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ATO could tax you on compensation payouts from banks

(Source: Getty)

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.

Compensation payments can also be made by superannuation funds, 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 has 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. 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).”

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