Edited version of private ruling

Authorisation Number: 1011597516827

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Ruling

Subject: Taxation of non-superannuation income stream

Questions

Are the income stream payments made to your client superannuation annuity payments under section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Are the income stream payments made to your client assessable as employment termination payments under section 82-145 of the ITAA 1997?

Are the fortnightly payments made to your client assessable income under subsection 6-5(2) of the ITAA 1997?

Are the fortnightly payments made to your client assessable income under section 27H of the Income Tax Assessment Act 1936?

Answers

No.

No.

Yes.

Yes.

This ruling applies for the following periods:

1 July 2008 to 30 June 2009

The scheme commences on:

1 July 2008

Relevant facts and circumstances

Your client's late spouse was employed by an employer and was killed in service during the income year.

A letter from the employer to your client advised that a Death and Disability Award (the Award) came into effect by agreement between the employer and a union (the Union) to ensure that eligible employees have access to death and disability cover. The Estate, spouse or nominated beneficiaries of an employee deceased between the between specific dates whilst in service with the employer may be retrospectively entitled to a death and disability benefit similar to the benefits available to employees eligible under the Death and Disability Award.

Although the Award came into effect during the income year, an agreement was reached between the employer and the Union that the spouse of an employee that died between specific dates may retrospectively be entitled to death and disability benefits similar to those available under the Award.

This was confirmed in an e-mail from the employer to your client's tax agent).

Your client is under 65 years of age.

Your client's late spouse is under 65 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 27H.

Income Tax Assessment Act 1997 Subsection 6-5(2).

Income Tax Assessment Act 1997 Subsection 82-130(1).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(a).

Income Tax Assessment Act 1997 Sub paragraph 82-130(1)(a)(i).

Income Tax Assessment Act 1997 Sub paragraph 82-130(1)(a)(ii).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(c).

Income Tax Assessment Act 1997 Subsection 82-130(2).

Income Tax Assessment Act 1997 Section 82-145.

Income Tax Assessment Act 1997 Section 307-5.

Income Tax Assessment Act 1997 Section 995-1.

Income Tax Regulations 1997 Regulation 995-1.01.

Reasons for decision

Summary

The income stream payments made to your client by the employer are neither payments of a superannuation income stream nor employment termination payments. The income stream payments are income under ordinary concepts.

Detailed reasoning

Employment termination payment

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of any employment of a taxpayer has changed. These payments formerly known as eligible termination payments will now be called employment termination payments. Where the payment is made during the life of a taxpayer the employment termination payment will be known as a life benefit termination payment (subsection 82-130(2) of the Income Tax Assessment Act 1997 (ITAA 1997)).

Section 995-1 of the ITAA 1997 states:

employment termination payment has the meaning given by section 82-130.

Subsection 82-130(1) of the ITAA 1997 states:

A payment is an employment termination payment if:

· it is received by you:

· in consequence of the termination of your employment; or

· after another person's death, in consequence of the termination of the other person's employment; and

· it is received no later than 12 months after the termination (but see subsection (4)); and

· it is not a payment mentioned in section 82-135.

Payment is made in consequence of the termination of employment

The first condition to be met is that there must be an employment termination payment that is made in consequence of the termination of employment of the taxpayer.

The phrase 'in consequence of termination of employment' is not defined in the legislation but the courts have considered the meaning of the words in consequence of in relation to eligible termination payments, the predecessor of employment termination payments.

Of note are the decisions made by the Full High Court in Reseck v. Federal Commissioner of Taxation (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v. Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 (McIntosh).

Suffice it to say that both Courts views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, while it is not necessary to show that termination of employment is the sole or dominant cause, a temporal sequence alone would not be sufficient.

The Commissioner in Taxation Ruling TR 2003/13 considered the phrase 'in consequence of' as interpreted by the Courts. In paragraph 5 of TR 2003/13 the Commissioner states:

a payment is made in respect of a taxpayer in consequence of the termination of the employment of the taxpayer if the payment follows as an effect or result of the termination. In other words, but for the termination of employment, the payment would not have been made to the taxpayer.

Thus if the payment follows as an effect or a result from the termination of employment, the payment will be made in consequence of the termination of employment and will be an employment termination payment unless it fails to satisfy the other requirements of an employment termination payment under section 82-130 of the ITAA 1997.

In this case, your client's late spouse was employed by the employer. Your client's late spouse was killed in service. The Award came into effect during a later income year by agreement between the employer and the Union to ensure that eligible employees access to death and disability cover.

An agreement was reached between the employer and the Union that eligible employees deceased between a specific dates, whilst in service with the employer, may be retrospectively entitled to a death and disability payment similar to the benefits available to employees eligible under the Award.

It is evident that the income stream payments paid to your client were made in consequence of the termination of employment your client's late spouse's employment with the employer. The income stream payments would not have been made had there been no termination of employment. The termination of employment and the payments are all intertwined and connected. If not for the termination of employment, the issue of paying the income stream would not have arisen.

In view of the above, it is considered that the income stream payments paid by the employer were made in consequence of the termination of employment. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

Another condition for a payment to be an employment termination payment under subsection 82-130(1) of the ITAA 1997 is that it is not a payment mentioned in section 82-135. Section 82-135 provides that certain payments are not employment termination payments, including:

· a superannuation benefit (paragraph 82-135(a));

· a payment of a pension or an annuity (whether or not the payment is a superannuation benefit) (paragraph 82-135(b));

· payment for unused annual leave or unused long service leave (paragraphs 82-135(c) and (d));

· the tax-free part of a genuine redundancy payment or an early retirement scheme payment (paragraph 82-135(e)).

· Relevant to this particular case is whether the payment represents a superannuation benefit or a payment of a pension or an annuity (whether or not the payment is a superannuation benefit).

Superannuation Benefit

Section 307-5 of the ITAA 1997 provides a table that list the types of payments that are superannuation benefits. Of relevance are items 1 and 8 of the table:

It is clear that the income stream payments do not represent a superannuation fund payment as the payments were not made from a superannuation fund, they were made the employer.

That then leaves item 8 of the table in section 307-5 of the ITAA 1997. That is, do the income stream payments represent superannuation annuity payments (and, hence, a superannuation benefit)?

Section 995-1(1) of the ITAA 1997 defines a superannuation annuity as having the meaning given by the regulations.

Regulation 995-1.01 of the Income Tax Regulations 1997 defines superannuation annuity as follows:

Superannuation annuity means:

· an income stream:

· that is issued by a life insurance company or registered organisation; and

· that commenced before 20 September 2007; and

· that is an annuity within the meaning of:

· subsection 10(1) of the SIS Act; or

· subregulation 1.07(1A) of the RSA Regulations; or

· an income stream that:

· is issued by a life insurance company or registered organisation; and

· meets the standards set out in subregulation 1.05(1) of the SIS Regulations.

In this case your client is not receiving an income stream that is issued by a life insurance company or registered organisation. The income stream is being paid by the employer. Therefore, the income stream payments do not represent superannuation annuity payments.

However, paragraph 82-135(b) of the ITAA 1997 excludes not only pensions and annuities that are superannuation benefits but also pensions and annuities that are not superannuation benefits - that is, pensions and annuities at common law.

Therefore, it is now necessary to examine whether the income stream payments are payments of a pension or annuity at common law.

Pension or annuity at common law

The terms 'pension' is not defined in either the ITAA 1997 or the Income Tax Assessment Act 1936 (ITAA 1936). It is therefore necessary to look for its meaning at common law.

In Tubemakers of Australia Ltd v. Commissioner of Taxation (Cth) (1993) 25 ATR 183; (1993) 93 ATC 4207 Justice Hill of the Federal Court (at ATC 4212) made the following observations on what 'pension' means:

There remains then the question whether the payments in either or both periods constituted a "pension" to the ex-employees.

The Macquarie Dictionary defines "pension" relevantly as:

"1. a fixed periodical payment made in consideration of past services, injury or loss sustained, merit, poverty etc.

an allowance or annuity."

The word has as its origin the Latin pensio meaning "payment".

The Oxford English Dictionary, 2d ed. Vol XI contains the following definition relevant to the present context:

"4. An annuity or other periodical payment made by a person or body of persons, now esp. by a government, a company, or an employer of labour, in consideration of past services or of the relinquishment of rights, claims, or emoluments."

What these dictionary definitions show is that it is a necessary characteristic of a pension that it be periodical.

The Administrative Appeals Tribunal (AAT), in Case [1999] AATA 1026 (1999) 43 ATR 1282; (1999) 2000 ATC 101, considered whether instalments paid to the Applicant on his retirement from a law firm that represented his share of the value given to certain work in progress at the time of a previous merger with two other law firms to form the current law firm was his assessable income. Senior Member Block concluded at ATC 129:

In summary:

A pension is inherently paid in relation to past services; the payments in question which were made to the Applicant were correctly characterised as pension, and including by the Applicant himself.

From the aforementioned cases, it can be seen that the word 'pension' embraces a fixed periodical payment made by a government in consideration of a person's past services, injury or loss or of the relinquishment of rights, claims, or emoluments of that person and that 'pension' and 'annuity' are inter-changeable words to denote payments with such characteristics. Further, it is clear that it is not necessary for a pension to be paid by a superannuation fund in order for it to be characterised as a pension.

Given that the income stream payments that your client has been receiving are of a periodical nature and are paid to your client on account of the death of your client's late spouse whilst in employment with the employer, they are a pension at common law.

The word 'annuity' is defined in subsection 995-1(1) of the ITAA 1997 as follows:

annuity includes:

· an annuity, within the meaning of the Superannuation Industry (Supervision) Act 1993; or

· a pension, within the meaning of the Retirement Savings Accounts Act 1997.

It is also defined in subsection 27H(4) of the ITAA 1936 as follows:

· annuity means an annuity, a pension paid from a foreign superannuation fund (within the meaning of the Income Tax Assessment Act 1997) or a pension paid from a scheme mentioned in paragraph 290-5(c) of that Act, but does not include:

· an annuity that is a qualifying security for the purposes of Division 16E; or

· a superannuation income stream (within the meaning of the Income Tax Assessment Act 1997)

The definition under subsection 995-1(1) of the ITAA 1997 is an 'inclusive' definition. It does not, however, exclude an annuity at common law. Similarly, the definition under subsection 27H(4) of the ITAA 1936 does not exclude an annuity at common law. Unfortunately, neither definition actually defines what an annuity at common law is. Consequently, it is necessary to seek guidance from judicial authorities.

Legal dictionaries have an assortment of definitions which generally lead to that given by Baron Watson in Foley v. Fletcher (1858) 3 H and N 769; (1858) 157 ER 678. That definition is, as cited with approval by Lord Hanworth, MR in Perrin v. Dickson [1930] 1 KB 107 at page 116:

annuities means, that where the annuity may be purchased with money the capital is gone and ceases to exist, and consequently, the person to be charged (tax) is the person receiving the annuity, that is, the yearly sum, year by year ....... No capital is taxed there, because the principal has been converted into an annuity, and the annuity is chargeable (to tax).

Another quality or characteristic of an annuity is that it is of a sum certain. When considering this aspect in Federal Commissioner of Taxation v. Knight (1983) 67 FLR 396; (1983) 14 ATR 1; (1983) 83 ATC 4096 (at 83 ATC 4106; 14 ATR 12-13), Justice Kelly of the Supreme Court of Western Australia referred to the following words of Justice Barton of the High Court in Deputy Federal Commissioner of Land Tax, Sydney v. Hindmarsh (1912) 14 CLR 334; (1912) 18 ALR 235, at 14 CLR 338:

What then is the meaning of 'annuity' as a legal or technical term? According to Co. Litt., 144b, an annuity is 'a yearly payment of a certain sum of money granted to another in fee for life or years, charging the person of the grantor only'. Viner's Abridgment, vol.II.,p.504, repeats the definition, with further passages showing that the sum need not be payable each year if only it is a yearly sum. Bacon's Abridgment, vol. 1., p. 233, says that 'an annuity, strictly taken, is a yearly payment of a certain sum of money granted to another in fee simple, fee tail, or life or years, charging the person of the grantor only : if payable out of lands, it is properly called a rent-charge; but if both the person and estate be made liable, as they most commonly are, then it is generally called an annuity'.

The text books generally adopt the definition in Co. Litt.; no case was found in which any other definition was offered; nor any case in which an indeterminate sum was held to be an annuity.

It is therefore a characteristic of an annuity that it be of a sum certain.

Justice Kelly went on to say in respect of the matter before him:

The element of certainty in the sum payable is sufficiently satisfied, I think, because by calculation and upon the happening of certain events it becomes certain even though it may vary from year to year. The basic figure is certain. [p.4106 ATC; p.13 ATR]

In Egerton-Warburton v. Deputy Commissioner of Taxation (Cth) (1934) 51 CLR 568; (1934) 8 ALJ 233; (1934) 3 ATD 40; [1934] ALR 380; [1934] HCA 40, a father sold certain farmland to his two sons in consideration of an annuity of £1,200 per annum to be paid by the sons to himself until his death. On his death an annuity of £1,000 per annum was then to be paid to his widow and a final payment on both their deaths of £10,000 to his three daughters. The High Court unanimously held the payments to the father were not instalments of a purchase price but were income and an annuity.

The reasoning of the court stressed the fact that there was no 'fixed gross sum'. In fact, the absence of anything which could be regarded as a purchase price meant that there was no deduction of a proportion of the purchase price from the annuity payment in accordance with the provision whose current equivalent is section 27H of the ITAA 1936.

One of the main difficulties experienced in connection with annuities is the determination in some cases whether annual payments are annuities and in the nature of income, or are instalments of capital which, of course, are not assessable. The general principle is that where annual payments are made in liquidation of a principal sum, they do not constitute annuities. If, on the other hand, there is no fixed sum or debt being liquidated, the annual payments are in the nature of annuities (Chadwick v. Pearl Life Assurance Co (1905) 2 KB 507).

From the cases quoted above it can be seen that, at common law, an annuity is a series of payments payable to a recipient for life or for a fixed term of years with certainty in the sum payable.

As the income stream payments being paid to your client by the employer are a series of payments to your client for life where the amount of each payment is ascertainable by reference to the formula specified in the Award, it is therefore an annuity at common law. Further, the payments do not represent instalments of capital as there is no fixed principal sum that is being liquidated - another reason why the payments could not be construed as being a series of employment termination payments.

The employer has stated that there is no agreement or contract in writing which provides for the income stream payments and that it was based on a verbal undertaking by the employer directed towards the union. However, it is clear that the intention of both parties was that the undertaking would be binding on the employer. This would negate the contention that the payments are ex gratia in nature.

Since your client's income stream payments are either a 'pension' or an 'annuity' within their ordinary meaning at common law, they are a payment mentioned in section 82-135 of the ITAA 1997 and are, therefore, not employment termination payments under paragraph 82-130(1)(c).

Ordinary income

As the income stream payments your client receives are not employment termination payments or a superannuation benefit, they cannot be taxed concessionally as such. Consideration of how the payments should be taxed has to be given to some other relevant provisions in the ITAA 1997 and ITAA 1936.

Subsection 6-10(2) of the ITAA 1997 states that:-

Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

Within the list of statutory income under section 10-5 of the ITAA 1997 are 'annuities', to which section 27H of the ITAA 1936 applies.

Subsection 27H(1) of the ITAA 1936 states that:-

Subject to Division 54 of the ITAA 1997, the assessable income of a taxpayer of a year of income shall include:

the amount of any annuity derived by the taxpayer during the year of income…; and

the amount of any payment made to the taxpayer during the year of income as a supplement to an annuity…

On the basis that the income stream your client receives is an annuity, it is assessable under section 27H of the ITAA 1936.

On the other hand, subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Based on case law, it can be said that ordinary income generally includes receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Compensation or similar payments which substitute income have been held by the courts to be income according to ordinary concepts (Commission of Taxation v. Inkster (1989) 24 FCR 53; (1989) 89 ALR 137; (1989) 20 ATR 1516; (1989) 89 ATC 5142 and Tinkler v. Commissioner of Taxation (Cth) (1979) 40 FLR 116; (1979) 29 ALR 663; (1979) 10 ATR 411; (1979) 79 ATC 4641).

Therefore periodic payments received following a death or disability that replaces lost earnings are generally regarded as assessable income.

In Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 26 ALJ 505; (1952) 10 ATD 82; [1953] ALR 17; [1952] HCA 65, weekly payments to a soldier from his former employer to make up the difference between his civil and military pay has been held to be income according to ordinary concepts. As were regular subsidies paid by a bank to selected former employees in order to counter the eroding effects of inflation on the real value of their pensions in Commissioner of Taxation v. Blake [1984] 2 Qd R 303; (1984) 75 FLR 315; (1984) 15 ATR 1006; (1984) 84 ATC 4661.

In determining whether payments received from the employer are assessable, consideration has to be given to the purpose of the payments. One of the intentions under the award was to provide benefits in the event that an injury results in the death of an employee.

The Death and Disability cover for employees provides that where a worker dies on duty, a fortnightly pension is payable to the spouse.

Although various names may be given to your client's payment such as a Death in Service Pension or an ex-gratia payment or Death and Disability benefit, it is necessary to consider the nature and character of the payment in order to determine whether the payments are assessable as ordinary income.

In determining the amount your client receives, reference is made to the employee's salary on the last day of service with the employer. Your client's entitlement is two thirds of the pension that would have been payable to the permanent employee.

The fortnightly benefits your client receives are in the nature of compensation for a loss of income and/or loss of income support.

Based on the facts of your client's case, it is considered that the regular fortnightly payments received by your client are income according to ordinary concepts. The payments are therefore assessable under subsection 6-5(2) of the ITAA 1997.