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Authorisation Number: 1012419171385

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Ruling

Subject: Superannuation disability benefit and legal fees

Question 1

Is any part of the lump sum payments received from your superannuation funds X, Y and Z as a result of total and permanent disablement to be included in your assessable income?

Answer

Yes.

Question 2

If the answer to question 1 is 'yes', can you claim a deduction in respect of legal fees incurred in receiving those payments?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

You are under 65 years of age.

You are a member of the following superannuation funds:

X

Y

Z

During the 2012-13 income year, you received superannuation lump sum payments from the funds listed above as a consequence of Total and Permanent Disability (TPD) insurance claims you had lodged with the trustees of the funds (the fund trustees).

During the 2008-09 income year, you became totally and permanently disabled.

You have been receiving a monthly disability support pension since the 2008-09 income year.

You have not worked for over four years.

During the 2011-12 income year, two registered medical practitioners certified that it is unlikely that you will ever to be able to work in a job for which you are reasonably qualified by education, training or experience due to your medical condition.

During the 2011-12 income year, you attempted to make a claim for TPD but were unsuccessful due to your disability and the complexity of the paperwork involved.

During 2012-13 income year, your lawyers lodged a claim for TPD to the following superannuation funds on your behalf:

X

Y

Z

During the 2012-13 income year, Superannuation fund X notified you of your withdrawal from the fund and enclosed the following:

a cheque for the payment (Payment X)

Pay-as-you-go (PAYG) payment summary for the superannuation lump sum.

Member benefits statement

A PAYG payment summary for a superannuation lump sum shows that a payment ("payment X") was made by fund X to you. The payment comprised of:

1. taxable component - taxed element

2. tax-free component

3. total tax withheld

In your fund X member benefit statement, you were provided with the following advice by the fund trustee:

Under the policy, whilst your life is insured under the additional insurance cover, the insurance policy with the insurer for TDP is owned by the fund trustee, and not by the member.

You incurred legal costs of over $5,500 in receiving payment X.

During the 2012-13 income year, Superannuation fund Y notified you of your withdrawal from the fund and enclosed the following:

a cheque for the payment (Payment Y)

Pay-as-you-go (PAYG) payment summary for the superannuation lump sum.

Member benefits statement

A PAYG payment summary for a superannuation lump sum shows that a payment ("payment Y") was made by fund Y to you. The payment comprised of:

1. taxable component - taxed element

2. tax-free component

3. total tax withheld

In your fund Y member benefit statement, you were provided with the following advice by the fund trustee:

Members have access to TPD cover which is provided through group life policies for Death and TPD issued by an insurance company to the Trustee of the Superannuation Fund.

You incurred legal costs of over $6,600 in receiving payment Y.

During the 2012-13 income year, Superannuation fund Z notified you of your withdrawal from the fund and enclosed the following:

a cheque for the payment (Payment Z)

Pay-as-you-go (PAYG) payment summary for the superannuation lump sum.

Member benefits statement

A PAYG payment summary for a superannuation lump sum shows that a payment ("payment Z") was made by fund Z to you. The payment comprised of:

1. taxable component - taxed element

2. tax-free component

3. total tax withheld

In your fund Z member benefit statement, you were provided with the following advice by the fund trustee:

A company is the Trustee of the Superannuation Fund. The paying superannuation fund is a division of the main superannuation fund.

You incurred legal costs of over $8,800 in receiving payment Z.

You commenced membership with fund X prior to year 2002.

You commenced membership with fund Y prior to year 2010.

You commenced membership with fund Z prior to year 2010.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Division 301

Income Tax Assessment Act 1997 Section 307-5

Income Tax Assessment Act 1997 Subsection 307-5(1)

Income Tax Assessment Act 1997 Section 307-145

Income Tax Assessment Act 1997 Section 307-210

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Summary

The TPD payments from the three superannuation funds X, Y and Z (as detailed in the 'Relevant Facts') are superannuation member benefits paid to you and are therefore subject to relevant taxation as superannuation lump sum benefits under the provisions of the ITAA 1997.

At the time of the payments made in the 2012-13 income year two legally qualified medical practitioners had certified that you were suffering from a medical condition which, in their opinion, is likely to preclude you from ever being able to be employed again in a capacity for which they are reasonably qualified by education, training or experience.

Therefore, the three payments made to you in the 2012-13 income year satisfy the definition of a disability superannuation benefit. Accordingly, section 307-145 of the ITAA 1997 will apply to modify the tax-free component of each payment. However, since funds X, Y and Z have already applied the modification of the tax-free component, no further modification of the tax-free component will be applicable. Therefore, the tax-free components of the TPD payments made by the three superannuation funds are not assessable. The taxable component of each lump sum made will be taxed at your marginal tax rate.

No deduction is allowable for the legal expenses you incurred.

Detailed reasoning

Question 1 - Is any part of the lump sum payments received from your superannuation funds X, Y and Z, as a result of total and permanent disablement to be included in your assessable income?

Superannuation lump sum benefits

A superannuation lump sum is a superannuation benefit that is not a superannuation income stream benefit (section 307-65 of the Income Tax Assessment Act 1997 (ITAA 1997)).

The table contained in subsection 307-5(1) of the ITAA 1997 lists various types of superannuation benefits. One type of superannuation benefit is a superannuation fund payment. Item 1 of the table states that a superannuation fund payment will be a superannuation member benefit if it is:

A payment to you from a superannuation fund because you are a fund member.

In your case, a number of superannuation lump sum payments were made to you by your various funds. Payments X, Y and Z (as detailed in the 'Relevant Facts') were all made in the earlier half of the 2012-13 income year. These benefit payments were made as a consequence of a TPD insurance claim that your lawyers had lodged to the trustees of the funds (X, Y and Z) on your behalf.

Funds X, Y and Z made payments for TPD to you because you were a fund member of each of those funds at the time of lodging your TPD claim.

Hence, payments X, Y and Z (as detailed in the 'Relevant Facts') are superannuation member benefits within the meaning of subsections 307-5(1) and 307-5(2) of the ITAA 1997.

As noted in the facts, you were advised by the fund trustee of fund X that whilst your life was insured under this additional insurance cover, the insurance policy with the insurer for TDP is owned by the fund trustee, and not by you in this instance. Therefore, payment X is a TPD payment which was made under a group insurance policy for the fund, where the owner of the policy is the trustee of the fund.

Similarly, you were advised by Fund Y that members have access to TPD cover which is provided through group life policies for Death and TPD issued by a Goup Insurance Policy to the Trustee of the Fund Y. Therefore, payment Y is a TPD payment which was made under a Group Life Insurance Policy for fund Y, where the owner of the policy is the trustee of the fund.

As mentioned in the facts, the TPD payment from fund Z was made from the head fund to you. This suggests that the TPD payment was made under a group insurance policy for the fund, where the owner of the policy is the trustee of the fund

Consequently, payments X, Y and Z are therefore subject to relevant taxation as superannuation lump sum benefits under the provisions of the ITAA 1997.

Superannuation lump sum benefits received in the 2012-13 income year

Superannuation lump sum benefits 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.

Proportioning rule

The proportioning rule is generally used to calculate the tax-free and taxable components of a superannuation lump sum benefit.

In accordance with subsection 307-125(2) of the ITAA 1997, when a lump sum superannuation 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.

In this instance, the three payments each comprise of a tax-free component and a taxable component - taxed element.

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.

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.

In this case, the payments received from funds X, Y and Z were made to you when you were under your preservation age of 65. Therefore, the tax-free component of each payment does not count towards your assessable income. Accordingly the sum of the tax-free components of the three payments will not be included in your income tax return for the 2012-13 income year.

Taxable component

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

The taxable component of a superannuation lump sum can consist of an element taxed in the fund and/or an element untaxed in the fund.

In this instance, the taxable component of a superannuation interest in a taxed fund consisted wholly of an element taxed in the fund. The tax treatment of the taxed element of a taxable component depends on the age of the taxpayer.

As you were under the preservation age at the time the three superannuation funds (X, Y and Z) made the payments to you, the taxed element of the taxable component of each benefit is included in your assessable income in accordance with subsection 301-35(1) of the ITAA 1997.

In accordance with subsection 301-35(2) of the ITAA 1997, a tax-offset will apply to ensure that the rate of tax payable on the taxable component of each benefit is not greater than 20% plus Medicare levy. The fund is obliged to withhold tax from the taxable component of each benefit.

The sum of the taxed elements of the taxable components of the three payments must be fully included in your assessable income for the 2012-13 income year.

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.

Section 307-145 of the ITAA 1997 provides for a modification for disability benefits and states:

(1) Work out the tax free component of the superannuation benefit under subsection (2) if the benefit is a superannuation lump sum and a disability superannuation benefit.

(2) 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.

(3) Work out the amount by applying the following formula:

Amount of benefit × Days to retirement

Service days + Days to retirements

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 her last retirement day.

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

(4) The balance of the superannuation benefit is the taxable component of the 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.

At the time that the payments were made by the three superannuation funds, two qualified medical practitioners had already certified that you were suffering from a medical illness which, in their opinion, is likely to preclude you from ever being able to be employed again in a capacity for which they are reasonably qualified by education, training or experience.

Therefore, the TPD payments made to you by these three superannuation funds satisfy the definition of a disability superannuation benefit. Accordingly, section 307-145 of the ITAA 1997 applies to modify the tax-free component in each case.

Based on the information provided, it appears that the three superannuation funds have already applied section 307-145 of the ITAA 1997 when working out the tax-free component as stated on the PAYG payment summaries for the superannuation lump sums.

Therefore, no further modification of the tax-free component will be applicable.

Question 2 - If the answer to question 1 is 'yes', can you claim a deduction in respect of legal fees incurred in receiving those payments?

Deduction for legal expenses incurred

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of assessable income. 

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. 

If the advantage is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer. 

You incurred the legal expenses in order to obtain the release of your superannuation as a lump sum disability benefit. The lump sum payment was received for the loss of your earning capacity and is a capital receipt. The payment remains a capital receipt despite the fact that a portion of the lump sum payment is assessable.  

As the payment you received is capital in nature, the expenses incurred in securing that payment are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred as expenditure of a capital nature is expressly excluded.