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Ruling

Subject: superannuation benefits - disability superannuation benefit

Question

1. Does the superannuation the lump sum received on early release of superannuation benefits contain a tax free component that can be increased by applying the modification for disability superannuation benefits?

2. Does the lump sum pension arrears of superannuation benefits received include an invalidity segment as defined in section 995-1 and section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997) ?

Advice/Answer

1. Yes.

2. No.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You are under age 55.

You commenced employment in X and you had a period of contributory service in the employer Fund (Fund 1) from that date until your employment termination date in Y.

You commenced to receive benefits from another entity (Fund 2) from Y.

In the relevant year, a decision was made by Fund 1 finding that at the time you terminated your employment, grounds existed on which you should have been retired on the ground of invalidity and accordingly Fund 1 exercised the discretion contained in their Fund Rules to treat your retirement as if you had been so retired (under the ground of invalidity).

In the relevant year, Fund 1 advised you of their decision on your invalidity classification under the Fund Rules and that your first invalidity pension benefits would include arrears of pension benefits backdated to your employment termination date in Y.

You were also advised that the invalidity pension benefits from Fund 1 may impact on benefits you may be receiving from Fund 2, and depending on your status with Fund 2, that Fund 2 may require a portion of the pension arrears payment to offset any benefit you may have received from them to date.

In letter from the relevant year, Fund 1 advised your invalidity classification with effect from your employment termination date in Y and included the payment details including pension benefits from Y.

The letter also stated your first payment in the relevant year would include a pension arrears payment and included relevant payment details relating to an amount to be withheld from your pension arrears pending advice from Fund 2 about any overpayment of Fund 2 entitlements.

You were also advised Fund 1 received advice from the Australian Taxation Office (ATO) that different taxation regulations apply if the lump sum pension arrears, relates to a benefit payable in excess of one year prior to the payment date.

As your pension benefit was payable from the relevant year and not subsequently paid to you until later in the relevant year, the pension arrears due for previous financial years was required to be taxed by Fund 1 at the time of payment and in accordance with a formula provided by the ATO.

As advised by the ATO, Fund 1 has provided you with a letter of explanation regarding the lump sum pension arrears payment which listed a break up of the pension arrears amounts payable to you during the arrears period in gross figures since Y.

This was to assist the ATO in making an accurate assessment at the end of the financial year in which the lump sum pension arrears amount was made to you to ensure the correct tax treatment of the amount when lodging your income tax return for the subsequent year.

Your PAYG payment summary - superannuation income stream for the subsequent year from Fund 1 included the specific details of the components of the pension payment and the pension arrears payment including the taxable components, the tax-free components (taxed and untaxed elements) and the total tax withheld amount.

In the relevant year, Fund 2 advised you of the re-assessment of your Fund 2 entitlements after receiving advice from Fund 1 that your superannuation was reclassified with effect from Y.

The result of this reclassification was an increase in your superannuation in Fund 1 and a corresponding decrease in your Fund 2 benefit, and because of this, there had been an overpayment of your Fund 2 benefit for the corresponding period Y to Z.

Fund 1 advised that they held the amount of $V from the lump sum pension arrears owing to you by Fund 1 after the reclassification of your retirement, so after the recovery of this amount, the overpayment to Fund 2 was $W

You were also advised the balance of this overpayment would be recovered from your Fund 2 benefit payments from the relevant year.

In the subsequent year you lodged objections to the relevant assessments to exclude the Fund 2 overpayments from your taxable income. These objections were successful and amended assessments issued.

In letter of Z, Fund 1 advised your preserved member benefit application for early release of benefits had been processed.

Your PAYG payment summary - superannuation lump sum included the details including the tax free component, the taxable component - taxed and untaxed element and the total tax withheld.

The tax-free component ($A) represented the contributions you made during your contributory service in Fund 1.

You have provided two medical certificates which show that two legally qualified medical practitioners have certified that because of your ill-health, it is unlikely that you can ever be gainfully employed in a capacity for which you are reasonably qualified because of education, experience or training.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-150.

Income Tax Assessment Act 1997 Subsection 307-120(3).

Income Tax Assessment Act 1997 Subsection 307-145(3).

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

Reasons for decision

Summary

Payment 1

The tax-free component of the superannuation lump sum received from Fund 1 on early release of superannuation benefits in April 2012 is increased by applying the modification for disability benefits under section 307-145 of the ITAA 1997 when calculating the components of the superannuation lump sum.

The tax-free component is increased from $A to $B and the taxable component is reduced to $NIL. Therefore the whole amount of this superannuation lump sum is tax-free.

Accordingly the details of the PAYG payment summary -superannuation lump sum should be as follows:

Tax free-component $B

Taxable component

Taxed element $NIL

Payment 2

The lump sum pension arrears received from Fund 1 does not include an invalidity segment as defined in section 995-1 and section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997). The lump sum is a pension arrears payment and not a superannuation lump sum payment.

The modification for disability benefits under section 307-145 of the ITAA 1997 will not apply to the lump sum pension arrears amount. This is because the modification concession only applies to a superannuation lump sum (and a disability benefit) as defined under section 307-145 of the ITAA 1997 and the lump sum pension arrears you received is an arrears of superannuation income stream benefits and not a superannuation lump sum.

Detailed reasoning

Disability superannuation benefit

A disability superannuation benefit is defined under subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as follows:

disability superannuation benefit means 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.

If a person receives a disability superannuation benefit as a superannuation lump sum, the tax free component of the benefit is increased to broadly reflect the period where they would have expected to have been gainfully employed (that is, their future employment service period).

The above is referred to as the modification for disability superannuation benefits if the benefit is a superannuation lump sum and a disability superannuation benefit.

Payment 1

Medical certification for disability superannuation benefits

On the basis of the information provided, it can be established you have received medical reports from two legally qualified medical practitioners which meet the requirements of a disability superannuation benefit as defined in subsection 995-1(1) of the ITAA 1997.

Superannuation benefit

A superannuation benefit includes a superannuation fund payment made to you from a superannuation fund because you are a fund member. When it is paid to you as a lump sum, this is referred to as a superannuation lump sum payment.

The components of a superannuation benefit are worked out under section 307-120 of the ITAA 1997 and will consist of the tax free component and the taxable component.

Modification for disability superannuation benefits

Under section 307-145 of the ITAA 1997, where a person receives a disability superannuation benefit as a superannuation lump sum, the tax free component of the benefit is increased to broadly reflect the period where they would have expected to have been gainfully employed.

In letter during the subsequent year Fund 1 advised your application for early release of your preserved member benefit had been processed and subsequently paid to you as a superannuation lump sum.

The tax-free component ($A) of the superannuation lump sum represented the contributions you made to Fund 1 during your contributory service.

As the payment is also a disability superannuation benefit, therefore, the modification for disability benefits under section 307-145 will apply to increase the original tax-free component calculated.

The tax-free component is increased from $A to $B (the whole amount of the superannuation lump sum) and the taxable component is reduced to $NIL. Therefore the whole amount of this superannuation lump sum is tax-free.

Accordingly the details of the PAYG payment summary -superannuation lump sum should be as follows:

Tax free-component $B

Taxable component

Taxed element $NIL

You need to lodge a copy of this ruling when lodging your income tax return for the subsequent year.

Payment 2

A superannuation income lump sum is defined in section 307-65 of the ITAA 1997 as:

A superannuation lump sum is a superannuation benefit that is not a superannuation income stream benefit …

A superannuation income stream benefit is defined in subsection 307-70(1) of the ITAA 1997 as:

A superannuation income stream benefit is a superannuation benefit specified in the regulations that is paid from a superannuation income stream.

The modification concession under section 307-145 of the ITAA 1997 only applies if the benefit is a superannuation lump sum and a disability benefit. The modification does not apply to the lump sum pension arrears as the benefit in question is an arrears amount of a superannuation income stream benefits. This is consistent with the information as provided by Fund 1 to you.

The components of the superannuation income stream benefit (including the lump sum arrears) are as determined by Fund 1.

In the relevant year, Fund 1 advised you that your payment of your first invalidity benefits would include arrears of pension backdated to your employment termination date.

It is clear from the information provided to you by Fund 1 in their letter the relevant year that your first pension payment in respect of your invalidity benefits entitlement included a lump sum arrears amount for previous financial years.

Therefore, it is evident the lump sum arrears payment determined by Fund 1 is an arrears amount of your invalidity pension payments and not a superannuation lump sum benefit as defined in section 307-65 of the ITAA 1997.

You were also advised that the invalidity benefits from Fund 1 may impact on the benefits you may be receiving from Fund 2, and that Fund 2 may require a portion of the pension arrears payment to offset any benefit you may have received from them.

Fund 1 withheld an amount from the lump sum pension arrears amount pending advice from Fund 2 regarding recovery of any overpayment of your Fund 2 entitlements.

Recovery of Fund 2 overpayment

In their letter from the relevant year, Fund 2 subsequently confirmed that the reclassification of your Fund 1 superannuation entitlements resulted in a corresponding decrease in your Fund 2 entitlement.

The total overpayment of Fund 2 entitlements was advised to you. Taking into account the amount Fund 1 withheld from your Fund 1 pension arrears for Fund 2 recovery, the balance of the Fund 2 overpayment was to be recovered by way of deduction from your ongoing Fund 2 entitlement.

As your pension benefits in arrears was payable from X and not subsequently paid to you until the relevant year, the arrears due for previous financial years was required to be taxed by Fund 1 at the time of payment and in accordance with a formula provided by the ATO.

Fund 1 provided the details of the income stream payment including the lump sum pension arrears on the PAYG payment summary-superannuation income from Fund 1.

Lump sum payment in arrears tax offset

A lump sum payment in arrears is a payment received in one tax year that includes income that accrued in previous tax years. The lump sum is assessable in the year of receipt. However, you may be eligible for a tax offset to reduce the amount of tax you have to pay.

In their letter from the relevant year, Fund 1 stated advice from the Australian Taxation Office (ATO) was that different taxation regulations apply if the lump sum pension benefits in arrears relates to a benefit payable in excess of one year prior to the payment date.

Fund 1 has provided you with a letter of explanation regarding the lump sum payment of arrears which listed a break up of the amounts payable to you as a lump sum in gross figures since X.

This was to assist the ATO in making an accurate assessment (on lodgement of your income tax return) at the end of the financial year in which the lump sum payment of arrears was made by listing a break up of the amounts payable to you as a lump sum in gross figures since Y.

15% tax offset for a disability superannuation income stream benefit

A disability superannuation benefit may be paid as either an income stream benefit or a lump sum benefit.

A disability income stream benefit may consist of:

· a tax-free component; and

· a taxable component which includes

o an element taxed in the fund, and/or

o an element untaxed in the fund.

The taxable component of a disability income stream benefit may consist of an element taxed in the fund or an element untaxed in the fund depending on whether the benefit is paid from a taxed or untaxed source. The payer of the disability income stream benefit will determine and calculate these components for each income stream benefit that is paid.

On the basis of the details on the PAYG payment summary - superannuation income stream for the subsequent year, Fund 1, the superannuation income stream benefits you received consisted of taxable components - taxed and untaxed elements.

Therefore, the 15% tax offset for disability superannuation income stream benefit may apply to the taxable component - taxed element of your superannuation income stream benefits as advised by Fund 1.

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