Australian resident for tax purposes and the compensation relates to investments they held for at least 12 months, the ATO said they may be entitled to the 50 per cent CGT discount where they disposed of their 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,” it said.

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

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

In terms of refunds or reimbursement of adviser fees, the tax treatment of this amount will depend on whether the taxpayer claimed a deduction for the adviser fees in their tax return.

“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,” the ATO noted.

If the individual did not claim a deduction for the adviser fees, the refund or reimbursement does not form part of their assessable income.

“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,” he said.

“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.”

The ATO also flagged that if an individual has disposed of investments and have returned any resulting capital gain or loss in a previous income year, they may need to amend your tax return for that year.

As a general rule, Mr Butler said if the compensation is to provide for lost income or a deduction, then the amount is likely to be income or reimburse for a prior expense.

“If the amount relates to capital, it may be on capital or CGT account. Care also has to be taken in relation to which taxpayer is involved,” said Mr Butler.

“For example, if some money relates to an SMSF, then the compensation should be paid to the SMSF and not the member as that can give rise to adverse consequences.”