House of Representatives

TAXATION LAWS AMENDMENT (SUPERANNUATION) BILL 1993

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

Chapter 3 Death Benefit ETPs

Summary of proposed amendments

Purpose of amendment:

Death benefit eligible termination payments (ETPs) within the deceased's reasonable benefit limits (RBLs) will be taxed as follows:

-
benefits paid to dependants will be exempt from tax;
-
benefits paid to non-dependants will be taxed as ordinary ETPs. However, the post-June 1983 component of such ETPs will be taxed at a maximum rate of 15% (plus medicare levy) if paid from a taxed source and 30% (plus medicare levy) if paid from an untaxed source.

Benefits in excess of the deceased's RBL entitlement will be taxed as an excessive component of an ETP.
Lump sum benefits arising as a result of superannuation pensions or annuities that have commenced to be payable will receive the same taxation treatment as death benefit ETPs.

Date of effect: 1 July 1994

Background to the legislation

Eligible termination payments (ETPs) are taxed in accordance with Subdivision AA of Division 2 of Part III of the Income Tax Assessment Act 1936. The most common types of ETPs that qualify as death benefits are:

employer related payments made after the death of an employee (other than amounts representing unused annual leave or accrued long service leave);
lump sum payments from superannuation funds made after the death of the member; and
payments from approved deposit funds (ADFs) made after the death of the member.

Recipients of death benefit ETPs fall within three main categories: dependants, non-dependants and trustees of deceased estates. The current taxation treatment of death benefit ETPs varies depending on the type of benefit and the category of the recipient receiving the payment.

Payments directly to dependants

Death benefits ETPs paid to dependants generally receive more concessional tax treatment than that which would apply had the deceased person received the benefit. A dependant for these purposes includes a spouse (including a de facto spouse or former spouse) and a child under 18 years of age.

The types of death benefits received by dependants and their general tax consequences are set out in Table 1.

Table 1: Dependants
Type of Death Benefit Tax Consequences
Employer payment Exempt via paragraph 27A(3)(b). Cannot be rolled-over.
Lump sum payment from a superannuation fund Exempt via paragraph 27A(3)(b). Cannot be rolled-over.
Approved deposit fund Exempt via paragraph 27A(3)(b). Cannot be rolled-over.
Residual capital value of a deferred annuity Exempt via subsection 27A(5BA) where paid during deferment phase. Cannot be rolled-over.
Residual capital value of a superannuation pension Assessable as an ETP. Can be rolled-over.
Residual capital value of an immediate annuity Assessable as an ETP. Can be rolled-over by the spouse or, if the annuity is payable under a super policy not purchased with rolled-over amounts, by any dependant.

Payments directly to non-dependants

Lump sum death benefits received by a non-dependant are taxed as ETPs. A non-dependant is a person who is not a dependant at the time of death of the deceased or at the time of payment of the benefit.

The types of death benefits received by non-dependants and their general tax consequences are set out in Table 2.

Table 2: Non-dependants
Type of Death Benefit Tax Consequences
Employer payment Assessable as an ETP. Cannot be rolled-over.
Lump sum payment from a superannuation fund Assessable as an ETP. Cannot be rolled-over.
Approved deposit fund Assessable as an ETP. Cannot be rolled-over.
Residual capital value of a deferred annuity Assessable as an ETP. Can be rolled-over provided the annuity is a superannuation policy not purchased with rolled-over amounts.
Residual capital value of a superannuation pension Assessable as an ETP. Can be rolled-over.
Residual capital value of an immediate annuity Assessable as an ETP. Can be rolled-over provided the annuity is a superannuation policy not purchased with rolled-over amounts.

Payments to trustees of the deceased's estate

The tax treatment of lump sum death benefits payable directly to the trustee of the deceased estate depends largely on the type of death benefit paid and the extent to which dependant beneficiaries are likely to benefit from the payment.

The types of death benefit ETPs received by trustees of deceased estates and their general tax consequences are set out in Table 3.

Table 3: Trustee of the deceased's estate
Type of Death Benefit Tax Consequences
Employer payment Exempt to the extent dependant beneficiaries are likely to benefit. Cannot be rolled-over.
Lump sum payment from a superannuation fund Exempt to the extent dependant beneficiaries are likely to benefit. Cannot be rolled-over.
Approved deposit fund Exempt to the extent dependant beneficiaries are likely to benefit. Cannot be rolled-over.
Residual capital value of a deferred annuity Exempt to the extent dependant beneficiaries are likely to benefit, where paid during deferment phase. Cannot be rolled-over.
Residual capital value of a superannuation pension Assessable as an ETP. Cannot be rolled-over.
Residual capital value of an immediate annuity Assessable as an ETP. Cannot be rolled-over.

The above tables illustrate that the taxation arrangements applying to death benefit ETPs are diverse and depend on the form of benefit, the manner of receipt and the relationship of the recipient to the deceased. Anomalies also arise when a non-dependant receives a death benefit ETP via an estate. The benefit is taxed in the hands of the trustee at the ETP tax rates according to the deceased's age. If the same benefit was received directly by the non-dependant, the benefit would be assessed in the recipient's hands according to the recipient's age.

Explanation of proposed amendments

Death benefit ETPs paid to both dependants and non-dependants will be classified into four categories. Category 1 and 3 benefits are payments made to the trustees of the deceased's estate. Category 2 and 4 benefits are payments made directly to the beneficiaries.

Category 1 death benefit ETPs

The first category of death benefit ETPs are payments made after the death of a taxpayer to the trustee of the taxpayer's estate that are:

payments from the deceased's employer, apart from payments of unused annual leave or accrued long service leave (paragraph (a) of the definition of ETP in subsection 27A(1) of the Income Tax Assessment Act);
payments from superannuation funds (paragraph (b) of the ETP definition);
payments from approved deposit funds (paragraph (c) of the ETP definition);
payments representing the commutation of a superannuation pension where the election to commute was made prior to the death of the deceased but the payment was not made until after their death (paragraph (d) of the ETP definition);
payments representing the residual capital value of a superannuation pension (paragraph (e) of the ETP definition);
payments representing the commutation of an annuity where the election to commute was made prior to the death of the deceased but the payment was not made until after their death (paragraph (g) of the ETP definition);
payments representing the residual capital value of an annuity (paragraph (h) of the ETP definition).

[New subsection 27AAA(2): Table 1 Item 1]

Category 2 death benefit ETPs

The second category of death benefit ETPs cover most payments made directly to a beneficiary. Payments under the relevant paragraph of the definition of an ETP will always qualify as death benefit ETPs. Category 2 death benefit ETPs consist of:

payments made directly from the deceased's employer, apart from payments of unused annual leave or accrued long service leave (paragraph (aa) of the ETP definition);
payments made directly from the deceased's superannuation fund (paragraph (ba) of the ETP definition);
payments made directly from the deceased's approved deposit fund (paragraph (ca) of the ETP definition);
lump sum payments made directly or indirectly from the deceased's superannuation fund where the beneficiary or some other person had a right to elect to receive a superannuation pension in lieu of the capital sum (paragraph (db) of the ETP definition);
payments representing the residual capital value of a superannuation pension payable to the deceased (paragraph (f) of the ETP definition);
lump sum payments made directly or indirectly from the deceased's superannuation fund where the beneficiary or some other person had a right to elect to receive a annuity in lieu of the capital sum (paragraph (gb) of the ETP definition);
payments representing the residual capital value of an annuity payable to the deceased (paragraph (j) of the ETP definition).

[New subsection 27AAA(2): Table 1 Item 2]

To achieve the outcome that all benefits paid directly from employers, superannuation funds and ADFs to both dependants and to non-dependants are death benefit ETPs within the scope of Item 2, subparagraph (ii) of paragraphs (aa), (ba) and (ca) of the definition of ETP in subsection 27A(1) is being removed [Subclause 12].

Category 3 death benefit ETPs

The third category of death benefit ETPs are payments made to the trustee of the estate of the deceased. Payments under the relevant paragraph of the definition of an ETP that applies to category 3 type death benefit ETPs will always qualify as death benefit ETPs. Category 3 death benefit ETPs consist of:

lump sum payments made directly or indirectly from the deceased's superannuation fund to the trustee of the deceased's estate where the beneficiary or some other person had a right to elect to receive a superannuation pension in lieu of the capital sum (paragraph (da) of the ETP definition);
lump sum payments made directly or indirectly from the deceased's superannuation fund to the trustee of the deceased's estate where the beneficiary or some other person had a right to elect to receive an annuity in lieu of the capital sum (paragraph (ga) of the ETP definition);

[New subsection 27AAA(2): Table 1 Item 3]

Category 4 death benefit ETPs

The final category of death benefit ETPs are payments made directly to a beneficiary. Category 4 death benefit ETPs consist of:

payments representing the commutation of a superannuation pension (paragraph (d) of the ETP definition) where there is required link with the deceased person and the payment is made in the specified period;
payments representing the commutation of an annuity (paragraph (g) of the ETP definition) where there is required link with the deceased person and the payment is made in the specified period;

[New subsection 27AAA(2): Table 1 Item 4]

The required link for paragraph (d) and (g) ETPs to qualify as Item 4 type death benefit ETPs is that the pension or annuity must be:

a reversionary pension or annuity (ie, a pension or annuity that is the continuation, usually at a lesser rate, of a pension or annuity that was payable to the deceased); or
a pension or annuity that became payable as the result of the death of another person.

[New subsection 27AAA(6)]

In addition, a paragraph (d) or (g) ETP with the required link will qualify as a death benefit ETP only if it is made within the specified period. The specified period is the longer of:

6 months after the date of death of the deceased person; or
3 months after the grant of probate of the deceased person's will or of letters of administration of the deceased person's estate.

[New subsection 27AAA(7)]

If a paragraph (d) or (g) ETP is made directly to a beneficiary outside the specified period, the amount received is taxed as an ordinary ETP in the recipients hands.

With the exception of paragraphs (d) and (g), each paragraph of the definition of ETP falls within only one Item in the Table of Death Benefits in new subsection 27AAA(2). Paragraphs (d) and (g) fall within two Items because they can be paid either:

to the trustee of the deceased's estate if the election to commute the pension or annuity was made by the deceased prior to death but the payment was not made until after death (Item 1 death benefit ETPs); or
directly to the beneficiary where the election to commute is made by the beneficiary, the requisite link exists and the payment is made within the specified period (Item 4 death benefit ETPs).

Death benefit ETPs paid directly to dependants

Death benefit ETPs paid to dependants will qualify for concessional tax treatment. A dependant is defined in subsection 27A(1) to include:

a spouse or former spouse (including a de facto spouse) of the deceased; and
a child under 18 years of age of the deceased.

If the benefit is paid directly to a dependant of the deceased it will be an Item 2 or Item 4 death benefit ETP . The ETP will be reduced so that it only consists of the notional excessive component, if any. Therefore, any amount received up to the notional excessive component is tax free [New subsection 27AAA(4)]. The notional excessive component is the excessive component of the death benefit ETP calculated assuming that the whole of the benefit is an ETP [New subsection 27AAA(5)].

Example Joan receives a reversionary pension following the death of her husband. 3 months later she elects to commute the pension and receives a lump sum payment of $600 000. The payment is less than her husband's pension RBL entitlement. The payment represents the commutation of a superannuation pension (a paragraph (d) ETP), has the necessary link in terms of subsection 27AAA(6) and is made in the period specified in subsection 27AAA(7). The payment is an Item 4 death benefit under the Table in new subsection 27AAA(2). Therefore, the payment received by Joan will be tax free in accordance with new subsection 27AAA(4).

Death benefit ETPs paid directly to non-dependants

A death benefit ETP paid to a non-dependant will be an Item 2 or Item 4 death benefit ETP . The ETP will be taxed as an ordinary ETP and broken into its ordinary components based on the deceased's eligible service period. Apart from the post-June 1983 component, the ordinary tax treatment applies to each of the components of the ETP.

The post-June 1983 component of a death benefit ETP is included in assessable income [New subsection 27B(1A)] . However, a rebate applies to ensure that the post-June 1983 component of a death benefit ETP is taxed at a maximum rate of 15% (plus medicare levy) if paid from a taxed source or 30% (plus medicare levy) if paid from an untaxed source [Items 7 and 8 in Table 1 in new section 159SA].

Example Leonard receives a lump sum payment from a taxed superannuation fund of $200 000 following the death of his brother. The payment is a paragraph (ba) ETP and comes within Item 2 of the Table of death benefit ETPs in new subsection 27AAA(2) . Leonard is a non-dependant and therefore does not qualify for the dependant's concession in new subsection 27AAA(4) . The ETP is broken into the following components:

undeducted contributions $25 000
pre-July 1983 component $60 000
post-June 1983 component $115 000

No part of the undeducted contributions will be included in Leonard's assessable income. 5% of the pre-July 1983 component (ie $3 000) will be included in his assessable income in accordance with subsection 27C(1) and taxed at marginal rates. The full amount of the post-June 1983 component will be included in Leonard's assessable income under new subsection 27B(1A) . However, the rebate in new section 159SA will apply to ensure that the rate of tax payable on that component will not exceed 15% plus medicare levy (see Item 7 in Table 1 of new subsection 159SA(1)) .

Death Benefit ETPs paid to the trustees of the deceased's estate

Death benefit ETPs paid to the trustee of the deceased's estate will be either Item 1 or Item 3 death benefit ETPs . The ETP is reduced by the amount the Commissioner considers appropriate having regard to the extent to which dependants of the deceased taxpayer may reasonably be expected to benefit from the estate. However, the ETP will not be reduced to the extent that it consists of notional excessive component, if any [New subsection 27AAA(3)] . The notional excessive component is the excessive component of the death benefit ETP calculated assuming that the whole of the benefit is an ETP [New subsection 27AAA(5)].

If the beneficiary of the deceased's estate is a non-dependant, the ordinary tax treatment applies to each of the components of the ETP. However, the rebate in new section 159SA applies to ensure that the tax payable on the post-June 1983 component of the death benefit ETP by the trustee of the estate will not exceed 15% (plus medicare levy) if paid from a taxed source or 30% (plus medicare levy) if paid from an untaxed source.

Example The trustees of Janet's estate receive a lump sum superannuation payment (a paragraph (b) ETP) of $900 000. The payment is an Item 1 death benefit under the Table in new subsection 27AAA(2). The sole beneficiary of the estate is Janet's husband, Brad. $100 000 of the payment is in excess of Janet's pension RBL. The ETP is reduced to $100 000 in accordance with new subsection 27AAA(3) and taxed as an excessive component in the hand's of the trustee of the estate.If a death benefit is paid to the trustees of the deceased's estate and distributed partly to a dependant and partly to a non-dependant, the payment is not an ETP to the extent that dependants can be expected to benefit from the estate [New subsection 27AAA(3)]. Each component of the ETP taxed in the trustees hands will be in the same proportion as the respective components of the original ETP (assuming that the whole of the payment is an ETP) reduced by the excessive component.

Example Richard's superannuation benefit of $1 000 000 is paid to the trustees of his estate following his death. The ETP (which is a paragraph (b) ETP) is broken into the following components:

undeducted contributions $40 000
excessive component $160 000
pre-July 1983 component $210 000
post-June 1983 component $590 000

Richard's estate is distributed in equal shares to Christine (who is a dependant) and Isabelle (who is a non-dependant). The ETP qualifies as an Item 1 death benefit ETP in Table 1 of new subsection 27AAA(2). The death benefit ETP is reduced in accordance with new subsection 27AAA(3) to the extent that Christine will benefit from the estate. Consequently, the ETP will be reduced by $500 000 (ie. $1 000 000 x 50%) to $500 000. Each component of the ETP taxed in the trustees hands will be in the same proportion as the respective components of the original ETP (assuming that the whole of the payment is an ETP) reduced by the excessive component. The original ETP less the excessive component amounts to $840 000 ($1 000 000 - $160 000). The reduced ETP less the excessive component is $340 000 ($500 000 - $160 000). Therefore, the ETP in the trustee's hands will consist of the following components:

excessive component $160 000
undeducted contributions $16 190

($340 000 x $40 000/$840 000)

pre-July 1983 component $85 000

($340 000 x $210 000/$840 000)

post-June 1983 component $238 810

($340 000 x $590 000/$840 000)

Total ETP $500 000

Roll-over restrictions

In order for an ETP to be rolled-over, it must be a qualifying ETP. Death benefit ETPs are specifically excluded from being qualifying ETPs and therefore cannot be rolled-over in any circumstances [Subclause 12(d) - new subsection 27A(12B)].

Paragraph 27A(12C) prevents amounts received on the commutation of a reversionary annuity from being rolled-over by anyone other than the spouse of the person to whom the annuity was first payable. To ensure consistency in the treatment between pensions and annuities, it is proposed to impose the same restriction on ETPs representing the commutation of a reversionary pension from a superannuation fund. Paragraph 27A(12C) will not, of course, apply to payments which qualify as death benefit ETPs [Subclause 12(e)].


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