Edited version of your written advice

Authorisation Number: 1012834715056

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Date of advice: 16 July 2015

Ruling

Subject: Superannuation lump sum - total and permanent disability payment

Questions

1. Is the receipt by the self-managed superannuation fund (SMSF) of a total and permanent disability (TPD) payment from an insurer to be included in the assessable income of the fund?

2. Does the TPD payment received by the SMSF constitute a tax-free component of the contributions segment of the fund?

3. If the SMSF receiving a TPD payment has other accumulations, and a superannuation benefit is paid to the member of the SMSF, will the proportioning rule apply?

Answers

1. No

2. Yes

3. Yes

This ruling applies for the following period:

Income year ending 30 June 2015.

Income year ending 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

An individual (the Member) is a member of a self-managed superannuation fund (the SMSF).

The SMSF paid insurance premiums to an insurance provider (the Insurer) on behalf of the Member in relation to Total and Permanent Disability (TPD) cover.

After the Member was affected by an illness, a TPD claim was made which was accepted by the Insurer.

As a result of this successful claim, a TPD payment was made by the Insurer to the SMSF during the relevant income year.

Before the TPD payment, the Member had other accumulations in the SMSF. These accumulations are entirely made up of a taxable component.

The SMSF intends to make a lump sum payment of a portion of the Member's total superannuation interest on the grounds of the Member's ill-health.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 118-30

Income Tax Assessment Act 1997 subsection 118-30(1)

Income Tax Assessment Act 1997 subsection 307-125(2)

Income Tax Assessment Act 1997 section 307-145

Income Tax Assessment Act 1997 subsection 307-145(2)

Income Tax Assessment Act 1997 subsection 307-145(3)

Income Tax Assessment Act 1997 section 307-210

Income Tax Assessment Act 1997 section 307-215

Income Tax Assessment Act 1997 section 307-220(1)

Income Tax Assessment Act 1997 section 307-400

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

Reasons for decision

Summary

The TPD payment from the Insurer to the SMSF is an exempt capital gain and as such is not assessable income.

As the TPD payment is tax-free in the hands of the SMSF, the amount constitutes a tax-free component of the contributions segments of the SMSF.

As the Member's interest in the SMSF contains both a tax-free and taxable component, the proportioning rule will apply to determine the tax-free and taxable components of the proposed payment to the Member.

Detailed reasoning

TPD payment from the Insurer

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

• are earned;

• are expected;

• are relied upon; and

• have an element of periodicity, recurrence or regularity.

In this case, the TPD payment received is not income from rendering personal services, income from property or income from carrying on a business. The payment is also not earned, expected, or relied upon and, as a once off payment, does not have an element of recurrence or regularity. The payment is a capital receipt and is not ordinary income. Consequently the amount is not assessable under section 6-5 of the ITAA 1997.

Receipt of a lump sum payment may give rise to a capital gain, which is statutory income. Section 118-300 of the ITAA 1997 provides that a capital gain or loss made from a CGT event happening in relation to a CGT asset that is your interest in rights under a general insurance policy, a life insurance policy or an annuity instrument, is disregarded in certain circumstances.

According to item 7 of the table in subsection 118-300(1) of the ITAA 1997, there will be no CGT consequences if a CGT event happens in relation to a policy of insurance against an individual suffering an illness or injury and the recipient of the capital gain is the trustee of a complying superannuation entity for the income year in which the CGT event happened.

In this case, it is considered that the TPD payment falls under item 7 of the table in subsection 118-300(1) of the ITAA 1997. As such, the capital gain from the TPD payment can thus be disregarded.

Tax free component of a superannuation interest

The contributions segment of a superannuation interest is defined under subsection 307-220(1) of the ITAA 1997.

(1) The contributions segment of a superannuation interest is so much of the value of the interest as consists of contributions made after 30 June 2007, to the extent that they have not been and will not be included in the assessable income of the superannuation provider in relation to the superannuation plan in which the interest is held.

As the TPD payment from the Insurer is not assessable to the SMSF in this case, the TPD payment amount will constitute the contributions segment of the SMSF. Section 307-210 of the ITAA 1997 states that the tax free component of a superannuation interest is comprised of the sum of the contributions segment and the crystallised segment. In other words, the amount of the TPD payment will be a tax free component of the Member's superannuation interest in the SMSF.

Superannuation lump sum benefit

The proposed payment from the SMSF to the Member will be the payment of a superannuation lump sum benefit. A superannuation lump sum benefit will generally be comprised of:

_ 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.

The proportioning rule is outlined under subsection 307-125(2) of the ITAA 1997. According to the rule, when a superannuation lump sum benefit is paid from a superannuation interest, 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.

According to the facts of this case, the Member's interest in the SMSF is comprised of the following components:

_ a tax-free component of $X; and

_ a taxable component of $Y

As such, the proposed payment from the SMSF to the Member must include a tax-free and taxable component in the ratio X: Y in accordance with the proportioning rule.