The ATO has published information about how tax applies for people who receive compensation from financial institutions.

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The ATO has recently provided information about how the tax system applies for someone who receives compensation from a financial institution that provided inappropriate advice and/or did not provide advice it should have. This can include compensation for the loss of an investment, or a refund of fees or interest.

Capital gains tax comes into play, because CGT event A1 happens when an individual disposes of an investment. The capital gain or loss made from a CGT event is to be reported in the same financial year as the event occurs.

Compensation may be paid to a person in connection with an investment they have already disposed of. This type of compensation payment can be treated as additional capital proceeds associated with the disposal. If more than one investment is associated with a compensation payment, the ATO says the additional capital proceeds need to be apportioned among the disposed-of investments.

If a person has been compensated for investments they still own, they need to reduce either the cost base or the reduced cost base by the compensation amount they receive, depending on whether they make a loss or gain when they later dispose of the investments. Again, the compensation amount needs to be apportioned if it relates to more than one investment.

A compensation payment may also include an amount that is a refund or reimbursement of adviser fees. If the compensated person claimed a deduction for the adviser fees in a tax return, the amount they receive as a refund or reimbursement will form part of their assessable income in the year they receive it. If they 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, the cost base and reduced cost base must be reduced by the amount of the refund or reimbursement. When the person later disposes of the investment, these reductions will be used to calculate the capital gain or loss they make

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Source: www.ato.gov.au/Individuals/Income-and-deductions/In-detail/Compensation-paid-from-financial-institutions/.