Compensation payments and capital gains tax

A compensation payment includes any amount (either money or other property) paid to a taxpayer in respect of a right to seek compensation or any proceeding instituted by the taxpayer in respect of that right. The right to seek compensation may arise in relation to any underlying asset. 
 
Typical compensation payments may be made for:

• an administrative error on behalf of a fund manager resulting in a loss to an investor
• the settlement of Class Action proceedings, either in court or out of court
• a missed opportunity of gain as a result of a delay in processing a buy or sell order
• an incorrect calculation of an interest rate that requires rectification.

A right to seek compensation is a capital gains tax (CGT) asset for tax purposes. The right to seek compensation is acquired at the time of the compensable wrong and includes all the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it’s satisfied, surrendered, released or discharged.

We’ll endeavour to report compensation payments received by investors in the most accurate way possible for tax purposes, based on information available. 
 
Where a component of the compensation received is interest, the amount will be reported in our reports as assessable interest income on the date the interest was paid. 
 
Where the compensation received is income (and replaces lost income), the amount will be reported in our reports as unfranked dividend income and will be reported as assessable on the date the unfranked dividend was paid. 
 
Where the compensation relates to a CGT event, the amount of the compensation may be reported in one of the following ways:

• a cost base adjustment in the form of a return of capital
• in the case of an asset realisation, an adjustment to the capital proceeds
• a distributed realised capital gain (reported as either discounted, indexed or other depending on the circumstances of the individual investor).

Where the nature of compensation cannot be determined or has not been disclosed to us, the payment will be treated as a disposal of a right to seek compensation on the date the compensation amount is received.

As the right being disposed of is a capital asset, a capital gain will arise to the extent the capital proceeds (eg the settlement amount) exceeds the cost base of the asset (eg legal expenses incurred in pursuing compensation). A capital loss will arise to the extent the reduced cost base of the asset exceeds the capital proceeds.