Edited version of your written advice

Authorisation Number: 1013110238197

Date of advice: 20 October 2016

Ruling

Subject: Taxation treatment of invalidity payments made under the Defence Force Retirement and Death Benefits Scheme

Question 1

Are invalidity benefits paid to you under the Defence Force Retirement and Death Benefits superannuation scheme (DFRDB) established under the Defence Force Retirement and Death Benefits Act 1973 (DFRDBA) superannuation benefits as that term is defined in section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If 'yes' to the previous question, are invalidity benefits (described in the DFRDBA as 'Invalidity Pay') paid to you excluded by section 307-10 of the ITAA 1997 from the definition of superannuation benefit in section 307-5 of the ITAA 1997?

Answer

No.

Question 3

If 'no' to the previous question, does the Invalidity Pay constitute a superannuation income stream as that term is defined in section 307-70 of the ITAA 1997 and regulation 995-1.01(1) of the Income Tax Assessment Regulations 1997 (ITAR 1997)?

Answer

Yes.

Question 4

If 'yes' to the previous question, can you make the election in regulation 995-1.03 of the Income Tax Assessment Regulations 1997 (ITAR 1997), before a particular payment of the invalidity pay is made, that the payment is not to be treated as a superannuation income stream benefit?

Answer

Yes

Question 5

Is the Invalidity Pay payable to you from the DFRDB an employment termination payment?

Answer

No.

Question 6

Is the invalidity benefit paid from the DFRDB paid in respect of an interest that is a defined benefit interest under section 291-175 of the ITAA 1997.

Answer

Yes.

This ruling applies for the following periods:

Income year ended 30 June 2015;

Income year ended 30 June 2016; and

Income year ending 30 June 2017

The scheme commences on:

1 July 2014

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You were over 60 years of age at all times relevant to this private ruling.

Your preservation age is 55

You were, but are no longer, a member of the Australian Defence Forces (ADF).

As a member of the ADF, you became a member of the DFRDB scheme. The DFRDB is a scheme which was established to provide benefits that are payable when an individual retires from the Armed Forces (now known as the ADF).

The DFRDB is established by the Defence Force Retirement and Death Benefits Act 1973. The DFRDB is administered by the Commonwealth Superannuation Corporation (CSC).

Amongst other things, the DFRDBA provides for the payment of Invalidity Pay to certain individuals who have been retired because of their invalidity.

According to the DFRDBA 'invalidity pay' is an invalidity benefit consisting of invalidity pay. 'Pension benefit' is defined to include Invalidity Pay (subsection 3(1) of the DFRDBA).

To determine whether Invalidity Pay is to be paid, the DFRDBA provides for a mechanism by which a determination is made of a particular individual's capacity/incapacity to engage in civil employment after their retirement from the ADF (section 30 of the DFRDBA). Under that provision, an individual is assessed as having a Class A, Class B or Class C incapacity for civil employment.

The DFRDBA provides that a person whose incapacity for civil employment is classified as either Class A or B is eligible for Invalidity Pay (subsection 31(1) of the DFRDBA).

When someone is classified as Class A they are entitled to Invalidity Pay of 76.5% of the annual rate of pay applicable to the person immediately before his or her retirement (subsection 31(2) of the DFRDBA).

Under the DFRDBA, the rate of pay on ordinary retirement is worked out by applying the percentage in the table in Schedule 1 to the DFRDBA that matches the person's number of complete years in his or her total period of effective service. Retirement pay is 76.5% of the annual rate of pay applicable where the person has 40 or more complete years of service.

However, for a person whose incapacity for civil employment is classified as Class B they are entitled to Invalidity Pay of a different amount, which is 38.25% of the annual rate of pay immediately before his or her retirement (subsection 31(2) of the DFRDBA). For a person with 23 or more years of service the Invalidity Pay will be higher (subsection 31(3) of the DFRDBA).

Invalidity Pay may be payable to a person whose incapacity for civil employment is classified as Class C (subsection 32(1) DFRDBA).

The DFRDBA provides the CSC with the power to require a person receiving Invalidity Pay to undergo a medical review of their level of incapacity for civil employment (section 35 of the DFRDBA). An individual's level of incapacity for civil employment may be adjusted by the CSC to the extent that they are reclassified to another classification (section 34 of the DFRDB). In those instances the amount payable may be adjusted.

From 1 July 2009 no CSC-initiated medical reviews of persons receiving DFRDB Invalidity Pay have taken place. This is stated on page 28 of the latest version of the DFRDB's 'About your scheme' booklet (also known as the 'DFRDB Book') which was published in 2016.

This decision to discontinue any CSC-initiated medical review of invalidity classification is also noted on page 8 in the DFRDB's Annual Report to Contributors 2008-2009.

A person who has been classified as Class B may seek a medical review if he or she believes they should be reclassified to Class A. A reclassification to Class A would mean the amount of Invalidity Pay would be increased.

Under the DFRDBA, instalments of pension benefit (which includes invalidity pay) are paid fortnightly: subsection 59(1) DFRDBA.

These instalments of pension benefit are paid by the Commonwealth and are paid out of the Consolidated Revenue Fund: subsections 125(1) and (3) DFRDBA.

The amount of invalidity pay is indexed twice each year in January and July with the indexation worked out by reference to increases in the consumer price index for the half-years ending 30 September and 31 March respectively: Part XA DFRDBA.

As you are [over 55 the indexing may be more favourable as the “55-plus percentage” may be higher than the prescribed percentage]

You were retired from the ADF on the grounds of invalidity as you were considered unfit for military service and consequently became eligible for invalidity benefits under the rules of the DFRDB.

You have advised that you have been classified as having Class A incapacity for civil employment.

The CSC is currently withholding amounts from your Invalidity Pay on the basis that each fortnightly payment is a superannuation income stream benefit that you are liable to include in your assessable income.

In your application for this private ruling you have contended that:

● the benefits you have received are not a superannuation income stream benefit as they are subject to regular medical reviews which can result in the payments being decreased or cancelled at any stage;

● the payment summaries provided to you by the CSC are incorrect;

● the benefits you have received are not a defined benefit; and

● benefits you have received are employment termination payments of which the invalidity component should be tax free.

In your application for this private ruling you also contended that the

Assumption

The CSC will provide you with a Pay As You Go Payment Summary after the end of the 2015-16 income year in which they will identify that your invalidity pension consists of both tax free component and taxable component. It will also identify the amount of the taxable component as the untaxed element of the taxable component.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 section 307-5

Income Tax Assessment Act 1997 section 307-10

Income Tax Assessment Act 1997 section 307-70

Income Tax Assessment Act 1997 section 307-145

Income Tax Assessment Act 1997 section 307-150

Income Tax Assessment Regulations 1997 subregulation 995-1.01(1)

Income Tax Assessment Regulations 1997 regulation 995-1.03

Superannuation Industry (Supervision) Act 1993 section 10

Superannuation Industry (Supervision) Regulations 1994 subregulation 1.06(1)

Defence Force Retirement and Death Benefits Act 1973 subsection 3(1)

Defence Force Retirement and Death Benefits Act 1973 subsection 31(1)

Defence Force Retirement and Death Benefits Act 1973 subsection 31(2)

Defence Force Retirement and Death Benefits Act 1973 subsection 31(3)

Defence Force Retirement and Death Benefits Act 1973 subsection 32(1)

Defence Force Retirement and Death Benefits Act 1973 section 34

Defence Force Retirement and Death Benefits Act 1973 section 35

Defence Force Retirement and Death Benefits Act 1973 subsection 59 (1)

Defence Force Retirement and Death Benefits Act 1973 Part XA

Defence Force Retirement and Death Benefits Act 1973 subsection 125(1)

Defence Force Retirement and Death Benefits Act 1973 subsection 125(3)

Defence Force Retirement and Death Benefits Act 1973 Schedule 1

Further issues for you to consider

Tax treatment of the invalidity pay (pension benefit) payments that are superannuation income stream benefits

As you are over age 60, the answers we have provided above mean that the:

● tax free component is not included in your assessable income (section 301-10 of the ITAA 1997; and

● taxable component (untaxed element) is included in your assessable income under subsection 301-100(1) of the ITAA 1997.

This treatment is provided for by section 301-90 of the ITAA 1997 which applies when a superannuation benefit includes an untaxed element.

You are entitled to a tax offset equal to 10% of the amount identified as the untaxed element of the taxable component of the pension under subsection 301-100(2) of the ITAA 1997.

The amounts of the tax free component and untaxed element of the taxable component will be set out the Pay As You Go Payment Summary you will receive from CSC for the year.

Disability superannuation benefit

A superannuation benefit may be taxed less than as explained above if it is a 'disability superannuation benefit' as defined in subsection 995-1(1) of the ITAA 1997.

A disability superannuation benefit is one that is paid to an individual because he or she suffers from ill-health (whether physical or mental) and two 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.

For a superannuation lump sum that is a disability superannuation benefit there is an additional tax concession. This extra tax concession would arise because the superannuation lump sum would have its tax free component increased (which is not taxed) and the untaxed element of the taxable component (which is taxed) would be reduced by the amount of the tax free component.

The amount of tax free component is worked out using the formula in section 307-145 of the ITAA 1997. The formula takes into account the length of your service and the days until you would normally have been expected to retire.

An additional tax concession applies to a superannuation income stream benefit that is a disability superannuation benefit but only when the person receiving that benefit:

● is under preservation age; and

● it can only apply to any taxed element of taxable component.

Membership of the DFRDB before 1 July 1983

When Invalidity Pay is a superannuation lump sum there is another concession if you were a member of the DFRDB before 1 July 1983.

The amount of the increase in the tax free component is worked out using the formula in section 307-150 of the ITAA 1997. Any increase in the tax free component will reduce the untaxed element of the superannuation lump sum.

You may apply for another ruling on these or any other matters.

Reasons for Decision

Question 1

Detailed reasoning

Item 1 of the table in subsection 307-5(1) of the ITAA 1997 effectively states that a 'superannuation benefit' includes a payment made to you from a superannuation fund because you are a fund member.

'Superannuation fund' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 10 of the Superannuation Industry (Supervision) Act 1993 (SISA).

Paragraph (b) of the superannuation fund definition in subsection 10(1) of the SISA refers to a 'public sector superannuation scheme'. This term is also defined in that subsection to include a scheme for the payment of superannuation, retirement or death benefits, where the scheme is established by or under a law of the Commonwealth or the government of a State or Territory.

The DFRDB is established under the law of the Commonwealth to pay superannuation, retirement or death benefits. In particular, it provides for benefits that are in the nature of superannuation benefits that are payable on retirement from the ADF, including where that retirement is due to invalidity. It is therefore a superannuation fund for both the SISA and income tax purposes.

This position is consistent with the position of the Administrative Appeals Tribunal in Michael James Hammerton v Comcare Australia [1995] AATA 63 regarding the DFRDB.

Further, the Invalidity Pay benefits under the DFRDB are made because the recipients are, or have been, fund members. Each individual's entitlement to the benefits arises because they were a fund member who retired due to invalidity.

For these reasons we consider that the DFRDB Invalidity Pay or pension benefits are superannuation benefits as defined in section 307-5 of the ITAA 1997.

Question 2

Detailed reasoning

Paragraph 307-10(a) of the ITAA 1997 excludes from the definition of 'superannuation benefit' amounts payable under an income stream because of the person's temporary inability to engage in gainful employment.

The DFRDB Invalidity Pay or pension benefit is paid because a member is retired from the ADF on the grounds of invalidity. It is not paid because of the person's temporary inability to engage in gainful employment but rather on the assessment of their incapacity in relation to civil employment.

The assessment of incapacity determines whether an individual is entitled to Invalidity Pay and if so how much is payable as the pension benefit. In view of the decision that no further CSC-initiated medical reviews be conducted, this confirms that the assessment of incapacity is not concerned with temporary incapacity.

As a result of a request for a review by an individual, the assessment of incapacity can also determine whether a different amount is payable such as an increase in the amount paid (if the individual is reclassified as having Class A incapacity after originally being classified as Class B).

The payment of an invalidity benefit under the DFRDB occurs when there is a permanent, not temporary incapacity. An individual's degree of incapacity must be such that first, the individual is retired from the ADF. Secondly, the degree of incapacity that is necessary for an individual to be paid an invalidity benefit is such that it has diminished the individual's capacity to undertake the kinds of civil employment which a person with the vocational, trade and professional skills, qualifications and experience the particular individual has and that they might reasonably undertake (see for example, section 30 of the DFRDBA).

We consider that the DFRDB invalidity benefits do not relate to temporary disability or temporary incapacity and they are therefore not excluded from being superannuation benefits by paragraph 307-10(a) of the ITAA 1997.

Question 3

Detailed reasoning

Superannuation benefits are either superannuation income stream benefits or superannuation lump sums (Subdivision 307-B of the ITAA 1997).

A superannuation income stream benefit is relevantly a payment from an interest that supports a superannuation income stream, other than a payment to which regulation 995-1.03 of the ITAR 1997 applies (subsections 307-70(1) and (2) of the ITAA 1997 and subregulation 995-1.01(2) of the ITAR 1997).

A definition of 'superannuation income stream' is set out in subregulation 995-1.01(1) of the ITAR 1997. On the issue of whether these pension benefits are superannuation income streams, an 'income stream' that commenced before 20 September 2007 is a superannuation income stream if it is an annuity or pension within the meaning of the SISA.

An income stream that commenced on or after 20 September 2007 is a superannuation income stream if it is taken to be a pension for the purposes of the SISA in accordance with subregulation 1.06(1) of the Superannuation Industry (Supervision) Regulations 1994 (SISR).

The expression 'income stream' is not defined by either the income tax or superannuation laws. Therefore, it must be given its ordinary meaning. We consider that an income stream is a series of periodic payments that relate to each other and that are payable over an identifiable period of time.

The Invalidity Pay payable under the DRFDBA amounts to such a series of fortnightly payments.

Having examined the terms under which the Invalidity pay is payable under the DFRDBA, we are satisfied that the Invalidity Pay or pension benefit is a pension that meets the requirements set out in subregulation 1.06(1) of the SISR.

You refer in your application to the circumstances in which the invalidity pension may vary under the DFRDBA and point to the conditions in regulation 995-1.03 of the ITAR 1997 in order to conclude that the invalidity pension is not a superannuation income stream. However, we note that regulation may only affect whether a particular payment from a superannuation income stream is a superannuation income stream benefit or a superannuation lump sum. It has no effect on whether a person's benefits paid from their superannuation fund are a superannuation income stream or not. Regulation 995-1.03 only applies if a member's benefits are being paid as a superannuation income stream as defined.

Question 4

Detailed reasoning

Regulation 995-1.03 of the ITAR 1997 effectively allows a person in receipt of a superannuation income stream to elect to have a payment made from the income stream be treated as a superannuation lump sum instead of a superannuation income stream benefit (provided the person makes the election before the payment is made).

However, an election under regulation 995-1.03 of the ITAR 1997 may only be made if the conditions to which the superannuation income stream is subject permit the amount of payments in a year to vary other than in the circumstances set out in sub-paragraphs (a)(i) to (iv). Effectively this means that an election can only be made if the payment amount in a year is capable of being varied other than by way of:

● indexation under the pension rules;

● the application of the family law splitting rules;

● the commutation of the income stream; or

● the payment of an assessment of excess contributions tax.

Section 34 of the DFRDBA allows a person to be reclassified at a future time.

Despite the absence of medical reviews initiated by the CSC there is the possibility that a person can request a medical review in seeking to be reclassified from having a Class B incapacity to a Class A incapacity. If successful, their annual payment amount would change to double the amount of Class B invalidity pay.

We consider that in the circumstance where the annual amount of payments from an DFRDB Invalidity Pay or pension benefit can be altered because of section 34 of the DFRDBA, this reflects a circumstance other than one set out in subparagraphs 995-1.03(a)(i) to (iv) of the ITAR 1997. Accordingly a person in receipt of a DFRDB Invalidity Pay may make an election under regulation 995-1.03 or the ITAR 1997 in respect of a payment provided they make the election before the payment from their pension is made.

Question 5

Detailed reasoning

Under section 82-130 of the ITAA 1997, a payment is an employment termination payment if each of three conditions is met:

● it is received by a person in consequence of the termination of the person's employment (subparagraph 82-130(1)(a)(i)),

● it is received no later than 12 months after that termination (paragraph 82-130(1)(b)), and

● it is not excluded from being an employment termination payment by section 82-135 of the ITAA 1997 (paragraph 82-130(1)(c)).

Even in the event it could be said that payments made from the DFRDB invalidity benefits meet the first two of these conditions, under paragraph (a) of section 82-135 of the ITAA 1997, the payment of a superannuation benefit is not an employment termination payment.

For the reasons set out for question 1 of this ruling, the invalidity pension payments are superannuation benefits. Therefore, your invalidity pension payments are excluded from the definition of employment termination payment under paragraph 82-135(a) of the ITAA 1997.

Further, paragraph 82-135(b) of the ITAA 1997 provides that the payment of a pension is not an employment termination payment. As the word 'pension' as used in that paragraph is not defined, it takes its ordinary meaning.

In Michael James Hammerton v Comcare Australia [1995] AATA 63, the Administrative Appeals Tribunal decided that the retirement pay payable under the DFRDB scheme was a pension within the ordinary meaning of that word. We consider that this position can be consistently applied to the payments of the Invalidity Pay from the DFRDB scheme.

Consequently, all of the fortnightly pension payments received by you are also excluded from the definition of employment termination payment under paragraph 82-135(b) of the ITAA 1997.

We note that because the invalidity pension is a pension within the ordinary meaning of the term 'pension', it may be included in assessable income as ordinary income under section 6-5 of the ITAA 1997 if it was not otherwise regarded as a superannuation benefit.

Question 6

Detailed reasoning

Subsection 291-175(1) of the ITAA 1997 provides that an individual's superannuation interest is a 'defined benefit interest' to the extent it defines the individual's entitlement to superannuation benefits payable from the interest by reference to (relevantly for this advice):

● the individual's salary or allowance in the nature of salary at a particular date or averaged over a period

● specified conversion factors.

However, subsection 291-175(2) of the ITAA 1997 provides that the interest is not a defined benefit interest if it defines that entitlement solely by reference to one or more of the following:

(a) disability superannuation benefits;

(b) superannuation death benefits;

(c) payments of amounts mentioned in paragraph 307-10(a) of the ITAA 1997.

As a member of the DFRDB scheme, an individual enjoys a range of potential prescribed entitlements under the scheme where the actual entitlement derived by the individual or their dependants upon the individual ceasing to be a member of the scheme is contingent upon the happening of some future event. Specifically, while a member of the scheme an individual has a contingent entitlement to benefits variously payable upon retirement, resignation, retrenchment and invalidity. Their dependants may also have a contingent entitlement to receive payments from the scheme on their death.

In the case of these contingent entitlements, the member's benefit is derived under the scheme rules by a formula that refers to the person's annual rate of pay immediately before retirement and factor taking into account the number of complete years in their total period of effective service. Retirement pay can be commuted and factors are used to calculate that amount and the retirement pay after commutation. Accordingly, we consider that a member's interest in the DFRDB is a defined benefit interest under subsection 291-175(1) of the ITAA 1997.

Further, as a member of the DFRDB scheme has a contingent entitlement to benefits that may be paid on retirement or resignation or retrenchment as well as upon invalidity or death, subsection 291-175(2) of the ITAA 1997 cannot apply as their interest in the DFRDB is not defined 'solely' by reference to disability superannuation benefits or death benefits as defined and, for the reasons set out in the answer to question 2 of this ruling, the invalidity pensions do not give rise to payments to which paragraph 307-10(a) of the ITAA 1997 applies.

This conclusion is not affected by the fact a person is actually in receipt of invalidity pay. This is because the right to the pension itself is not the only right the person has in the scheme.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).