Edited version of private ruling

Authorisation Number: 1011554474553

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Ruling

Subject: Trauma insurance and deductibility of insurance premiums

Issue 1

Questions

1. Can a complying self managed superannuation fund (SMSF) purchase a trauma insurance policy from its own resources for the sole purpose of providing benefits to its member in the case of the member experiencing common trauma such as cancer or heart attack?

2. Whether a trauma insurance benefit paid by an insurer to the trustee of an SMSF is assessable income of the SMSF under the Income Tax Assessment Act 1997 (ITAA 1997)?

3. Can a deduction be claimed under the ITAA 1997 by the trustee of an SMSF for premiums paid to an insurer in respect of:

(a) life insurance for its members

(b) permanent disability insurance for its members, and

(c) trauma insurance for its members

Advice/Answers

1. Yes.

2. No.

3. (a) Yes, to the extent specified in an actuary's certificate to be attributable to the fund's liability to provide a superannuation death benefit for the member.

(b) Yes, to the extent specified in an actuary's certificate to be attributable to the fund's liability to provide a disability superannuation benefit for the member.

(c) No.

Issue 2

1. Whether a member of an SMSF suffering a common trauma such as cancer or heart attack meets a condition of release under the Superannuation Industry (Supervision) Regulations 1994?

Advice/Answers

1. The Commissioner is unable to rule on this question.

This ruling applies for the following period

Year ending 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

An SMSF that is a complying superannuation fund. As its trustee, you own an insurance policy (the policy) effected with an Australian insurer (the insurer) on the life of a member of the fund (the life insured).

The policy provides life cover and total and permanent disability (TPD) cover that commenced in relevant year, renewable annually on payment of a yearly or monthly premium.

Under the policy, the insurer will pay the amount insured in a lump sum as a death benefit if the life insured dies. If the life insured has a terminal illness the insurer may pay the amount insured as a terminal illness benefit in lieu of death benefit. The life insured is regarded as having a terminal illness if, in the opinion of an appropriate specialist physician approved by the insurer, the illness is likely to lead to the death of the life insured within 12 months from the date the opinion is provided to the insurer.

Under the policy, the insurer will pay the amount insured against TPD as a TPD benefit in a lump sum if the life insured becomes totally and permanently disabled and meets the conditions of the TPD definition chosen at the time of application for the policy.

You have chosen the 'unlikely ever again to be able to do any occupation' TPD definition, which reads:

As a result of illness or injury the life insured:

· has been absent from, and unable to work for three consecutive months and

· disabled at the end of the period of three consecutive months, to such an extent that they are unlikely ever again to be able to engage in any occupation

- for which they are reasonably suited by their education, training or experience, and

- which is likely to generate average monthly earnings of at least a specified percentage of the life insured's average monthly earnings in the 12 months prior to claim.

The policy also provides that if the life insured suffers a specific loss (being the total and permanent loss of the use of one limb or one eye), the insurer will pay a partial amount as a specified percentage of the TPD cover amount insured, up to a specified maximum.

The yearly premium charged for the period comprises the following components:

· premium on life cover

· premium on TPD cover

· yearly premium

· add: policy fee

The amounts insured for the period are as follows:

· life cover As specified in the policy

· TPD cover As specified in the policy

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 295-460.

Income Tax Assessment Act 1997 Section 295-465.

Income Tax Assessment Act 1997 Section 295-480.

Income Tax Assessment Act 1997 Section 307-5.

Income Tax Assessment Act 1997 Subsection 995-1(1).

Superannuation Industry (Supervision) Act 1993 Section 62

Superannuation Industry (Supervision) Regulations 1994 Regulation 6.01

Superannuation Industry (Supervision) Regulations 1994 Regulation 6.18

Reasons for decision

Summary

An SMSF can purchase a trauma insurance for the benefit of its members so long as the provision of such a benefit is not inconsistent with the sole purpose test in the Superannuation Industry (Supervision) Act 1993 (SIS Act). The premium paid on such insurance is, however, not deductible to the SMSF under the ITAA 1997.

Any trauma insurance benefit paid by an insurer to the trustee of an SMSF, being of a capital nature, is not assessable income of the SMSF.

A complying superannuation fund that has current or contingent liabilities to provide superannuation death benefit and/or disability superannuation benefit for its members may claim a deduction for part of the premium it pays for an insurance policy or policies that cover those liabilities.

In your case, a deduction may be available for so much of the insurance policy premium that an actuary calculates as being attributable to the fund's liability to provide a superannuation death benefit and a disability superannuation benefit.

Detailed reasoning

Purchase of trauma insurance by superannuation fund

Section 62 of the SIS Act stipulates that a trustee of a regulated superannuation funds must maintain the fund solely for one or more of the core and ancillary purposes specified in subsection 62(1) of the SIS Act. The core purposes relate essentially to the provision of:

· retirement benefits for members of the fund on or after their retirement; and

· death benefits for members' legal personal representatives and/or dependants when members die before they retire.

The ancillary purposes relate essentially to the provision of benefits for:

· members on or after their termination of employment or cession of work on account of ill-health; and

· members' legal personal representatives and/or dependants when members die after they retire.

The sole purpose test in section 62 of the SIS Act requires exclusivity. A trustee of a regulated superannuation fund who maintains the fund for any other purposes than any of the core and ancillary purposes contravenes section 62. Matters relevant to determining if the maintenance of a regulated superannuation fund is in accordance with the sole purpose test include the types of benefits provided and the cost thereof.

Under a trauma insurance policy the insurer normally pays the owner of the policy a lump sum if the life insured is diagnosed with one of a range of critical illnesses or suffers injuries that are defined in the policy. Trauma conditions commonly covered include cancer, stroke, coronary bypass and heart attack (paragraph 14 of Self managed Superannuation Funds Determination SMSFD 2010/1).

A trustee of a regulated superannuation fund that is an SMSF can purchase a trauma insurance for the benefits of fund members if:

(a) any benefits payable under the trauma insurance so purchased are paid to the trustee of the SMSF

(b) the benefits so paid become part of the assets of the SMSF at least until such time as the relevant member satisfies a condition of release under the Superannuation Industry (Supervision) Regulations 1994 (SISR), and

(c) the purchase of the trauma insurance is not made to secure some other benefit for another person such as a member or a member's relative (paragraphs 1, 2 and 13 of SMSFD 2010/1).

However, if a trustee purchases a trauma insurance that provides for benefits to be payable directly to someone other than the trustee, this would be inconsistent with the sole purpose test, and the trustee would contravene section 62 of the SIS Act.

In determining whether to purchase trauma insurance, trustees should consider their obligations to members generally and factors such as the proportion of contributions applied to the purchase. An unreasonable diversion of contributions to pay premiums on trauma insurance would be difficult to reconcile with the sole purpose test and the fundamental retirement objective of superannuation.

Assessability of trauma insurance benefit received by superannuation fund

In Federal Commissioner of Taxation v. Slaven (1984) 1 FCR 11; (1984) 52 ALR 81; (1984) 15 ATR 242; (1984) 84 ATC 4077, the Federal Court upheld a decision of the Supreme Court of Victoria in Slaven v. Commissioner of Taxation (Cth) (1983) 14 ATR 431; (1983) 83 ATC 4387, that compensation payments made under the revised Motor Accident Act (Vic) 1973 were for the deprivation or impairment of the earning capacity which the injured person has suffered and were, therefore, not liable to income tax (paragraph 4 of Taxation Ruling IT 2193).

A trauma insurance benefit is typically paid when the life insured is diagnosed with suffering a trauma condition and survives a specified period from the date of occurrence or diagnosis of the trauma condition. It is paid to provide financial assistance to the life insured or his/her family to tackle the effects of the trauma, including rehabilitation and life style changes, regardless of whether the life insured ceases work or becomes permanently disabled (even though this may be the case) because of the trauma condition (paragraphs 15 and 16 of SMSFD 2010/1). It is not paid to compensate for the loss of earnings but for the loss of earning capacity of the life insured (paragraph 35 of Product Ruling PR 2007/20). It provides a capital amount to the life insured (paragraph 2 of Taxation Determination TD 95/41).

Any trauma insurance benefit received by the trustee of a superannuation fund from an insurer is, therefore, not assessable income of the fund.

Premium on life cover

As a general rule, the deductibility of expenditure incurred by a complying superannuation fund is governed by the general deduction provisions of the ITAA 1997 unless a specific provision applies or the general rules are modified.

Section 295-460 of the ITAA 1997 provides that the deduction available to a complying superannuation fund for insurance premiums paid apply to the following benefits:

(a) a superannuation death benefit;

(b) a disability superannuation benefit;

(c) a benefit consisting of an amount payable to a person under an income stream because of the person's temporary inability to engage in gainful employment, that is payable for no longer than:

(i) 2 years; or

(ii) if an approval under section 62 of the Superannuation Industry (Supervision) Act 1993 is in force for benefits of that kind and the approval specifies a longer maximum period - that longer period; or

(iii) if there is no such approval in force - a longer period allowed by the Commissioner.

Subsection 995-1(1) of the ITAA 1997 states that 'superannuation death benefit' has the meaning given by section 307-5 of the ITAA 1997. Subsection 307-5(4) of the ITAA 1997 states that a superannuation death benefit is a payment described in column 3 of the table under subsection 307-5(1) of the ITAA 1997. The payments listed in column 3 includes, under item 1, a payment to a person from a superannuation fund after another person's death because the other person was a fund member.

Subsection 995-1(1) of the ITAA 1997 defines a 'disability superannuation benefit' as a superannuation benefit if:

(a) the benefit is paid to a person because he or she suffers from ill-health (whether physical or mental); and

(b) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

A complying superannuation fund can deduct the proportions of premiums specified in the table under subsection 295-465(1) of the ITAA 1997 it pays for insurance policies that are wholly or partly for current or contingent liabilities of the fund to provide benefits referred to in section 295-460 of the ITAA 1997 for its members.

Items 1, 2, 3 and 4 of the table in subsection 295-465(1) of the ITAA 1997 refer to whole of life policies or endowment policies. Item 5 of the table allows a deduction for the part of the premium that is specified in the policy as being wholly for the liability to provide benefits under section 295-460 of the ITAA 1997. Item 6 refers to so much of other insurance policy premiums as are attributable to the liability to provide benefits referred to in section 295-460.

Subsection 295-480(1) of the ITAA 1997 defines a 'whole of life policy as an insurance policy which satisfies the following conditions:

· the policy includes an investment component;

· the premiums for the investment component are not dissected; and

· the sum insured (and any bonuses) are payable on the death of the person insured or on the person insured attaining the age specified in the policy which is at least 85.

Subsection 295-480(2) of the ITAA 1997 defines an 'endowment policy' as an insurance policy which satisfies the following conditions:

· the policy is not a whole of life policy

· the policy includes an investment component

· the premiums for the investment component are not dissected; and

· the sum insured (and any bonuses) are payable on a day specified in, or worked out under, the policy or on the death of the person insured if the death occurs before that day.

In your case, out of the yearly premium covering the period, a lesser amount relates to life cover. In respect of that cover the policy states that the insurer will pay the amount insured as either:

(a) a death benefit if the life insured dies; or

(b) a terminal illness benefit if the life insured is diagnosed as having a terminal illness.

As the policy is not a whole of life policy or an endowment policy, a deduction is not available under items 1 to 4 of the table in subsection 295-465(1).

Item 5 of the table allows a deduction for the part of the premium that is specified in the policy as being wholly for a liability to provide a superannuation death benefit. A deduction is not allowed under item 5 for the remaining part of the premium.

A terminal illness benefit is not a benefit for which a deduction is available under section 295-460 of the ITAA 1997. The part of the lesser amount that refers to the terminal illness benefit under the policy is, therefore, not deductible. As no part of the lesser amount is specified as being wholly for the provision of a superannuation death benefit under section 295-460, a deduction is therefore not available under item 5 of the table.

Where a deduction is not allowed under item 5 of the table, item 6 of the table may apply to allow a deduction for so much of the insurance policy premium as is attributable to the fund's liability to provide a superannuation death benefit.

An apportionment of the lesser amount between the provision of a superannuation death benefit and that of a terminal illness benefit under the policy is therefore required. Under subsection 295-465(3) of the ITAA 1997 an actuary's certificate must be obtained before the date for lodgement of the fund's income tax return for the income year concerned in order for part of the premium to be deducted under item 6.

Premium on TPD cover

For a total and permanent disability insurance premium paid by a complying superannuation fund to be deductible under section 295-465 of the ITAA 1997 the law requires a connection between the payment of the premium and the current or contingent liabilities of the fund to provide a disability superannuation benefit defined in subsection 995-1(1) of the ITAA 1997.

In your case, the TPD cover provided by the policy, however, does not relate wholly to the fund's liability to provide a superannuation disability benefit as defined. The premium paid on the TPD cover, which is $B, is therefore not deductible or not deductible in full.

Where the TPD definition in an insurance policy differs from the definition of disability superannuation benefit under subsection 995-1(1) of the ITAA 1997, an apportionment of $B between the provision of disability superannuation benefit as defined under subsection 995-1(1) and that of the other disability benefits payable under the policy is required. As noted earlier, this apportionment must be supported by an actuary's certificate that must be obtained before the date for lodgement of the fund's income tax return for the income year concerned.

It should also be noted that a complying superannuation fund may provide a benefit to a member in respect of whom an insured event occurs only if a condition of release stipulated in Schedule 1 to the SISR has been satisfied. Permanent incapacity is one of the conditions of release. Under subregulation 6.01(2) of the SISR, 'permanent incapacity', in relation to a member, means:

ill health (whether physical or mental), where the trustee is reasonably satisfied that the member is unlikely, because of the ill-health, to engage in gainful employment for which the member is reasonably qualified by education, training or experience.

It follows that even though an insurer may have paid a complying superannuation fund the amount insured on the happening of an insured event in relation to a member of the fund, before the trustee of the fund can pay a benefit from the fund (whether based on the amount received from the insurer or otherwise) to the member, the trustee of the fund must be reasonably satisfied that the member's disability caused by the insured event nevertheless meets the definition of permanent incapacity under the SISR noted above, or otherwise satisfies another relevant condition of release.

Premium on trauma insurance

As noted earlier the deductions available to a complying superannuation fund for an insurance premium paid under section 295-460 of the ITAA 1997 apply to:

· a superannuation death benefit

· a disability superannuation benefit, or

· a benefit consisting of an amount payable to a person under an income stream arising from the person's temporary disability.

A trauma insurance benefit does not meet the definition of a 'superannuation death benefit' as the payment of the trauma insurance benefit is not conditional upon the death of a fund member.

In your case, the trauma cover available under the policy (if taken) provides that, to be eligible for a claim, the life insured needs, among other things, to:

(a) meet the definition of the specified trauma condition; and

(b) be diagnosed and certified of the trauma condition by a medical practitioner.

However, to qualify as a disability superannuation benefit (in respect of which the premium paid for an insurance policy to cover a fund trustee's current or contingent liability is deductible), a benefit paid by the fund trustee to a fund member must be based on the fund member:

(a) suffering from ill-health; and

(b) having been diagnosed by two legally qualified medical practitioners that because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

It follows that the criteria used to determine if a trauma insurance benefit is payable do not match those applying to a disability insurance benefit. Any premium paid by a complying superannuation fund on trauma insurance does not, therefore, have the necessary connection to the fund's current or contingent liability to provide disability superannuation benefit.

Finally, a trauma insurance benefit being a capital payment is not an income stream benefit as is described in paragraph 295-460(c) of the ITAA 1997.

Because of the aforementioned factors, a premium paid by a complying superannuation for trauma insurance is not deductible.

Issue 2

Division 359 of Schedule 1 to the Taxation Administration Act 1953 (TAA) provides that a private ruling is a written statement of the Commissioner's opinion of how a relevant provision applies, or would apply, to a particular entity in relation to a specified scheme. The provisions that are relevant for rulings are those about the following:

(a) income tax

(b) Medicare levy

(c) fringe benefits tax

(d) franking tax

(e) withholding tax

(f) mining withholding tax

(g) the administration or collection of those taxes

(h) a grant or benefit mentioned in section 8 of the Product Grants and Benefits Administration Act 2000, or the administration or payment of such a grant or benefit.

The issue you have raised in your request for a private ruling relates to the application of the Superannuation Industry (Supervision) Act 1993. This is not a relevant provision for the purposes of the TAA. Therefore, the Commissioner is unable to rule on the matter that you have raised.

Other relevant comments

As noted before, the TPD insurance premium is deductible only to the extent that the policies have the necessary connection to a liability of a superannuation fund to provide its members with disability superannuation benefit as defined in subsection 995-1(1) of the ITAA 1997. However, within the industry there has been a practice to deduct TPD insurance premium even though a policy is insuring against some form of permanent disability which does not fully meet the definition of disability superannuation benefit.

To allow superannuation funds enough time to make necessary administrative changes in order to comply with the law regarding deductibility, the Federal Government has agreed to amend the tax law to provide transitional relief for the income years from 2004-05 to 2010-11.

On 24 June 2010 the Superannuation Legislation Amendment Bill 2010 was introduced to the Federal Parliament. For the transitional relief to apply to a TPD insurance policy premium, the insured permanent disability must be one that is described in regulations made for the purposes of the transitional provisions.

At this stage no regulations have yet been made.

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