Case M29
Members: HP Stevens ChCF Fairleigh QC
JR Harrowell M
Tribunal:
No. 1 Board of Review
J.R. Harrowell (Member)
In this reference the taxpayer retired from the Commonwealth Public Service on 13 May 1977. In his return of income for the year ended 30 June 1978 he claimed an amount of $88 as a deduction under sec. 26AA(1) of the Act as being that portion of the undeducted purchase price calculated in accordance with sec. 26AA(2)(a).
2. The Commissioner disallowed the deduction on the grounds that the total pension of $10,756 received by the taxpayer in that year was assessable income under sec. 25(1) or sec. 26AA and that no part was excluded by the operation of sec. 26AA as the pension was not an annuity which had been purchased by the taxpayer.
3. The taxpayer was born on 20 November 1916 and was in his sixty-first year when he retired. He joined the New South Wales Public Service on 10 June 1935 and transferred to the New South Wales Taxation Department on 3 February 1941 and following war service was transferred to the Commonwealth Public Service on 1 July 1946 as a member of the Commonwealth Taxation Office. At the time of his transfer he had been a member of the State superannuation scheme and his contributions paid under that scheme were transferred to the Commonwealth scheme governed by the Superannuation Act 1922 as amended (1922 Act). He continued his contributions under that Act until it was superseded by the present Act - Superannuation Act 1976 (1976 Act) on 1 July 1976.
4. The transition process to change from the 1922 Act to the 1976 Act required the Treasurer to determine, in relation to the net assets of the existing fund (under the 1922 Act) the amount to be treated as basic and supplementary contributions made by its existing contributors on the commencing day of the 1976 Act - 1 July 1976. This determination took over two years to complete. Some time prior to 15 December 1978 but after the taxpayer had retired the amounts were duly allocated. The amounts allocated to the taxpayer from the old fund as at 1 July 1976 in the new fund were:
Basic contributions $20,519.29
Supplementary contributions 4,472.18
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$24,991.47
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5. Between 1 July 1976 and 13 May 1977, the date of retirement, the taxpayer's contributions to the new fund under the 1976 Act were based on 5% of his fortnightly rate of salary by way of deductions from his salary each fortnight. It was accepted by both parties that $1,458 represented the ``undeducted purchase price''.
6. My colleague Mr. H. P. Stevens, Chairman, has set out the details of the 1922 and 1976 Acts as they relate to this matter. I accept what he has written and will only refer to them where they are part of my reasons.
7. Prior to his retirement on 13 May 1977 the taxpayer had been on sick leave for a little over 12 months. The taxpayer retired on grounds of invalidity and he had been advised on 9 May 1977 that he was entitled to a pension at the rate of $13,710.48 per annum as he had had 41 years' contributory service. Under sec. 68 of the 1976 Act he could elect to be paid a pension of $9,928.28 per annum and a lump sum payment of $18,038.63 representing a refund of his accumulated contributions; this figure being the sum of the actual contributions paid by him during his 41 years period of service and forming part of the sum of $24,991.47 determined later (para. 4).
8. The first pension payment was made to the taxpayer on 19 May 1977, being the amount due to that date, and thereafter he was to receive a pension of $527.33 per fortnight less the appropriate tax instalment deduction. The fortnightly rate was based on an annual pension of $13,710.48 comprising a standard pension of $9,928.28 per annum and an additional pension of $3,782.20 per annum. These amounts conform to the invalidity pension rates provided in Sch. 3 of the 1976 Act. Under that Schedule the maximum pension payable where the period of service is over 40 years is 72.5% of annual salary and 72.5% of $18,911 (the taxpayer's annual salary at time of retirement) is $13,710.48. The standard pension of $9,928.28 is 52.5% of $18,911 which under Sch. 3 is the pension payable when an
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election is made under sec. 68 of that Act to be paid a lump sum equal to the accumulated contributions paid.9. On 1 August 1977 the taxpayer, having been granted an extension of time to do so, lodged an election in terms of sec. 68. At that date his share of the allocation referred to in para. 4 had not been ascertained but it was known that the total pension contributions made by the taxpayer during his period of service amounted to $18,038.63 (see para. 19). On or about 25 August 1977 the taxpayer received the sum of $17,088.77 representing a refund of his total contributions less an adjustment for excess pension he received between 14 May 1977 and the pay period date when his election under sec. 68 became effective. Thereafter the taxpayer's pension was reduced from 72.5% to 52.5% of his salary at time of retirement subject to any later cost of living adjustments. This basic pension of 52.5% was paid by the Government from the Consolidated Revenue Fund.
10. The issue before this Board is whether the taxpayer is entitled to claim a deduction in respect of a sum of money being part of the undeducted purchase price of an annuity in terms of sec. 26AA which reads as follows:
``26AA (1) The assessable income of a taxpayer shall include the amount of any annuity, excluding, in the case of an annuity which has been purchased, that part of the amount of the annuity which represents the undeducted purchase price.
(2) Subject to the next succeeding sub-section, the amount to be excluded under the last preceding sub-section from the amount of an annuity derived by a taxpayer during a year of income -
- (a) in the case of an annuity payable until the death of the taxpayer or for a term that will not end before his death - is an amount ascertained by dividing the undeducted purchase price of the annuity by the number of years in the complete expectation of life of the taxpayer, as ascertained by reference to the prescribed Life Tables, at the time when the annuity first commenced to be derived; and
- (b) in the case of an annuity payable for a term of years certain - is an amount ascertained by dividing the undeducted purchase price of the annuity by the number of years in the term.
(3) Where the amount of an annuity derived by the taxpayer during a year of income is more than, or less than, the amount payable for a whole year, the amount to be excluded from the amount so derived is the amount which bears to the amount which, but for this sub-section, would be the amount to be so excluded the same proportion as the amount so derived bears to the amount payable for a whole year.
(4) For the purposes of this section, `the undeducted purchase price', in relation to an annuity, means so much of the purchase price of the annuity paid by the taxpayer as has not been allowed and is not allowable as a deduction, has not been, and is not to be, treated as a rebatable amount for the purposes of section 159N and is not an amount in respect of which a rebate of income tax has not been allowed and is not allowable in assessments for income tax under this Act or any previous law of the Commonwealth.''
11. Except in the case of a deferred annuity or other like provision for the taxpayer's spouse or child the Act contains no direct provision granting a deduction or a rebate in respect of an annuity purchased by him as provision for himself.
12. Premiums paid by the taxpayer in respect of life assurance on his life form part of the rebatable amount provided under sec. 159R(1)(a) and this may well include an annuity type policy provided it conforms to the terms of that section. The old sec. 82H(1)(a) contained similar provisions in respect to deductions.
13. The issue to be determined here may be expressed simply whether or not an amount of $95 ($88 claimed) should be excluded from the taxpayer's assessable income derived during the year ended 30 June 1978 in terms of sec. 26AA. The amount of $95 was arrived at by dividing $1,458 (``the undeducted purchase price'') by
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15.27 (the taxpayer's life expectation at date of retirement) in terms of sec. 26AA(2)(a).14. ``The question what constitutes an `annuity' for the purpose of income tax laws has been the subject of much judicial decision without any clear or satisfactory test emerging''
Atkinson
v.
F.C. of T.
(1951) 84 C.L.R. 298
at p. 304
. The situation is no better today.
Halsbury
in its 3rd ed. vol. 32 p. 534 states: ``An annuity is a certain sum of money payable yearly either as a personal obligation of the grantor or out of property not consisting exclusively of land''. The
Shorter Oxford English Dictionary
defines
annuity
as ``the grant of an annual sum for a term of years, for life, or in perpetuity, chargeable primarily upon the grantor's person, and his heirs, if named''. A ``pension'' has been described as ``an annual allowance made to anyone, usually in consideration of past services''
Wharton's Law Lexicon
14th ed. p. 751. By general usage the terms ``pension'' and ``annuity'' have become interchangeable but I am not prepared to say that these terms are synonymous; instead I find that the term ``pension'' can include an annuity and vice versa. Both require that there be an obligation to make the periodic payments otherwise the amount paid could take the form of a series of non-connected payments.
15. On my understanding of the
Income Tax Assessment Act,
as amended, it draws a distinction between these two terms. Sections 26AA and 82H refer specifically to annuities and sec. 23AD, 78, 23(kc) and 221A to pensions. Section 6(1) defines ``income from personal exertion'' as including pensions but makes no reference to annuities. Section 26AA which concerns us in this reference does not refer to an annuity
or pension,
it confines itself only to an annuity. We therefore have a situation where the Act draws this distinction between two words which common usage often treats as being interchangeable without defining either.
Romer
L.J. in
I.R. Commrs.
v.
Ramsay
20 T.C. 79
at p. 98
had this to say on annuities: ``If a man has some property which he wishes to sell on terms which will result in his receiving for the next twenty years an annual sum of
£
500, he can do it in either of two methods. He can either sell his property in consideration of a payment by the purchaser to him of an annuity of
£
500 for the next twenty years, or he can sell his property to the purchaser for
£
10,000, the
£
10,000 to be paid by equal instalments of
£
500 over the next twenty years. If he adopts the former of the two methods, then the sums of
£
500 received by him each year are exigible to Income Tax. If he adopts the second method, the sums of
£
500 received by him in each year are not liable to Income Tax and they do not become liable to Income Tax by it being said that in substance the transaction is the same as though he had sold for an annuity. The vendor has the power of choosing which of the two methods he will adopt, and he can adopt the second method if he thinks fit, for the purpose of avoiding having to pay Income Tax on the
£
500 a year.
The question which method has been adopted must be a question of the proper construction to be placed upon the documents by which the transaction has been carried out
'' (the emphasis is mine).
Mathew
L.J. in
Scoble and Others
v.
Secretary of State for India
4 T.C. 618
at p. 622
said: ``Annuity, in the ordinary sense of the expression, means the purchase of an income. It generally involves the conversion of capital into income, and, reasonably enough, where the taxpayer places himself in that position, the Act of Parliament taxes him; he is taken at his word, he has got an income secured in the way I have mentioned''.
16. Prior to the case of
Scoble (supra
) the statement of Baron
Watson
in
Foley
v.
Fletcher
(1858) H.
&
N. 769
at p. 785
was considered as defining an annuity when he said: ``Where an income is purchased with a sum of money the capital has gone and ceased to exist, the principal having been converted into an annuity''. Following the decision in that case it was generally accepted that the definition in
Foley v. Fletcher (supra)
``was satisfied if you put down, or gave up the right to, or divested yourself of, a capital sum and got back a series of payments of equal amount over a period in which the capital and income were indistinguishably blended, the whole thing being calculated so that you got something equivalent to the capital and the interest when all the instalments had been paid''.
Rowlatt
J.
Perrin
v.
Dickson (H.M. Inspector of Taxes)
14 T.C. 608
at p. 614
. That general view was not accepted in the case of
Scoble
which dealt with the sale of a
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railway in India where what was called an annuity was the alternative form of paying for it. It was held in that case that that was not an annuity but was the payment of the debt with interest as the debt was repayable over a period.17. The foregoing cases were generally considered by the High Court in
Egerton-Warburton
v.
D.F.C. of T.
(1934) 51 C.L.R. 568
.
18. In the reference before this Board the taxpayer during his 41 years of combined State and Commonwealth service was required to contribute to the three superannuation funds: the first commenced some time on or after 10 June 1935 when he joined the New South Wales Public Service, the second commenced on 1 July 1946 on transferring to the Commonwealth Public Service when his contributions to that date were transferred from the New South Wales fund to the fund under the 1922 Act. When the 1976 Act came into force on 1 July 1976 the Treasurer was required under sec. 177(2) of that Act to determine, as soon as possible after the commencing day, in relation to the value of the net assets of the fund under the 1922 Act:
``(a) the amount that is to be treated as basic contributions made by existing contributors on the commencing day; and
(b) the amount that is to be treated as supplementary contributions made by existing contributors on the commencing day.''
19. These amounts were not determined until December 1978, about one and a half years after the taxpayer had retired. The only figure known at the date of retirement was the sum total of the contributions actually paid by the taxpayer during his 41 years of service and which amounted to $18,038.63. At that time it was the policy of the office administered by the Commissioner for Superannuation to offer to make an immediate lump sum payment of an amount equalling the sum of the contributions paid to those eligible to elect to receive a lump sum benefit under sec. 68 of the 1976 Act. It was considered at the time that the amount to be determined under sec. 177(2) would be in excess of that sum and so the payment of the lesser sum would avoid the risk of an excess distribution requiring a refund. Section 68(5) states:
``Where a person makes an election under sub-section (1), the lump sum benefit to which the person is entitled is an amount, payable out of the Fund, equal to the person's accumulated contributions.''
20. The taxpayer on invalidity grounds was entitled to make the necessary application under sec. 68 and did so.
21. In this case we are dealing with the 1976 Act notwithstanding that all but $813.80 out of $18,038.63 was contributed under the 1922 Act and perhaps also the State Act. The 1976 Act is a complex piece of legislation. In a legal sense it appears to break new ground in that it can amend itself by its subordinate regulations. Division 8 of the present Act containing sec. 212A to 221 inclusive was added by S.R. 1978 No. 281 as a modification. My colleague, Mr. Fairleigh Q.C., has written more on this.
22. Under the 1976 Act the taxpayer had the right on ceasing to be an eligible employee to elect to be paid a lump sum equalling his accumulated contributions or what is statutorily deemed to be such. If he had died on or after 1 July 1976 whilst still an eligible employee his spouse, under the definition this includes de facto wife, had a similar right of election. Under the current Act he was required to contribute to the fund at the rate of 5% of his annual salary. This rate applied to all eligible employees married or single. The taxpayer ceased to be an eligible employee on grounds of invalidity and so became entitled to an invalidity pension (sec. 66). Within one month of becoming so entitled the taxpayer had the right to have an amount equal to his accumulated contributions refunded to him and to receive thereafter an annual pension based on 52.5% of his annual salary at time of retirement. If he had chosen not to so elect his accumulated contributions, maybe with interest, would have been paid from the Superannuation Fund into the Consolidated Revenue Fund and his annual pension would have been 72.5% of $18,911. Whichever the choice his pension would be paid from the Consolidated Revenue Fund, not the Superannuation Fund.
23. Under sec. 26AA the assessable income of a taxpayer shall include the
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amount of any annuity. The section goes on to exclude that part of the amount of the annuity which represents the ``undeducted purchase price'' as defined in subsec. (4). The section requires that the annuity must have been purchased. The amount to be excluded is obtained by dividing the undeducted purchase price by either the number of years in the complete expectation of life of the taxpayer (sec. 26AA(2)(a)) or by the number of years in the term of the annuity (sec. 26AA(2)(b)), the choice of divisor being dependent on whether the annuity was payable until the death of the taxpayer or for a term that will not end before his death or whether the annuity was paid for a term of years certain.24. It is difficult to understand what the draftsman or Parliament meant by the words ``an annuity... for a term of years that will not end before his death''. Re Smith (1905) 1 I.R. 453 deals with the consequences of a purchased annuity operative beyond the life of a first annuitant. I accept that under sec. 26AA a purchased annuity is not confined to one that ceases on the death of a taxpayer. The difficulty here is that if the term of the purchased annuity ``is certain in years'' it would fall within sec. 26AA(2)(b). On the other hand if the terms are that the purchased annuity will be paid to the taxpayer during his life and on his death is to be paid to his widow for a stated number of years the question would be whether it could fall within either sec. 26AA(2)(a) or (b). A contract, deed or statute governing a purchased annuity deals with the unknown future not the known past.
25. In this reference we are inquiring whether there is a particular class of annuity, one which has been purchased and the purchase price has been met in whole or in part by the taxpayer. In my opinion there is a distinction between the terms ``annuity'' and ``pension'' where the annuity has been purchased. The term ``purchase'' indicates the existence of a buyer and a seller. In the case of a purchased annuity under sec. 26AA the buyer is the taxpayer who meets part or all of the purchase price either by a lump sum payment or by agreed instalments. The seller is the person, organization, corporate body employer undertaking to pay the annuity on the happening of a stipulated event, e.g. on retirement. The item being purchased is the right to future annual income assessable under sec. 26AA as an annuity. Under established definition an annuity is a sum of money payable annually, not a lump sum paid once and for all. It is generally accepted that the definition includes sums of money paid at shorter intervals but based on an annual rate.
26. A purchased annuity indicates that some kind of relationship exists between the purchase price and the benefit purchased. Where the annuitant is the purchaser and the annuity is for life as from retirement one would expect the purchase price to be influenced by such factors (whether for an individual or a class of individuals) as amount of annuity, expectation of life or term of years, rate of interest, ages of wife and children if the annuity is to benefit them on first annuitant's death. I would assume that the existence of future annuitants would need to be known when determining the purchase price in the first instance. For example, where an unmarried man purchases an annuity initially for his own benefit I would be surprised if the initial purchase price could include the payment of an annuity for life to his wife if he later married and predeceased her. I realize that a price could be negotiated to cover such an eventuality but if determined in a business-like manner it would cost much more than the rate for a single annuitant because of the unknown but possible additional liability.
27. The foregoing are some of the factors I would expect to be considered when an annuity is purchased but I do not wish to infer that an annuity cannot be purchased other than on the basis of proper financial considerations and calculations. Whether an arrangement results in a purchased annuity or a pension in my opinion depends on the extent to which it departs from these standard factors.
28. Under the 1976 Act all persons on becoming eligible employees make regular contributions under that Act at the rate of 5% of their annual salaries irrespective of whether they are married or single or have children.
29. The administration of the 1976 Act is under the Commissioner for Superannuation appointed pursuant to the Act. He receives the contributions payable by the eligible
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employees and pays them into the Superannuation Fund. This fund is administered by the Superannuation Investment Trust controlled by three Trustees also appointed under the Act. The Trust has wide powers of investment. ``The Trust plays no other part in the general statutory scheme of superannuation; it has no concern with contributories, the receipt of contributions or their rate, with payments out of the fund, the extent of benefits or the like.'' Stephen J. inSuperannuation Fund Investment Trust v. Commr. of Stamps (S.A.) 79 ATC 4429 at p. 4433 . Mason J. in that same case at p. 4441 when speaking of the Fund said: ``The Act prescribes the amounts of the benefits to which contributors become entitled but it does not, as I read the provisions, give them any property or equitable interest in the Fund''. On my understanding of the evidence the detailed records of each eligible employee's accumulated contributions are kept, not by the Trust, but by the office administered by the Commissioner for Superannuation. It is therefore quite obvious that an eligible employee's accumulated contributions cannot be traced to the assets of the Fund. Further the benefits payable to those who have retired, except under certain circumstances not relevant here, e.g. sec. 69, are paid out of the Consolidated Revenue Fund which in turn receives payments from the Superannuation Fund. In spite of this inability to trace the individual contributions paid to the Superannuation Fund I find that the payment of a lump sum of money equalling the accumulated contributions of an eligible employee at the date of retirement is for the purpose of sec. 26AA and the consideration of annuities generally statutorily deemed to be a refund of those contributions. In the case of the taxpayer in this reference the amount of $18,038.63 was the amount received as equalling his accumulated contributions but for the reasons stated in para. 19 he was entitled to and did receive in a later year the balance of his lump sum entitlement following the determination of his portion of the net assets of the fund under the 1922 Act at 30 June 1976.
30. In my opinion that is not the end of the matter; it is still necessary to decide if the taxpayer's contributions during the period of his service were for the purchase of an annuity. Under the 1976 Act as it applies to this taxpayer he was entitled to a pension of 72.5% of final annual rate of salary at time of retirement. However because he made the election under sec. 68 and received the lump sum payment his pension was reduced to 52.5% of that salary. In other words it would seem that the difference of 20% of final annual rate of salary is the additional annual pension the taxpayer would have received it he had left the lump sum, referred to in sec. 68(5), in the Fund.
31. It appears to be a generally accepted fact in the Taxation Office and amongst such authorities as Messrs. Hannan and Ryan that contributions made by an eligible employee to a superannuation fund are made in the course of purchasing an annuity. The Chairman, Mr. H.P. Stevens, refers to these statements and traces the history of sec. 26AA in his reasons. He refers to the Treasurer of the day stating, when introducing legislation in this area, that this view was supported by the Courts. In this most difficult case I would have welcomed references which gave such a view the authority of the Courts. In my opinion, and in the absence of an authority to the contrary, such a view is an unsupported assumption. I accept that regular contributions to a superannuation fund may be for the purchase of an annuity but whether it is or not must be a question of the proper construction to be placed on the document or documents governing that fund.
32. I find that the taxpayer's contributions made by him during his period of service were not made to purchase an annuity. In my reasons I have attempted to draw a distinction between the terms ``purchased annuity'' and ``pension''. I believe that the word ``purchased'' requires a more precise identification of the ultimate benefits to flow from that purchase than what is contained in the 1976 Act. In my opinion the benefits ultimately received by an eligible employee, the widow and the orphan children each depending on their own specific facts are more properly described as pensions. Finally I cannot accept that an annuity is being purchased when ultimately the equivalent of its cost may be returned to
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the purchaser in the form of a lump sum if the person so elects.33. In concluding I make one comment on a matter not in issue before this Board. I leave open the question whether, where no election is made under the 1976 Act to be paid the lump sum, the payment by the Trust of an amount equalling a pensioner's accumulated contributions to the Consolidated Revenue Fund may constitute, at that point, the purchase of an annuity in terms of sec. 26AA, the annuity purchased being the 20% additional annual payment forgone by the taxpayer in this reference when he made his election in terms of sec. 68. It could be argued that when that payment between funds was made the precise benefit was clearly known and those who stood to benefit were there to be seen. However I can make no decision on this as it was not a matter for decision and the evidence as to the financial working of the Superannuation Fund in regard to its transfers to the Consolidated Revenue Fund was in the hands of a witness who had no first hand knowledge of this aspect.
34. I would uphold the decision of the Commissioner on the objection and would confirm the assessment of income tax for the year ended 30 June 1978.
Claim disallowed
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