Edited version of private advice

Authorisation Number: 1051572009754

Date of advice: 9 September 2019

Ruling

Subject: Total and permanent disability payment

Question

Is the lump sum total and permanent disability payment received by a person under the Employer Insurance Scheme, a tax-free lump sum?

Answer

No

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed by an entity (the Employer) for more than XX ears.

You were a member of a complying superannuation fund (the Fund).

You applied for a total and permanent disability (TPD) payment from the Fund, which approved your claim.

In the 20XX-XX income year, you received a TPD payment from the Fund.

Subsequently, your superannuation account was closed.

You were insured for the Employer TPD benefits through the Fund.

The Fund received the payment from an insurance entity (the Insurer).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 118-300

Income Tax Assessment Act 1997 section 301-1

Income Tax Assessment Act 1997 section 307-5

Income Tax Assessment Act 1997 section 307-120

Income Tax Assessment Act 1997 section 125

Income Tax Assessment Act 1997 section 145

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Summary

A TPD payment from the Insurer to the Fund is an exempt capital gain and, as such, is not assessable income. Consequently, it constitutes a tax-free component of the contributions segment of the fund.

As you received the TPD payment from the Fund and not directly from the insurer as a part of an insurance policy, the payment is a superannuation benefit. Consequently, the payment is taxed as a superannuation benefit and not as a payment from an insurance policy. The tax-free component of the payment is not assessable income and is not exempt income. As such, it is tax-free.

The taxable component of the lump sum is assessable income and needs to be included in your income tax return.

Detailed reasoning

TPD payment from an 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 instance, the TPD payment 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 likely that the TPD payment falls under item 7 of the table in subsection 118-300(1) of the ITAA 1997.

As the payment was made by insurer to the Fund, the benefit of the event having no CGT consequences as per item 7 of the table in subsection 118-300(1) of the ITAA 1997 would apply to the Fund

Superannuation benefit

Payments that are superannuation benefits are set out in subsection 307-5(1) of the ITAA 1997 and include a payment made to person from a superannuation fund because the person is a member of the fund. Consequently, payments to the Taxpayer from the Fund are superannuation benefits.

In accordance with subsection 307-120(1) of the ITAA 1997, a superannuation benefit may consist of the tax free component and the taxable component.

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 under subsection 307-125(2) of the ITAA 1997 is generally used to calculate the tax free and taxable components of a benefit.

The tax free component of a superannuation benefit is not assessable income and is not exempt income. The tax treatment of the taxable component varies depending on the age of the member when they receive the benefit (section 301-1 of the ITAA 1997).

In this instance, your death and disability payment policy was taken out through the Fund and the claim for the TPD payment was made through the Fund.

You received a payment for a TPD claim from the Fund, because you are a member of the Fund. Therefore, the payment made you is a superannuation benefit and is taxed as a superannuation benefit and not as an insurance policy payment.

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 x Days to retirement/(Service days + Days to retirement)

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.