Edited version of your written advice

Authorisation Number: 1013040931376

Date of advice: 24 June 2016

Ruling

Subject: Payments from invalidity pension paid under rules of the Military Superannuation and Benefits Scheme

Question 1

Are invalidity pension benefits paid to you from the Military Superannuation and Benefits Scheme (MSBS) superannuation benefits as that term is defined in section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

Question 2

Are your invalidity pension payments excluded from the definition of a superannuation benefit by section 307-10 of the ITAA 1997?

Answer 2

No.

Question 3

Does the invalidity pension constitute a superannuation income stream as that term is defined in section 307-70 of the ITAA 1997 and subregulation 995-1.01(1) of the Income Tax Assessment Regulations 1997 (ITAR)?

Answer 3

Yes.

Question 4

Can you make the election in regulation 995-1.03 of the ITAR, before a particular payment of the invalidity pension is made, that the payment is not to be treated as a superannuation income stream benefit?

Answer 4

Yes

Question 5

Is the invalidity pension, payable to you under the rules of the MSBA, an employment termination payment?

Answer 5

No.

Question 6

Is your invalidity benefit a defined benefit interest under section 291-175 of the ITAA 1997?

Answer 6

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20YY

The scheme commenced on:

The scheme has commenced

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Military Superannuation and Benefits Scheme is the superannuation scheme for most Australian Defence Force (ADF) members, with the rules established under the Military Superannuation and Benefits Act 1991 (MSBA).

As a member of the ADF you became a member of the MSBS.

Amongst other things, the MSBA Rules provide for the payment of an invalidity pension to certain individuals who have been retired because of their invalidity.

To determine whether an invalidity pension is payable, the MSBA Rules provide for a mechanism by which a determination is made of a particular individual's capacity/incapacity to engage in civil employment after their retirement from the ADF. Under rule 22, an individual is assessed as having a Class A, Class B or Class C incapacity for civil employment.

The MSBA Rules provide that a person whose incapacity for civil employment is classified as Class A is eligible for an invalidity pension, the starting amount for which is worked out having regard to an amount called the employer benefit (rule 27). A person whose incapacity for civil employment is classified as Class B is entitled to a pension of a different amount, which in very broad terms, may be half of the amount payable to a Class A recipient (rule 28). However, no invalidity pension is payable to a person whose incapacity for civil employment is classified as Class C (rule 31).

In very simple terms, the 'employer benefit' is worked out having regard to your final average salary and your eligible service period. Schedule 8 to the MSBA Rules sets out the calculation of an employer benefit for a person who is retired from the ADF because of invalidity. Schedule 5 to the MSBA Rules sets out the rules used to calculate the rate of pension that is payable by conversion from the amount of the employer benefit.

The MSBA Rules require an individual to undergo periodical reviews of their level of incapacity for civil employment (rule 25). The MSBA Rules generally provide that if an individual's level of incapacity for civil employment is adjusted to the extent that they are reclassified to another classification, the amount payable may be adjusted. If an individual is reclassified to Class C, the invalidity pension that had been payable to them (as either a Class A or Class B individual) is cancelled and the individual will have a preserved benefit of the amount of their employer benefit (rule 29).

However, an individual who has reached the age of 55 cannot be reclassified to Class C incapacity for civil employment (subrule 23(2)).

Upon becoming entitled to receive an invalidity pension under the MSBS, an amount equal to the funded employer benefit is paid by the Commonwealth Superannuation Corporation (CSC) to the Commonwealth and the invalidity pension is payable to the individual by the Commonwealth from the Consolidated Revenue Fund (section 13 of the MSBA).

If an invalidity pension that was payable to an individual who was classified as having a Class A or Class B incapacity for civil employment is cancelled because the individual is reclassified to Class C, the Commonwealth must pay to the CSC an amount equal to the individual's funded employer benefit (section 15 of the MSBA).

You have advised that you were discharged from the ADF and were classified as having Class B incapacity for civil employment. An invalidity pension of the amount relevant to that classification has been payable to you since this time.

In your application for this private ruling you contend that:

the benefits you have received are not a superannuation income stream benefit as they are subject to regular medical reviews which can result in the payments being decreased or cancelled at any stage;

the payment summaries provided to you by the CSC are incorrect

the benefits you have received are not a defined benefit

the benefits you have received are employment termination payments of which the invalidity component should be tax free.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 section 291-175

Income Tax Assessment Act 1997 section 307-5

Income Tax Assessment Act 1997 section 307-10

Income Tax Assessment Act 1997 section 307-70

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Regulations 1997 regulation 995-1.01

Income Tax Assessment Regulations 1997 regulation 995-1.03

Superannuation Industry (Supervision) Act 1993 section 10

Superannuation Industry (Supervision) Regulations 1994 regulation 1.06

Military Superannuation and Benefits Act 1991

Defence Force Retirement and Death Benefits Act 1973 section 125

Case law

Michael James Hammerton v Comcare Australia [1995] AATA 63

Reasons for decision

Question 1

Are the payments of the invalidity pension paid to you from the MSBS superannuation benefits as that term is defined in section 307-5 of the ITAA 1997?

Reasons

Item 1 of the table in subsection 307-5(1) of the ITAA 1997 effectively states that a 'superannuation benefit' includes a payment made to you from a superannuation fund because you are a fund member.

'Superannuation fund' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 10 of the Superannuation Industry (Supervision) Act 1993 (SISA).

Paragraph (b) of the superannuation fund definition in subsection 10(1) of the SISA refers to a 'public sector superannuation scheme.' This term is also defined in subsection 10(1) to include a scheme for the payment of superannuation, retirement or death benefits, where the scheme is established by or under a law of the Commonwealth or the government of a State or Territory.

The MSBS is established under the law of the Commonwealth to pay superannuation, retirement or death benefits. In particular, it provides for benefits that are in the nature of superannuation benefits that are payable on retirement from the ADF, including where that retirement is due to invalidity. It is therefore a superannuation fund for both SISA and income tax purposes.

In Michael James Hammerton v Comcare Australia [1995] AATA 63, the Administrative Appeals Tribunal reached a similar conclusion about the scheme established under the Defence Force Retirement and Death Benefits Act 1973 (DFRDBA). The DFRDBA also provides for certain invalidity benefits to retired service personnel. Section 125 of the DFRDBA, like the MSBA, provides that all benefit payments are made by the Commonwealth and are made out of the Consolidated Revenue Fund.

Further, the invalidity pension payments are made because the recipients are, or have been, fund members. Each individual's entitlement to the benefits arises because they were a fund member who retired due to invalidity.

For these reasons we consider that the MSBS invalidity pensions are superannuation benefits as defined in section 307-5 of the ITAA 1997.

Question 2

Are your invalidity pension payments excluded from the definition of a superannuation benefit by section 307-10 of the ITAA 1997?

Reasons

Subsection 307-10(a) of the ITAA 1997 excludes from the definition of 'superannuation benefit' an amount payable under an income stream because of the person's temporary inability to engage in gainful employment.

The MSBS invalidity pension is paid because a member is retired from the ADF on the ground of invalidity. It is not paid because of the person's temporary inability to engage in gainful employment but rather on the assessment of their incapacity in relation to civil employment.

The assessment of incapacity determines whether an individual is entitled to a pension and if so, how much is payable as the pension. On review, the assessment of incapacity can also determine whether a different amount is payable or whether a pension should be cancelled (if the individual is reclassified as having Class C incapacity).

The payment of an invalidity pension under the MSBS occurs when there is a permanent, not temporary incapacity. An individual must first be retired from the ADF due to invalidity. Secondly, the individual retiree is classified according to their degree of incapacity for their appropriate civilian employment. The types of employment are determined by what the individual could reasonably undertake based on their qualifications; skills and experience, disregarding their medical condition (see rules 22 and 23 of the MSBA).

We consider the MSBS invalidity payments do not relate to temporary disability or temporary incapacity as they are paid to retired individuals. Subsequently, they are not excluded from being superannuation benefits by subsection 307-10(a) of the ITAA 1997.

Question 3

Can you make the election in regulation 995-1.03 of the ITAR, before a particular payment of the invalidity pension is made, that the payment is not to be treated as a superannuation income stream benefit?

Reasons

Superannuation benefits are either superannuation income stream benefits or superannuation lump sums (Subdivision 307-B of the ITAA 1997).

A superannuation income stream benefit is a payment from an interest that supports a superannuation income stream, other than a payment to which regulation 995-1.03 of the ITAR applies (subsection 307-70(1) and (2) of the ITAA 1997 and subregulation 995-1.01(2) of the ITAR).

A definition of "superannuation income stream" is set out in subregulation 995-1.01(1) of the ITAR. On the issue of whether these MSBS pensions are superannuation income streams, an 'income stream' that commenced on or after 20 September 2007 is a superannuation income stream if it is taken to be a pension for the purposes of the SISA in accordance with subregulation 1.06(1) of the Superannuation Industry (Supervision) Regulations 1994 (SISR).

The expression 'income stream' is not defined by either the income tax or superannuation laws. It must be given its ordinary meaning. We consider that an income stream is a series of periodic payments that relate to each other and that are payable over an identifiable period of time.

The invalidity pension payable under the MSBS amounts to such a series of fortnightly payments.

Having examined the terms under which the invalidity pension is payable under the MSBA and MSBS, we are satisfied that the invalidity pension is a pension that meets the requirements set out in subregulation 1.06(1) of the SISR.

You refer in your application to the circumstances in which the invalidity pension may vary under the MSBA rules and point to the conditions in paragraph 995-1.03 of the ITAR in order to conclude that the invalidity pension is not a superannuation income stream. However, we note that regulation may only affect whether a particular payment from a superannuation income stream is a superannuation income stream benefit or a superannuation lump sum. It has no effect on whether a person's benefit paid from their superannuation fund is a superannuation income stream or not. Regulation 995-1.03 only applies if a member's benefits are being paid as a superannuation income stream as defined.

Question 4

Can you make the election in regulation 995-1.03 of the ITAR, before a particular payment of the invalidity pension is made, that the payment is not to be treated as a superannuation income stream benefit?

Reasons

Regulation 995-1.03 of the ITAR effectively allows a person in receipt of a superannuation income stream to elect to have a payment made from the income stream be treated as a superannuation lump sum instead of a superannuation income stream benefit (provided the person makes the election before the payment is made). However, an election under regulation 995-1.03 of the ITAR may only be made if the conditions to which the superannuation income stream is subject, permit the amount of payments in a year to vary other than in the circumstances set out in sub-paragraphs (a)(i)-(iv). Effectively this means that an election can only be made if the payment amount in a year is capable of being varied other than by way of: indexation under the pension rules; the application of the family law splitting rules; the commutation of the income stream; or the payment of an assessment of excess contributions tax.

Rule 23 of the MSBA permits a person who has been classified under Rule 22 to be reclassified under Rule 22 at a future time. For example, a retiree who was classified as Class A under Rule 22 may, where the requirements of Rule 23 are met, be reclassified as Class B or Class C at some later time (and vice versa).

In the case of a person in receipt of an MSBS invalidity pension who is reclassified Class A or Class B, this effectively means the annual payment amount of their pension will change significantly given the annual amount of a Class B invalidity pension may in general terms equate to only half the annual amount payable as a Class A invalidity pension.

We consider that in the circumstance where the annual amount of payments from an MSBS invalidity pension is altered in response to the application of Rule 23, this reflects a circumstance other than one set out in sub-paragraphs 995-1.03(a)(i)-(iv) of the ITAR. Accordingly a person in receipt of an MSBS invalidity pension may make an election under regulation 995-1.03 in respect of a payment provided they make the election before the payment from their pension is made.

Question 5

Is the invalidity pension, payable to you under the rules of the MSBA, an employment termination payment?

Reasons

Under section 82-130 of the ITAA 1997, a payment is an employment termination payment if each of three conditions is met:

• it is received by a person in consequence of the termination of the person's employment (subparagraph 82-130(1)(a)(i)),

• it is received no later than 12 months after that termination (paragraph 82-130(1)(b)), and

• it is not excluded from being an employment termination payment by section 82-135 of that Act (paragraph 82-130(1)(c)).

Even in the event it could be said that payments made from the MSBS invalidity pension meet the first of these two conditions, under subsection 82-135(a) of the ITAA 1997, the payment of a superannuation benefit is not an employment termination payment. For the reasons set out for question 1 of this ruling, the invalidity pension payments are superannuation benefits. Therefore, your invalidity pension payments are excluded from the definition of employment termination payment under subsection 82-135(a) of the ITAA 1997.

Further, subsection 82-135(b) of the ITAA 1997 provides that the payment of a pension is not an employment termination payment. As the word 'pension' as used in that paragraph is not defined, it takes its ordinary meaning.

In Michael James Hammerton v Comcare Australia [1995] AATA 63, the Administrative Appeals Tribunal decided that the pension payable under the DFRDB scheme was a pension within the ordinary meaning of that word. We consider that this position can be consistently applied to the payments of the MSBS invalidity pension.

Consequently, all of the fortnightly pension payments received by you are also excluded from the definition of employment termination payment under subsection 82-135(b) of the ITAA 1997.

We note that because the invalidity pension is a pension within the ordinary meaning of the term "pension", it may be included in assessable income as ordinary income under section 6-5 of the ITAA 1997 if it was not otherwise regarded as a superannuation benefit.

Question 6

Is your invalidity benefit a defined benefit interest under section 291-175 of the ITAA 1997?

Reasons

Subsection 291-175(1) of the ITAA 1997 provides that an individual's superannuation interest is a "defined benefit interest" to the extent it defines the individual's entitlement to superannuation benefits payable from the interest by reference to (relevantly for this advice):

(a) the individual's salary or allowance in the nature of salary at a particular date or averaged over a period; …

(d) specified conversion factors.

However, subsection 291-175(2) provides that the interest is not a defined benefit interest if it defines that entitlement solely by reference to one or more of the following:

(a) disability superannuation benefits;

(b) superannuation death benefits;

(c) payments of amounts mentioned in paragraph 307-10(a).

As a member of the MSBS, an individual enjoys a range of potential prescribed entitlements under the scheme where the actual entitlement derived by the individual or their dependants upon the individual ceasing to be a member of the scheme, is contingent upon the happening of some future event. Specifically, while a member of the scheme an individual has a contingent entitlement to benefits variously payable upon retirement, resignation, retrenchment and invalidity. Their dependants may also have a contingent entitlement to receive payments from the scheme on their death.

In the case of these contingent entitlements, the member's employer benefit is derived under the scheme rules by a formula that references their final average salary and various other factors such as their years of service. In the event the benefit paid from the scheme is a pension, the annual pension amount is further derived by the application of specified conversion factors. Accordingly, we consider that a member's interest in the MSBS is a defined benefit interest under subsection 291-175(1) of the ITAA 1997.

Further, as a member of the MSBS has a contingent entitlement to benefits that may be paid on retirement or resignation or retrenchment as well as upon invalidity or death, subsection (2) cannot apply as their interest in the MSBS is not defined 'solely' by reference to disability superannuation benefits or death benefits as defined and, for the reasons set out in the answer to question 2, the invalidity pensions do not give rise to payments to which paragraph 307-10(a) applies.

This conclusion is not affected by the fact a person is actually in receipt of an invalidity pension. This is because the right to the pension itself is not the only right the person has in the scheme. For example, in the circumstances where a person has been receiving a pension which is reclassified to Class C incapacity for civil employment (and the pension is cancelled), the Commonwealth must pay an amount of funded employer benefit back to CSC. The person then has an entitlement to the employer benefit again and that benefit is not any one of the kinds specified in subsection 291-175(2) of the ITAA 1997.