Edited version of private advice

Authorisation Number: 1051617519904

Date of advice: 23 April 2020

Ruling

Subject: Lump sum payment in arrears, Medicare levy and surcharge

Question 1

Is the lump sum payment you received assessable in the year ended 30 June 2019?

Answer

Yes

Question 2

Are you eligible for the lump sum payment in arrears tax offset?

Answer

Yes

Question 3

Are you exempt from paying half the Medicare Levy?

Answer

Yes.

Question 4

If you are liable for the Medicare levy surcharge are you entitled to a Medicare levy surcharge tax offset?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You were discharged from the Defence Forces a number of years ago.

Recently, you applied for a retrospective invalidity pension.

It was determined by the delegate that you could have retired on the grounds of invalidity.

In the 2018-19 income year you received a lump sum in arrears payment with an amount of tax withheld.

You received a Lump Sum E Letter payment summary providing gross arrears payable for each financial year.

You hold a current Department of Veterans' Affairs (DVA) Health card/Veteran Totally and Permanently Incapacitated (TPI) Gold card.

Your spouse has not received any taxable income and is not required to lodge an income tax return.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 159ZR

Income Tax Assessment Act 1936 Section 159ZRA

Income Tax Assessment Act 1936 Section 251S(1)(a)

Income Tax Assessment Act 1936 Section 251U(1)(a)

Income Tax Assessment Act 1936 Subsection 251U(2)

Income Tax Assessment Act 1936 Section 251U(3)

Income Tax Assessment Act 1936 Section 251VA

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 61-580

Income Tax Assessment Act 1997 Section 61-590

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

Medicare Levy Act 1986 Section 3A

Medicare Levy Act 1986 Sections 8B to 8G

Reasons for decision

Summary

The lump sum in arrears payment you received has the characteristics of income according to ordinary concepts under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and is therefore assessable as ordinary income in the year of receipt. However under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936) you are eligible for the lump sum in arrears taxoffset.

As a prescribed person with a spouse who is not a prescribed person you are not fully exempt from the Medicare levy but you will be entitled to half exemption from the Medicare levy. Furthermore, if your spouse does not have adequate private patient hospital cover you will be liable for the Medicare levy surcharge (MLS); however you are eligible for the MLS tax offset.

Detailed Reasoning

Lump sum arrears payment

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

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.

Based on case law, it can be said that ordinary income generally includes receipts that:

·        are earned

·        are expected

·        are relied upon, and

·        have an element of periodicity, recurrence or regularity.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82).

Compensation payments or similar payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433). Therefore periodic payments received following a disability that replaces lost earnings are generally regarded as assessable income.

In FC of T v. Dixon (1952) 10 ATD 82; (1952) 86 CLR 540, weekly payments to a soldier from his former employer to make up the difference between his civil and military pay has been held to be income according to ordinary concepts, as were regular subsidies paid by a bank to selected former employees in order to counter the eroding effects of inflation on the real value of their pensions in FC of T v. Blake 84 ATC 4661, 15 ATR 1006.

In determining whether the payment received from the DFRDB is assessable, consideration has to be given to the purpose and nature of the payment. One of the intentions under the DFRDB is to provide payment of invalidity benefits to members who are discharged as being medically unfit for further service.

The CSC considers those eligible to receive a DFRDB invalidity benefit and makes a decision based on their capacity, or incapacity to be employed in the civilian workforce. If you are classed as either Class A or Class B, you will be entitled to receive invalidity pay.

Your ongoing benefit was worked out as a percentage of your salary at retirement for DFRDB purposes and is paid fortnightly and the lump sum payment you received represents an arrears payment of the invalidity pension you should have received after being discharged from the ADF.

Your invalidity pension is in the nature of compensation for a loss of income due to your injury rather than compensation for the injury itself. Your invalidity pension is considered to be ordinary income. A lump sum back payment of income is also considered to be income.

Division 52 of the ITAA 1997 provides exemptions for certain pension, benefits and allowances; however your pension is not listed as an exempt pension.

Taxation Ruling TR 98/1 considers the appropriate method of determining when income is derived under subsection 6-5(2) of the ITAA 1997 where income is earned in one tax year but received in another. Paragraph 42 of TR 98/1 states that salary and wages or other similar remuneration is assessable on a receipts basis. This is irrespective of whether that income relates to a past or future income period. Similarly, pension income is assessable on a receipts basis.

Therefore, the lump sum payment of pension in arrears received by you in the 2018-19 income year is assessable under subsection 6-5(2) of the ITAA 1997 in that income year.

Lump sum payment in arrears tax offset

Individual taxpayers, who receive certain assessable lump sum payments containing an amount that accrued in earlier income years, may be entitled to a lump sum in arrears tax offset under section 159ZRA of the ITAA 1936. The tax offset is intended to overcome the problem of the lump sum attracting more tax in the year of receipt than would have been payable if the payment had been taxed in each of the years in which it accrued.

Your invalidity pension qualifies as eligible income for the purposes of the tax offset (section 159ZR of the ITAA 1936 and section 12-120 in Schedule 1 to the Taxation Administration Act 1953).

The other requirement to obtain the tax offset is the amount of the eligible lump sum must not be less than 10% of the amount (if any) remaining after deducting the lump sum amount from the normal taxable income of the year of receipt.

In your case, the lump sum payment that you received in the 2018-19 income year is greater than 10% of the amount remaining after deducting the lump sum amount from your taxable income in the 2018-19 income year. As such, you are eligible for the tax offset under section 159ZRA of the ITAA 1936 for your lump sum payment of pension arrears which accrued in earlier income years.

Medicare levy

Section 251S of the ITAA 1936 provides that the Medicare levy is payable by any person who was, at any time during the year, a resident of Australia.

Persons who are normally exempt from the Medicare levy are defined as 'prescribed persons' in subsection 251U(1)(a) of the ITAA 1936. They include a person who is entitled to full free medical treatment by the Defence Forces or under veterans' entitlement (repatriation) legislation. However, under subsection 251U(2) of the ITAA 1936 a person will not be a 'prescribed person' if any of their dependants are not prescribed persons.

Paragraph 3 of TR 93/35 states the broad principle is that if a prescribed person:

·        does not have any dependants,

·        has dependants who all qualify as exempt in their own right,

·        has a dependant who is subject to the levy on a separate income; or

·        has a spouse who is liable to pay the levy, and the spouse contributes to the maintenance of a dependant,

then that prescribed person is completely exempt from the levy.

If a person is not completely exempt from the levy in accordance with paragraph 3, then that prescribed person will be required to pay half the levy under subsection 251U(3) of the ITAA 1936.

In your circumstances you are a 'prescribed person' as your DVA gold card entitles you to full free medical treatment. However your spouse does not qualify as a 'prescribed person', therefore you are not completely exempt and you will be required to pay half the levy under subsection 251U(3) of the ITAA 1936.

Medicare Levy Surcharge

Exemption from the Medicare levy does not automatically entitle a prescribed person to exemption from the Medicare levy surcharge. The surcharge operates as an additional amount of Medicare levy rather than as a separate charge and consequently, is based largely on existing Medicare levy provisions.

Under section 251VA of the ITAA 1936 the special rule in subsection 251U(3) of the ITAA 1936 which treats a taxpayer as a prescribed person for one-half of the period where the taxpayer has a dependant who is not a prescribed person does not apply. That is, for surcharge purposes, the taxpayer is taken not to be a prescribed person at any time during the period.

You are a prescribed person who receives a half exemption from the Medicare levy but your spouse is not a prescribed person. Under subsection 8D(1)(c) of the Medicare Levy Act 1986 if your spouse does not have appropriate private patient hospital cover you may be liable for the Medicare levy surcharge.

However, section 61-580 of the ITAA 1997 may allow a Medicare levy surcharge lump sum in arrears tax offset if the Medicare levy surcharge was imposed because you received an eligible lump payment in arrears in the year of income.

You are entitled to a Medicare levy surcharge lump sum in arrears tax offset if the following conditions are met:

a)     you are an individual; and

b)     Medicare levy surcharge is payable by you for the current year because of:

                     i.            section 8B, 8Cor 8D of the Medicare Levy Act 1986; or

                      ii.          the A New Tax System (Medicare Levy Surcharge - Fringe Benefits) Act 1999; and

c)     your assessable income or exempt foreign employment income for the current year includes one or more MLS lump sums paid to you; and

d)     the total of the MLS lump sums paid to you is greater than or equal to one-eleventh of the total of the following amounts:

                           i.          your normal taxable income (within the meaning of section 159ZR of the Income Tax Assessment Act 1936) for the current year;

                         ii.          your exempt foreign employment income for the current year;

                        iii.          your reportable fringe benefits total for the current year;

                        iv.          the amounts that would be included in your assessable income for the current year if, and only if, subsection 271-105(1) (family trust distribution tax) in Schedule 2F to the Income Tax Assessment Act 1936 were ignored;

                         v.          your reportable superannuation contributions for the current year;

                        vi.          your total net investment loss for the current year.

A Medicare levy surcharge lump sum for the tax offset purposes is defined in section 61-590 of the ITAA 1997 to be:

·        A lump sum payment of eligible income (within the meaning of section 159ZR of the Income Tax Assessment Act 1936 (ITAA 1936)) that is included in the individual's assessable income for the current year (but only to the extent that it accrued in an earlier income year); or

·        A lump sum payment that is included in the individual's exempt foreign employment income for the current year (but only to the extent that it accrued during a period ending more than 12 months before the date of which it was paid).

Your invalidity pension qualifies as eligible income under section 159ZR of the ITAA 1936.

As you received a lump sum payment in arrears of your invalidity pension, you satisfy the conditions of the tax offset. Therefore, if you are liable for the Medicare levy surcharge you would be entitled to a Medicare levy surcharge tax offset under section 61-580 of the ITAA 1997.