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Ruling

Subject: Total and permanent invalidity pension

Question.

1. Are the fortnightly payments you have been receiving since 1 July 2007 from the employer employment termination payments under Subdivision 82-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Are the fortnightly payments you have been receiving since 1 July 2007 from the employer payments of superannuation income stream benefit or superannuation annuity under subsection 307-70(1) of the ITAA 1997?

3. Are the fortnightly payments you have been receiving since 1 July 2007 from the employer pension or annuity payments under section 27H of the Income Tax Assessment Act 1936 (ITAA 1936)?

4. Are the fortnightly payments you have been receiving from the employer assessable income under subsection 6-5(2) of the IITAA 1997?

Advice/Answers

1. No.

2. No.

3. Yes.

4. Yes.

This ruling applies for the following periods:

Year ended 30 June 2008

Year ended 30 June 2009

Year ending 30 June 2010

The scheme commences on:

1 July 2007

Relevant facts and circumstances

You were employed by an employer.

During the 1996-97 income year you sustained injuries at work.

During the 1998-99 income year, as a result of your injuries, you were medically retired from your employment with the employer.

At the time of your medical retirement the employer did not have death and disability provisions for employees. The matter was raised by the union with the employer. After protracted discussions between the employer and the union and on application by the latter, the matter was referred to an Industrial Relations Commission (IRC) for a decision. In 2003 the IRC made an Award.

Under a subclause of the Award, which took effect during the 2002-03 income year, the intentions and commitments of the Award are to:

· provide benefits in the event that an on duty or off duty injury results in the death or total and permanent incapacity or partial and permanent incapacity of an employee;

· provide rehabilitation and retraining in the event that on duty or off duty injury results in an employee suffering partial and permanent incapacity; and

· develop and implement an agreed heath and fitness programme for employees..

Under a clause of the Award 'total and permanent incapacity' means:-

The employee is unlikely, by reason of ill health (whether physical or mental) to ever again engage in gainful employment for which the employee is reasonably qualified by education, training or experience.

A subclause of the Award reads:-

[The employer] will establish, with the agreement of [the union], [a superannuation fund] to pay the superannuation pensions and lump sum payments prescribed by the relevant clauses of this Award. The Fund shall operate in accordance with relevant Commonwealth legislation and the terms of the trust deed by which it is created.

In accordance with a clause of the Award both the employer and employees will contribute to the fund.

In an internal email of the department, it is stated, among other things, that:

5. Any award made by the Full Bench (or other agreed outcome) to be made retrospective to [a specified month in the 2006-07 income year].

In a ministerial letter to your local member of parliament, it was advised that:

As the parties to the dispute have agreed that any award made by the IRC (or other agreed outcome) will be made retrospective to [a specified month in the 2006-07 income year], any benefit awarded will also apply to [you].

In 2004 you applied for an on-duty total and permanent incapacity (TPI) pension, and received from the employer, a retrospective eligible termination payment (ETP), which included a post-June 1994 invalidity component.

From towards the end of the 2003-04 income year onward you have been receiving from the employer a fortnightly on-duty TPI pension based on the formula specified in the Award. Up to 30 June 2007, the employer continued to treat payments of such fortnightly pension as ETPs, part of which was a post-June 1994 invalidity component.

From 1 July 2007 onward, the employer has treated payments of such fortnightly pension as your ordinary income.

This fortnightly pension, payable for life, is calculated in accordance with a formula provided in the Award that takes into account an employee's deemed salary on the employee's last day of service and is indexed. "Deemed salary" refers to an employee's hourly rate of pay multiplied by a specific factor. In a letter from the employer to you it was advised that:

Up until 30 June 2007 this pension was being paid by [the employer] as an Eligible Termination Payment (ETP). Due to changes by the ATO on 1 July 2007, ETPs no longer exist therefore [the employer] are required to tax this pension payment as income.

In a letter from the employer to you, it was advised that:

[The employer] has received advice confirming that (unless the Taxation Commissioner is prepared to make a determination on an individual basis) the regular periodical payments made to you from [the employer] are ordinary income and are to be taxed at ordinary rates without any concessions.

In a ministerial letter received by you, it was advised that:

I am advised that you currently receive a fortnightly pension from [the employer]. This benefit is paid to you pursuant to an agreement reached between [the employer] and [the union] which covered employees who were medically retired between [ a specified date during the 1996-97 income year] and prior to the introduction of the Award.

The retrospective payment received by you is not, however, payable under the Award, as you ceased employment prior to the Award's commencement. The payment is made on an ex-gratia basis by [the employer], consequently the benefit cannot legally be assigned to [the superannuation fund established under the Award].

In a letter responding to the Tax Office's letter to you, the employer's Director of Human Resources advised, among other things, as follows:

(a) (in response to question 2) The agreement to extend the benefits of the 2003 Award retrospectively to [ a specified month during the 1996-97 income year] is not contained in the 2003 Award. It was an agreement reached between the parties during the lengthy period of negotiation that led to the 2003 Award. [Attached] is a copy of an internal email … outlining the resolution of an industrial dispute. Point 5 refers to the retrospectivity.

(b) (in response to question 3) The income stream is calculated on the same basis as a total and permanent invalidity under the 2003 Award. It is also indexed annually in accordance with the annual CPI Index.

(c) (in response to question 4) Up until 1 July 2009, the source of the income stream payment was from [a government]. [The employer] paid the pension and then recovered the amount from [the government]. An initial funding provision had been created to fund the retrospective benefits. From 1 July 2009 [the employer] still pays the pension but due to changes in the funding model for [the employer] the source of the funds is now the contribution to funding made by [a number of government agencies] as contributions to [a certain levy].

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 27A(1) [repealed].

Income Tax Assessment Act 1936 Section 27G [repealed].

Income Tax Assessment Act 1936 Subsection 27H(1).

Income Tax Assessment Act 1936 Subsection 27H(4).

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)(b).

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 82-135.

Income Tax Assessment Act 1997 Paragraph 82-135(b).

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 fortnightly payments of on-duty TPI pension you received from the employer are not superannuation lump sums or superannuation income stream payments. Therefore, they are not superannuation benefits. The payments are ordinary income and are therefore subject to tax at normal rates.

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 (ETPs), will now be called employment termination payments. Paragraphs 4.4 and 4.5 of the Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 states:

4.4 Under current legislation, the concessional taxation treatment of ETPs is in line with the taxation arrangements that apply to superannuation benefits, including the application of the reasonable benefit limits (RBLs).

4.5 The reforms made as part of Simplified Superannuation mean that it is no longer appropriate to continue to treat these payments as having a retirement payment characteristic.

Where an employment termination payment is made during the life of a taxpayer the payment will be known as a life benefit termination payment under subsection 82-130(2) of the 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:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

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

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

(c) it is not a payment mentioned in section 82-135.

Payment is made in consequence of the termination of employment

For a payment to qualify as an employment termination payment, the first condition to be met is that you receive the payment in consequence of the termination of your employment.

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 ETP, 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 the payment 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 a payment follows as an effect or a result of the termination of employment, the payment will be made in consequence of the termination of employment and may be an employment termination payment unless it:

(a) fails to satisfy the other requirements of an employment termination payment under section 82-130 of the ITAA 1997; or

(b) otherwise falls within the types of payments listed in section 82-135 of the ITAA 1997.

The Award came into effect in 2003. By an agreement between the employer and the union, the terms of the Award apply retrospectively to a specified month during the 1996-97 income year for eligible permanent and retained employees who were injured before the Award commenced. As your injury occurred in 1997, pursuant to that agreement the employer has provided you with an on-duty TPI pension similar to that available to employees eligible under the Award, retrospective to the time of your injury.

In other words, although your on-duty TPI pension is calculated in accordance with the formula provided in the Award, it has been paid to you by the employer, not by the superannuation fund established under the Award.

No payment of the on-duty TPI pension would have been made to you had you not been injured and had your employment not been terminated in consequence thereof. The termination of employment and payment of the on-duty TPI pension are all intertwined and connected. If not for the termination of employment, the issue of paying the on-duty TPI pension would not have arisen. In other words, payment of the on-duty TPI pension follows as an effect or result of the termination. It is, therefore, accepted that the payments of the on-duty TPI pension you have been receiving were made in consequence of the termination of your employment due to your injury. The first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has, therefore, 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 your case is whether the payments of on-duty TPI pension your have been receiving since 1 July 2007 represent payments of superannuation benefit or payments of pension or annuity.

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:

A superannuation benefit that is a superannuation fund payment can be either a superannuation income stream or a superannuation lump sum (sections 307-65 and 307-70 of the ITAA 1997).

It is clear that the income stream payments received by you do not represent superannuation fund payments as the payments were not made from a superannuation fund but were made by 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:

(a) an income stream:

(i) that is issued by a life insurance company or registered organisation; and

(ii) that commenced before 20 September 2007; and

(iii) that is an annuity within the meaning of:

(A) subsection 10(1) of the SIS Act¹; or

(B) subregulation 1.07(1A) of the RSA Regulations²; or

(b) an income stream that:

(i) is issued by a life insurance company or registered organisation; and

(ii) meets the standards set out in subregulation 1.05(1) of the SIS Regulations³.

In your case you are 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.

Consequently, the income stream payments described as on-duty TPI pension are not superannuation benefits.

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.

2. 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:

27. In summary:

(a) …

…

(d) 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 on-duty TPI pension you have been receiving is of a periodical nature and is paid to you on account of the injury you suffered in the course of your employment, it is a pension at common law.

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

annuity includes:

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

(b) 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:

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

(b) 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, M.R. 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 of 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 on-duty TPI pension being paid to you by the employer is a series of payments to you 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 payments described as on-duty TPI pension and that it was based on an 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 on-duty TPI pension is either a 'pension' or an 'annuity' within their ordinary meaning at common law, it is a payment mentioned in section 82-135 of the ITAA 1997 and is, therefore, not an employment termination payment under paragraph 82-130(1)(c).

Ordinary income

As your on-duty TPI pension is not an employment termination payment or a superannuation benefit, it cannot be taxed concessionally as such. Consideration of how it 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:

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

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

On the basis that your on-duty TPI pension is an annuity, it is assessable under section 27H.

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, irrespective of what they may be called.

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 the on-duty TPI pension you have been receiving from the employer since 1 July 2007 is assessable as your ordinary income, consideration has to be given to the purpose of the payments. One of the intentions under the Award is to provide benefits to an injured employee.

The Award provides that pension be paid to an employee if the employee sustained an on-duty injury and has as a result suffered total and permanent incapacity.

Although the fortnightly payments you have been receiving are called an 'on-duty TPI pension', for income tax assessment purposes it is necessary to consider their nature and character in order to determine whether they are assessable as ordinary income.

In determining the fortnightly amount you receive, reference is made under the Award to your deemed salary on your last day of service with the employer. This indicates that the fortnightly amount you receive is in the nature of compensation for loss of income and/or loss of income support based on your last deemed salary.

As compensation or similar payment that substitute income have been held to be income according to ordinary concepts, your on-duty TPI pension is therefore assessable as ordinary income under subsection 6-5(2) of the ITAA 1997.

As your on-duty TPI pension is assessable under subsection 6-5(2) of the ITAA 1997 as ordinary income, it will not be assessed under section 27H of the ITAA 1936.