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Edited version of your written advice

Authorisation Number: 1012825611309

Date of advice: 24 June 2015

Ruling

Subject: Superannuation lump sum - total and permanent disability payment

Question

Will a member of the SMSF be entitled to concessional tax treatment in relation to a lump sum payment made to them on the grounds of total and permanent disability?

Answer

Yes

This ruling applies for the following period:

Income year ending 30 June 2015; and

Income year ending 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

An individual (the Member) is a member of a self-managed superannuation fund (the SMSF).

The Member has been affected by ongoing medical conditions since the relevant income year.

Two legally qualified medical practitioners have certified that, as a result of the Member's ill health, it is unlikely that the Member can ever be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.

The SMSF intends to make a lump sum payment to the Member on the grounds of the Member's ill-health.

The Member's interest in the SMSF is entirely employer sponsored, with tax having already been paid on the employer contribution.

The Member has not yet reached their preservation age.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 301-35(1)

Income Tax Assessment Act 1997 subsection 307-125(2)

Income Tax Assessment Act 1997 section 307-145

Income Tax Assessment Act 1997 subsection 307-145(2)

Income Tax Assessment Act 1997 subsection 307-145(3)

Income Tax Assessment Act 1997 section 307-215

Income Tax Assessment Act 1997 section 307-400

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Summary

The proposed superannuation lump sum payment to the Member will be a disability superannuation benefit because the medical certification requirements of the legislation have been met. Consequently, the tax-free component of the lump sum will be modified in accordance with the legislation and the taxable component correspondingly reduced.

As the Member will not yet have reached their preservation age at the time they receive the superannuation lump sum, the taxable component will be included in the Member's assessable income for the relevant income year. However, a tax-offset will apply ensure that the rate of tax payable is not greater than 20% plus Medicare levy.

Detailed reasoning

Superannuation lump sum benefit

A superannuation lump sum benefit will generally be comprised of:

Superannuation funds will calculate these components for each benefit that is paid. The proportioning rule is generally used to calculate the tax free and taxable components of a benefit.

The proportioning rule is outlined under subsection 307-125(2) of the ITAA 1997. According to the rule, when a superannuation lump sum benefit is paid from a superannuation interest, the benefit will include both tax-free and taxable components calculated in the same proportion that these components make up the total value of the superannuation interest.

In this case, the SMSF has provided information to indicate that the Member's interest in the SMSF is entirely comprised of a taxable component. As such the amount of the tax-free component for the proposed lump sum benefit, worked out in accordance with the proportioning rule, is nil.

Modification of the tax-free component for disability benefits

However, section 307-145 of the ITAA 1997 operates to effectively increase the tax-free component where the superannuation benefit is a superannuation lump sum and a 'disability superannuation benefit.'

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

disability superannuation benefit means a superannuation benefit if:

(a) the benefit is paid to an individual 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 individual can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

According to the facts of the case, the medical certification requirements under condition (b) above have been met. In addition, it is accepted that the proposed lump sum benefit to be made by the SMSF was because the Member suffers from ill-health.

In view of this, the amount of the tax-free component for the proposed lump sum in this case will be modified in accordance with subsection 307-145(2) of the ITAA 1997, which states:

(2) The tax-free component is the sum of:

(a) the tax free component of the benefit worked out apart from this section; and:

(b) the amount worked out under subsection (3).

However, the tax free component cannot exceed the amount of the benefit.

Subsection 307-145(3) of the ITAA 1997 provides that the amount is worked out using the following formula:

Amount of benefit x _______Days to retirement______

Service days + Days to retirement

where:

days to retirement is the number of days from the day on which the person stopped being capable of being gainfully employed to his or her last retirement day.

service days is the number of days in the service period for the lump sum.

A person's last retirement day is generally when they would turn 65.

'Service period' is defined under section 307-400 of the ITAA 1997. In this case, the service period effectively includes all days in the period beginning on the day the Member joined the SMSF and ending on the day the proposed lump sum is made. If any part of the lump sum is attributable to an earlier roll-over benefit, the service period for the lump sum will also include any days in the service period for the earlier roll-over benefit.

In relation to the denominator in the formula in subsection 307-145(3) of the ITAA 1997, any days that are included in both 'service days' and 'days to retirement' are to be counted only once.

The result of the calculation in subsection 307-145(3) of the ITAA 1997 will then be added to the tax free component of the benefit worked out using the proportioning rule ($0 in this case) to determine the total tax-free component.

Taxable component

Under section 307-215 of the ITAA 1997 the taxable component of a lump sum superannuation benefit is the amount remaining after reducing the benefit by the tax-free component.

The tax treatment of the taxable component depends on the age of the taxpayer and on whether the element is taxed or untaxed in the fund. In this case, no portion of the taxable component is untaxed in the fund.

As the Member has not yet reached their preservation age, the element taxed in the fund in respect of a taxable component is fully included in the taxpayers assessable income according to subsection 301-35(1) of the ITAA 1997. However, a tax-offset will apply to ensure that the rate of tax payable is not greater than 20% plus Medicare levy.

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