The Royal Commission into misconduct in 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.
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 (ie 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.
Remember you may be entitled to the 50% CGT discount where you disposed of your investments for a capital gain (if you’re an Australian resident and have held the investment for at least 12 months). If 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 in some situations.
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.