Edited version of private ruling

Authorisation Number: 1011725278467

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Ruling

Subject: Tax on superannuation income stream

Questions

1. Will the taxable component of an indexed pension paid to you as a member of a public sector superannuation scheme (the Fund) include an element taxed in the fund when the employer component of a transfer value originating in a taxed fund was paid to the Fund?

Answer: Yes.

2. Are you entitled to a 15% tax offset under subsection 301-25(2) of the Income Tax Assessment Act 1997 for the taxable component of a pension paid by the Fund?

Answer: Yes.

This ruling applies for the following period

Year ending 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You rolled over an amount from a taxed superannuation fund to an untaxed public sector superannuation Scheme (the Fund).

You retired from the public service in the 2010-11 income year.

You advised that you receive an indexed pension plus a lump sum from the Fund on retirement from the public service.

The indexed pension on retirement paid from the Fund is based on a formula which depends on the total length of contributory service.

In a letter the Fund advised you that they accepted your rollover amount from a taxed superannuation fund and this rollover has been treated as a Transfer Value.

The transfer value paid into the Fund consisted of the employer component and notional productivity amount.

Where a rollover amount is received by the Fund in respect of the Fund member, they will determine if there is any employer component included in the rollover. If this is the case, the member can elect to have the rollover amount treated as a transfer value in lieu of lump sum only accumulation.

The transfer value is then transferred to consolidated revenue in return for the credit of an additional period of contributory service which counts towards the value of the Fund indexed pension.

You made an election and the employer component of the rollover amount has been transferred into consolidated revenue. In return you have received a credit of an additional period of contributory service in the scheme.

The notional productivity amount was included in your final benefit as an additional amount of productivity. Interest on this amount was applied at the rate relevant at the time your benefit is paid.

You are under 60 years of age but have reached your preservation age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 307-200(1)

Income Tax Assessment Act 1997 Subsection 307-200 (3)

Income Tax Assessment Act 1997 Paragraph 307-125(3)(a)

Income Tax Assessment Act 1997 Section 301-25

Income Tax Assessment Act 1997 Section 301-25(2)

Income Tax Assessment Act 1997 Section 301-100(2)

Income Tax Assessment Act 1997 Subsection 301-105(2)

Income Tax Assessment Act 1997 Section 301-110

Income Tax Assessment Act 1997 Section 307-295

Income Tax Assessment Regulations 1997 Regulation 307-200.03

Income Tax Assessment Regulations 1997 Subregulation 307-200.03(2)

Income Tax Assessment Regulations 1997 sub-subregulation 307-200.03(2)(a)

Income Tax Assessment Regulations 1997 Regulation 307-200.03

Income Tax Assessment Regulations 1997 Regulation 307-205.02B

Income Tax Assessment Regulations 1997 subregulation 307-205.02(2)

Reasons for decision

Summary

The taxable component of an indexed pension paid to you as a member of a public sector superannuation scheme (the Fund), will contain an element taxed in the fund.

The pension payments from the Fund are included in your assessable income for the 2010-11 income year and taxed at your marginal rate of tax. However, you will be entitled to a 15% tax-offset on the employer component of a transfer value originating in a taxed superannuation fund paid into the Fund.

Detailed reasoning

Taxable component of an indexed pension

Subsection 307-200(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that regulations may specify that a superannuation interest can be treated as two or more superannuation interests in certain circumstances.

Subsection 307-200(3) of the ITAA 1997 provides that the regulations may also specify a way of treating a superannuation interest in relation to the element taxed in the fund and the element untaxed in the fund.

Regulation 307-200.03 of the Income Tax Assessment Regulations 1997 (ITAR 1997) deals with the circumstances in which an interest in a public sector superannuation scheme is to be treated as two or more superannuation interests.

Sub-subregulation 307-200.03(2)(a) of the ITAR 1997 provides that if the superannuation benefit to be paid is sourced partly from contributions made into a public sector superannuation scheme or earnings on those contributions and partly from one or more other sources it is to be treated as two superannuation interests.

In your case, the indexed pension payable to you on age retirement from the Fund was sourced:

· partly from contributions made into the Fund that originated from other taxed funds and converted into a credit of additional contributory service; and

· partly from the public sector employer.

Therefore, subregulation 307-200.03(2) of the ITAR 1997 requires that the interest supporting the indexed pension payable to the taxpayer be treated as two separate interests.

Your two separate interests consist of:

· a 'contributions' interest consisting of contributions made into the Fund that were converted to a credit of additional contributory service (i.e. the employer component); and

· a 'remainder' interest consisting of the remainder of the amount sourced from the public sector employer.

Accordingly, the Commissioner considers that if the origin of part of an indexed pension is contributions to the scheme from accruals in other taxed funds, then that part of the pension should be treated as sourced from those contributions.

This differs from the case where contributions that are made during employment with the public sector employer partly fund an additional non-indexed pension or the lump sum commutation of that pension.

Section 307-210 of the ITAA 1997 provides that the tax free component of a superannuation interest includes the contributions segment and the crystallised segment. Under section 307-215 of the ITAA 1997 the taxable component of a superannuation interest is the value of the interest less the tax free component of the interest.

Subsection 307-295(2) of the ITAA 1997 provides that if a superannuation benefit is not sourced to any extent from contributions made into a superannuation fund or earnings on such contributions, the benefit will consist wholly of an element untaxed in the fund.

The remainder interest does not have a crystallised segment in accordance with subsection 307-225(3) of the ITAA 1997. Therefore all benefits paid from the remainder interest will consist of an element untaxed in the fund in accordance with subsection 307-295(2) of the ITAA 1997.

For the contributions interest, if the crystallised segment was not determined as at 30 June 2007, the components of the crystallised segment of this interest will need to be determined by administrator of the Fund in accordance with section 307-225 of the ITAA 1997.

There could be a crystallised segment if a taxpayer had a pre-July 83 component. This could be the case if that taxpayer had any pre-July 83 service in accordance with paragraph 307-225(2)(e) of the ITAA 1997.

The taxable component of the contributions interest is the total interest less any tax free component.

It will be necessary for the Fund to determine the proportions of each indexed pension payment that is paid from the 'contributions' interest and the 'remainder' interest.

In order for the Fund to calculate the proportions of each indexed pension payment paid from the two interests, it will be necessary for the total value of the two interests supporting the indexed pension to be determined as at the commencement date of the pension, as required by paragraph 307-125(3)(a) of the ITAA 1997.

The method of valuing the combination of the two interests supporting the indexed pension payable to the taxpayer is set out in regulation 307-205.02B of the ITAR 1997 and is:

· if the public sector superannuation scheme had a practice for valuing the indexed pension payable to the member in use immediately before 28 June 2007, by using that practice; or

· otherwise, by using the method set out in subregulation 307-205.02(2) of the ITAR 1997.

The proportion of each benefit paid from each interest will then be determined using the following method:

· let the combined value of the two interests supporting the indexed pension at its commencement date be $X.

· the value of the contributions interest is equal to the amount of the employer component of the transfer value ($employer component).

· the proportion of each indexed pension payment that is paid from the contributions interest will be equal to ($employer component / $X).

· the proportion of each indexed pension payment that is paid from the remainder interest will be [1 - ($employer component / $X)].

In this case, the proportion of each indexed pension payment that is paid from the remainder interest will consist of an element untaxed in the fund only.

The proportion of each indexed pension payment that is paid from the contributions interest will consist of tax-free component and/or an element taxed in the fund only.

According to the proportioning rule in section 307-125 of the ITAA 1997, when a superannuation income stream benefit is paid from a superannuation interest the benefit will include tax free and taxable components calculated in the same proportion that these components make up the total value of the superannuation interest.

Therefore, the proportion of each indexed pension payment that is paid from the contributions interest must be divided between the tax free component (if any) and the element taxed in the fund in the same ratio as in the contributions interest at the commencement date of the indexed pension, where the ratios are as follows:

· the ratio of tax free component of the original contributions interest is

(crystallised segment / $employer component)

and

· the ratio of element taxed in the fund of the original contributions interest is

[1 - (crystallised segment / $employer component)]

Taxation of pension or income stream

The pension payments comprising the element untaxed in the fund are included in a taxpayer's assessable income and taxed at marginal rates plus Medicare levy, under section 301-110 of the ITAA 1997. However, the taxpayer may be entitled to a 15% tax-offset on the taxable component.

As previously mentioned, the indexed pension payable to you on age retirement was sourced:

· partly from the contributions made into the Fund; and

· partly from the public sector employer.

A tax-offset will be available on the taxable component under subsection 301-25(2) of the ITAA 1997.

Tax-offset on the indexed pension from the contributions made into the fund

As you are over preservation age but under 60 years of age, the taxable component of the pension is included in your assessable income under subsection 301-25 (1) of the ITAA 1997 and taxed at your marginal rate plus Medicare levy.

A tax offset equal to 15% of the element taxed of the income steam benefit will be allowable to you under subsection 301-25(2).

Tax-offset on the indexed pension from the defined benefit part in the fund

The Fund is a hybrid superannuation fund. That is, it's a combination of two types of funds, a defined benefit fund and an accumulation fund.

In a defined benefit fund, member benefits are 'defined' by a formula. In the fund, the defined benefit part is generally the indexed pension which is defined by a formula based on the member's final super salary, length of contributory service and age at exit (this is known as the 'employer-financed component').

The defined benefit part does not accrue in a superannuation fund. Rather, it is paid out of consolidated revenue. Because of this, the defined benefit part has not been subject to the 15% tax payable by most superannuation funds and is referred to as the 'element untaxed in the fund'.

In an accumulation fund, member benefits are determined by the value of contributions and investment returns. The accumulation part is the member's contributions plus Fund earnings (known as the 'member component') and the employer's fortnightly contributions to superannuation (known as the 'productivity component').

Unlike the defined benefit part, the accumulation part does accrue in a superannuation fund. Consequently, the accumulation part has been subject to the 15% tax payable by most superannuation funds and is referred to as the 'taxed element'.

In your particular case, the indexed pension you receive from the Fund is a defined benefit and is paid out of consolidated revenue. As the defined benefit never accrued in a superannuation fund no part of the benefit has been subject to tax in the fund. Accordingly, except for that part of the pension funded by the contributions paid into the fund from a taxed fund as discussed above, it will be an element untaxed in the fund.

As you are over preservation age but under 60 years of age each payment of the indexed pension on the element untaxed from the fund is fully included in your assessable income and taxed at your marginal rate of tax plus Medicare levy.

A tax offset is not available to you as you are under age of 60.

Once you reach age 60 you may be entitled to a tax offset of 10% in respect of pension payments received after your 60th birthday under subsection 301-100(2) of the ITAA 1997.