Edited version of your written advice

Authorisation Number: 1051517691018

Date of advice: 27 May 2019

Ruling

Subject: Total and permanent disability payment

Questions

1. Is the receipt by Fund of a total and permanent disability (TPD) payment (the Payment) assessable income of the fund?

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

3. If the SMSF receiving the Payment has other accumulations will the proportioning rule apply?

Answers

1. No

2. Yes

3. Yes

This ruling applies for the following period:

Income year ended 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The Member is a member of the Fund, a complying self-managed superannuation fund.

The Member was under 65 years of age in the 2016-17 income year. You have advised they were a principal of a medical practice until they retired in early 2016 for ill health.

At the time of their retirement the Member was in the transition to retirement phase.

The SMSF had two relevant policies with the Insurer:

I. Income protection – regular payments made to the Member under this policy and

II. TPD cover – this policy was the source of the Payment.

Two medical certificates have been provided by Medical Practitioners that certify that the Member will not likely be able to work in their own occupation now or in the near future and are not likely to be able to work in any occupation now or in the future.

A TPD claim was made which was accepted by the Insurer. As a result of this successful claim, you have advised the Payment was made by the Insurer to the SMSF in early 2017.

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 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.

In the event 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 amount of 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 will be a tax free component of the Member’s superannuation interest in the SMSF.

Superannuation lump sum benefit

A lump sum payment of 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.

Modification of the tax-free component for disability benefits

Section 307-145 of the ITAA 1997 operates to effectively increase the tax-free component where the superannuation lump sum benefit is 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 an individual because he or she suffers 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 individual can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

If the requirements above are satisfied, the amount of the tax-free component for the proposed lump sum in this case will be modified in accordance with subsection 307-145(2) of the ITAA 1997, which states:

(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.

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 her last retirement day.

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

A person’s last retirement day is generally when they would turn 65.

‘Service period’ is defined under section 307-400 of the ITAA 1997.

In relation to the denominator in the formula in subsection 307-145(3) of the ITAA 1997, any days that are included in both ‘service days’ and ‘days to retirement’ are to be counted only once.

The result of the calculation in subsection 307-145(3) of the ITAA 1997 will then be added to the tax free component of the benefit worked out using the proportioning rule to determine the total tax-free component.

Note that the total tax-free component for the proposed benefit cannot exceed the amount of the benefit itself.

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