Edited version of private ruling

Authorisation Number: 1011791020219

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Ruling

Subject: Total and permanent disability payment

Questions

Is any part of the lump sum payment from a superannuation fund paid on early release because of ill-health tax-free?

Answers

Yes.

This ruling applies for the following period

1 July 2009 to 31 June 2010.

The scheme commenced on

1 July 2009.

Relevant facts

Your client is under preservation age.

Your client commenced employment with the Employer 19XX until your client's administrative discharge during the 2005-06 income year.

Your client was a member of the employer-sponsored superannuation fund (the Fund) since commencing employment with the Employer.

Your client has provided certification by two legally qualified medical practitioners that as a result of the injury he will be unlikely ever to be gainfully employed in a capacity for which he is reasonably qualified by education, experience or training. The latest of these certifications was dated during the 2009-10 income year.

Later in the 2009-10 income year the Fund's Board assessed your client on medical grounds and fully released your client's superannuation balance. The Fund determined that your client had become incapacitated to such an extent as to render your client unlikely ever to engage in gainful employment in any occupation for which your client is reasonably qualified by education, experience or training.

Several days later your client received a lump sum payment from the Fund. This payment comprised:

· taxable component - taxed element;

· taxable component - untaxed element; and

· tax free component.

Tax was withheld from this lump sum.

Reasons for decision

Summary

The lump sum amount paid to your client by the Fund was a superannuation lump sum benefit. This payment was made to your client because your client was a member of the Fund.

The superannuation lump sum benefit is comprised of:

· a tax free component which includes an invalidity segment, This component is not assessable income and is not exempt income;

· a taxable component - taxed element which is fully included in your client's assessable income for the 2009-10 income year; and

· a taxable component - untaxed element which is fully included in your client's assessable income for the 2009-10 income year.

The superannuation lump sum benefit was paid to your client because your client suffered from ill-health and, because the medical certification requirements of the legislation have been met, it will be a disability superannuation benefit.

Consequently, the tax-free component will be modified in accordance with the legislation and the taxable component correspondingly reduced.

As your client was under preservation age at the time of receipt of the superannuation lump sum, a tax-offset will apply to the taxable component - taxed element to ensure that the rate of tax payable is not greater than 20% plus Medicare levy. A tax-offset will also apply to the taxable component - untaxed element, up to the untaxed cap amount, to ensure that the rate of tax payable is not greater than 30% plus Medicare levy.

Detailed reasoning

Superannuation lump sum benefits made on or after 1 July 2007

From 1 July 2007, the taxation treatment of lump sum payments made to a taxpayer from a superannuation fund has changed.

A superannuation lump sum benefit will generally comprise:

· a tax-free component; and

· a taxable component which may include:

· an element taxed in the fund; and/or

· an element untaxed in the fund.

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

Proportioning rule

Under subsection 307-125(2) of the ITAA 1997, when a superannuation lump sum benefit is paid from a superannuation interest (generally any amount, benefit or entitlement which a member holds in a superannuation fund), the benefit will include both tax-free and taxable components calculated in the same proportion that these components make up the total value of the superannuation interest.

Tax free component

Under section 307-210 of the ITAA 1997 the tax free component is comprised of a crystallised segment and a contributions segment.

The crystallised segment can include the following existing components (where applicable) as at 30 June 2007:

· the concessional component;

· the post-June 1994 invalidity component;

· undeducted contributions;

· the capital gains tax (CGT) exempt component; and

· the pre-July 83 component.

The contributions segment consists of all contributions made after 30 June 2007 which have not been included in the assessable income of the superannuation fund. This includes personal contributions where a deduction is not claimed, spouse contributions and the government co-contribution amongst others.

In your client's case, as your client ceased to be a contributing member of the Fund prior to 1 July 2007, there is no contributions segment.

However, based on the information provided, there is a crystallised segment that appears to represent undeducted contributions.

Accordingly, the tax-free component of the superannuation lump sum benefit was that amount.

Section 301-30 of the ITAA 1997 states:

If you are under your preservation age when you receive a superannuation benefit, the tax free component of the benefit is not assessable income and is not exempt income.

Therefore, the tax-free component of a superannuation lump sum benefit does not count towards a taxpayer's assessable (or taxable) income.

Consequently, the tax-free component will not count towards your client's assessable income.

Modification of tax-free component for disability benefits

Section 307-145 of the ITAA 1997 modifies the tax-free component where the superannuation benefit is a superannuation lump sum and a disability superannuation benefit.

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

disability superannuation benefit means a superannuation benefit if:

(a) the benefit is paid to a person because he or she suffered from ill-health (whether physical or mental); and

(b) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training.

Subsection 307-145(2) of the ITAA 1997 states:

The tax-free component is the sum of:

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

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

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

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

Amount of benefit ×

where:

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

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

Subsection 307-145(4) of the ITAA 1997 provides that the balance of the superannuation benefit is the taxable component of the benefit.

In your client's case, during the 2009-10 income year, the Fund assessed your client and determined that, on medical evidence, your client had become incapacitated to such an extent as to render your client unlikely ever to engage in or work for a reward in any occupation for which your client is reasonably qualified for by education, training or experience. As a result, your client received a superannuation lump sum several days later.

You have provided copies of letters from two legally qualified medical practitioners certifying that, as a result of the injury, your client will be unlikely ever to be gainfully employed in a capacity for which your client is reasonably qualified by education, experience or training. The latest of these certifications is dated in a specific date in 2009-10 income year.

Accordingly, it is accepted that the medical certification requirements under paragraph (b) of the definition of 'disability superannuation benefit' in subsection 995-1(1) of the ITAA 1997 have been met. In addition, it is accepted that the lump sum benefit made by the Fund was paid to your client because your client suffered from ill-health.

Consequently, the benefit paid is considered to be a disability superannuation benefit.

For the purposes of the formula under subsection 307-145(3) of the ITAA 1997:

· the service days are based on the period from when your client joined the Fund to the date your client ceased to be a contributing member; and

· the days to retirement are based on the period from the date of the latest medical certification to the date your client will reach age 65.

The modification of the tax-free component of your client's disability superannuation benefit is calculated as follows:

Amount of benefit ×

Therefore, in accordance with section 307-145 of the ITAA 1997, the tax-free component is the sum of the benefit worked out apart from this section, and the amount worked out under this section.

Taxable component

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

The taxable component of your client's disability superannuation benefit is calculated as follows:

Amount of lump sum - Modified tax-free component = Taxable component.

As the original taxable component of the superannuation lump sum benefit contained both an element taxed in the fund and an element untaxed in the fund, your client will need to contact the Fund in order for them to re-calculate these elements based on the revised amount of the taxable component.

Taxation treatment of taxable component

The tax treatment of both the element taxed in the fund and the element untaxed in the fund in respect of a taxable component depend on the age of the taxpayer.

For taxpayers who are under the preservation age, the element taxed in the fund in respect of a taxable component is fully included in the taxpayers assessable income (subsection 301-35(1) of the ITAA 1997). A tax-offset will apply to ensure that the rate of tax payable is not greater than 20% plus Medicare levy (subsection 301-35(2)).

For taxpayers who are under the preservation age, the element untaxed in the fund in respect of a taxable component is fully included in the taxpayers assessable income (subsection 301-115(1) of the ITAA 1997). A tax-offset will apply to ensure that the rate of tax payable is not greater than 30% plus Medicare levy (subsection 301-115(2)).

However, any amount of the element untaxed in the fund that exceeds the untaxed plan cap amount for the superannuation plan at the time of receiving the benefit will be taxed at the top marginal rate (subsection 301-115(3) of the ITAA 1997). For the 2009-10 income year the untaxed plan cap amount is $1,100,000.