In 2022 Tax Tips

Tax Consequences Of Compensation For Dodgy Advice

Did you know that there may be tax consequences if you receive compensation for dodgy advice? In this blog post, we’ll take a look at the tax implications of getting paid for giving bad advice. We’ll also explore some strategies to reduce or avoid any tax penalties. So, if you’re thinking about offering dodgy advice for pay, read on!

You may have heard of the recent case of a financial advisor who was ordered to pay back over $5 million in taxes and penalties after giving dodgy advice to his clients. This case serves as a reminder that you need to be aware of the tax consequences of any compensation you might receive for advice.

When it comes to tax planning, it’s important to get professional help to make sure you’re taking all the necessary deductions and allowances. However, what happens if that professional advice is wrong or downright dodgy? Unfortunately, you might end up with a bigger tax bill than you expected. In this post, we’ll take a look at the consequences of getting bad advice from your accountant or financial advisor. So, if you’re ever in doubt about what to do, be sure to seek out qualified professionals!

ATO Could Tax You On Compensation Payouts From Banks

Remediation costs paid out to customers wronged by financial institutions have been estimated to be as high as $10 billion as the government works its way through implementing recommendations recommended by the banking Royal Commission.

But those customers who received compensation from their bank as a result of the major inquiry are now warned that their payout could have “tax consequences”.

The ATO’s website says Aussies who have been remediated for receiving advice that was inappropriate or paying for advice they didn’t receive would have to “consider the tax consequences”.

“The tax treatment of the compensation depends on what the compensation is being paid for and how you hold (or held) the investments,” the ATO said on its website.

The compensation payment could include compensation for an investment loss, a refund or reimbursement of fees, or compensation for interest.

“You may need to contact us for advice if: you held the investments on revenue account; you held the investments on trust; or the compensation related to a superannuation account or self-managed super fund.”

Failing to declare compensation payments could mean taxpayers are under-reporting their interest income, which could then lead to more taxes or penalties from the taxation office.

But an ATO spokesperson told Yahoo Finance that “not all compensation payments” were taxable and would depend on the individual’s circumstances.

“If after reviewing the information available on the ATO website any taxpayers have questions or concerns, we encourage them to contact the ATO for further assistance,” the spokesperson advised.

Superannuation funds can also make compensation payments, and more information on tax implications where this is the case is available here.

Why Would My Compensation Payment Be Taxed?

The idea is that you are being compensated for the investment you would have otherwise made, and therefore income you would have otherwise earned.

Tax Institute of Australia senior counsel Bob Deutsch explained: “The general principle that has been applied in relation to compensation payments in the past is that, if the payment being compensated is for an amount that, if it had been received in the normal course would be assessable, then the compensation payment itself is assessable.

“It would seem compensation payments which are a substitute for income are themselves income according to ordinary concepts, even if they are received as a lump sum,” he told the AFR in January.

What Do I Do About It?

Australians are advised to seek advice if they have received financial compensation payments.

“The first thing to do is to determine if any of it is taxable,” H&R Block director of tax communications Mark Chapman told Yahoo Finance. “This is where it gets complicated.”

Chapman has seen taxpayers who have received financial compensation in the last few years, and in nearly all instances, it has been necessary to take a closer look at the “written documentation around the payout to determine the basis of the compensation”.

“This is because different tax treatments apply to different types of compensation. So, for example, if you receive compensation for interest that you have lost (say, by being sold a product that paid less interest than was appropriate to your circumstances), the compensation for that lost interest will be taxable (on the basis that the interest – if you’d receive it – would also have been taxable).

“If you receive compensation for fees paid to advisers who gave dodgy advice, that compensation would be taxable if you claimed a tax deduction for the original fees but NOT taxable if you didn’t claim a tax deduction.

“If you receive compensation for an investment that you have since sold, that compensation will need to be added to the sale proceeds from the original investment – which could involve extra Capital Gains Tax and amending a previously lodged tax return.

“That’s three examples of wildly differing tax treatments, and there are others – this really only skims the surface,” he said.

Due to the complexity of the matter, Aussies should turn to a tax agent or advisor, Chapman added.

“This is all very difficult, and I wouldn’t recommend anybody try to navigate this without getting advice from a qualified tax professional,” he said.

“That is especially true as the ATO may receive information from the banks as to who has been paid out, which means that they will be able to data-match recipients details with the bank data to identify who isn’t correctly accounting for tax on their compensation payouts.

“So, talk to a tax adviser and in addition make sure you get and keep detailed paperwork identifying exactly what you are being paid out for.”

“Also, don’t forget that if the payout you receive is taxable, you may be able to claim a deduction for any fees you incurred in getting it (such as lawyers charges).”

Tax Consequences Of Compensation For Dodgy Advice

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With the big financial institutions rushing to compensate their customers as a result of the media exposure from the Royal Commission, now is the time to look at the tax consequences of such payments. Put simply, the tax treatment of this type of compensation received depends on what the compensation is being paid for and how the investment was held. Therefore, the tax consequences of each amount must be carefully considered to ensure that each component is treated appropriately.

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.

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. If you held the investment in a capital account, the compensation received will most likely be treated as additional capital proceeds related to the investments’ disposal.

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 investment disposal and compensation receipt may occur 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 that 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 a revenue account, on trust, or the compensation relates to a superannuation account or an SMSF account.

Compensation Paid From Financial Institutions

If you receive a compensation payment from a financial institution, the tax treatment of the payment will depend on what the compensation payment covers.

You may personally receive compensation from a financial institution because you:

  • received advice from them that was found to be inappropriate
  • paid for advice that you did not receive.

The tax treatment of the compensation depends on what the compensation is being paid for and how you hold (or held) the investments.

Your compensation payment can include some or all of:

The compensation may relate to multiple investments, with different amounts of compensation granted against each one. Therefore, you treat each compensation amount separately.

You may need to contact us for advice if:

  • you held the investments on revenue account
  • you held the investments on trust
  • the compensation relates to a superannuation account or self-managed super fund.

Compensation For Loss On An Investment

You may receive compensation for a loss amount if the value of your investments is lower than it would have been if you had received appropriate advice.

The tax treatment will depend on the status of your investment. Find out how to treat:

Compensation When You Have Disposed Of The Investment

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A capital gains tax (CGT) event occurs when you dispose of the relevant investment. Therefore, you report capital gains or losses you make from a CGT event in the income year you dispose of the asset.

Compensation payments you receive 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 you are an Australian resident for tax purposes and the compensation relates to investments you held for at least 12 months, you may be able to claim the 50% CGT discount. This occurs where you disposed of your investments for 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 income year.

Compensation In Relation To Existing Investments

If you receive compensation for investments you still own, you need to reduce either the cost base or the reduced base. You reduce one of these amounts by the compensation amount you received, depending on whether you make a loss or gain when you dispose of the investments.

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

Refund Or Reimbursement Of Adviser Fees

Your compensation payment may include an amount that is a refund or reimbursement of adviser fees. The tax treatment of this amount depends on whether you claimed a deduction for the adviser fees in your tax return.

Deduction Claimed For Adviser Fees

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.

Deduction Not Claimed For Adviser Fees

If you did not claim a deduction for the adviser fees, the refund or reimbursement does not form part of your 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 the cost base by the amount of the refund or reimbursement.

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.

If you have disposed of these investments and have returned any resulting capital gain or loss in a previous income year, you may need to amend your tax return for that year.

Victims Of Dodgy Financial Advice Still Waiting On Thousands Of Dollars In Compensation

Victims of dodgy financial advice have been waiting for years to receive hundreds of thousands of dollars in compensation payments, as granted to them by the financial services ombudsman.

A key recommendation of the royal banking commission was to set up an industry-funded Compensation Scheme of Last Resort to compensate victims of companies that go broke after giving them misleading advice.

The scheme was deemed necessary as people who had won decisions against insolvent companies were not being paid as there was often no money left over to pay them.

But more than two years after Commissioner Kenneth Hayne handed down his final report, hundreds of Australians are still waiting to receive compensation despite the Australian Financial Complaints Authority already ruling that many of them were entitled to significant payments.

The federal government had committed to introducing the scheme to Parliament by December 30, 2020, before pushing back this deadline to June 30, 2021, as a result of the pandemic.

But that deadline has also now been missed – prompting consumer group Choice to call on the government to make the reform a priority for the first week that Parliament returns to work in August.

“We would say this issue is probably the most important recommendation of the royal banking commission, and it should be one of the biggest priorities,” Choice CEO Alan Kirkland told The New Daily.

“In a practical sense, the delay means that there are people who are entitled to compensation because that’s been [ruled] by the financial complaints authority, and that compensation is not being paid.

“And there are other people whose complaints have never even been heard by the Australian Financial Complaints Authority because of these delays.”

IN OCTOBER, the ABC reported that 620 people had complained to AFCA about insolvent firms before the ombudsman decided to stop hearing complaints in April 2020, with one couple telling 7.30 they had lost more than $200,000 as a result of a misleading investment.

AFCA took the decision to stop hearing complaints because it was unsure when the federal government would get around to setting up the compensation scheme.

An AFCA spokesperson told the ABC the ombudsman it “did not feel it was right to ask consumers to invest considerable time and energy in pursuing such matters until it was clear there was a prospect that they may be paid compensation if awarded”.

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