Private ruling: Tax Treatment Invalidity Pensions
Date of advice: 17 August 2016
Published: October 2016
Ruling period: Income year ending 30 June 2015 and later years
Date scheme commenced: 1 July 2008

Ruling: Q1: Are the payments of the invalidity pension paid to you under the rules of the Relevant Superannuation and Benefits Scheme (XXXX) established by trust deed under the Relevant Superannuation and Benefits Act 1991 (XXXX) superannuation benefits as that term is defined in section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1:  | Q2: If yes to the previous question, are the payments of the invalidity pension paid to you excluded by section 307-10 of the ITAA 1997 from the definition of superannuation benefit in section 307-5 of the ITAA 1997? | A2: No. | Q3: If no to the previous question, does the invalidity pension constitute a superannuation income stream as that term is defined in section 307-70 of the ITAA 1997 and regulation 995-1.01(1) of the Income Tax Assessment Regulations 1997 (ITAR)? | A3: Yes. | Q4: If yes to the previous question, 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? | A4: Yes | Q5: Is the invalidity pension payable to you under the rules of the Relevant Superannuation Scheme an employment termination payment? | A5: No. | Q6: Is the invalidity benefit paid from the Relevant Superannuation Scheme paid in respect of an interest that is a defined benefit interest under section 291-175 of the ITAA 1997? | A6: Yes.

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. As a member of the XXX, you became a member of the Relevant Superannuation Scheme. The Relevant Superannuation Scheme is a scheme which was established to provide benefits that are payable when an individual retires from the XXX. Amongst other things, the Relevant Superannuation Scheme 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 Relevant Superannuation Scheme 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 XXX: rule 22 Relevant Superannuation Scheme. Under that rule, an individual is assessed as having a Class A, Class B or Class C incapacity for civil employment. The Relevant Superannuation Scheme 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 Relevant Superannuation Scheme Rules. 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 Relevant Superannuation Scheme Rules. However, no invalidity pension is payable to a person whose incapacity for civil employment is classified as Class C: rule 31 Relevant Superannuation Scheme Rules. 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 Relevant Superannuation Scheme Rules sets out the rules for the calculation of the employer benefit for some members, including a person who is retired from the XXX because of invalidity. Schedule 5 to the Relevant Superannuation Scheme 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 Relevant Superannuation Scheme Rules require an individual to undergo periodical reviews of their level of incapacity for civil employment: rule 25 Relevant Superannuation Scheme Rules. The Relevant Superannuation Scheme 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 Relevant Superannuation Scheme Rules. However, an individual who has reached the age of 55, cannot be reclassified to Class C incapacity for civil employment: subrule 23(2) Relevant Superannuation Scheme Rules. Upon becoming entitled to receive an invalidity pension under the Relevant Superannuation Scheme, an amount equal to the funded employer benefit is paid by the YYY to the Commonwealth and the invalidity pension is payable to the individual by the Commonwealth from the Relevant Fund: section 13 Relevant Superannuation Scheme. 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 YYY an amount equal to the individual's funded employer benefit: section 15 Relevant Superannuation Scheme. Since you commenced the pension in 2007-08 financial year you have advised that you were classified as having Class B incapacity for civil employment. In your application for this private ruling you have contended 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 relevant Super corporation are incorrect; and • the benefits you have received are not a defined benefit. In your application for this private ruling you also contended that the benefits you have received are employment termination payments of which the invalidity component should be tax free. Assumptions The YYY provided you with a Pay As You Go Payment Summary after the end of the 2008-09 income year, including later years, in which they will identify that your invalidity pension consists entirely of taxable component and will identify the amount of the taxable component that is the: • taxed element of the taxable component, and • untaxed element of the taxable component.

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 301-35 | Income Tax Assessment Act 1997 Section 301-40 | Income Tax Assessment Act 1997 Section 301-115 | Income Tax Assessment Act 1997 Section 301-120 | 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 307-145 | 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 Subregulation 1.06(1) Michael James Hammerton v Comcare Australia [1995] AATA 63 | Further issues for you to consider | Disability superannuation benefit | A superannuation benefit may be taxed less than set out above if it is 'disability superannuation benefit' as defined in subsection 995-1(1) of the ITAA 1997. A disability superannuation benefit is one that is paid to an individual because he or she suffers from ill-health (whether physical or mental) and 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. | In your case the additional tax concession only applies to a superannuation lump sum. The extra tax concession would arise because the superannuation lump sum would be deemed to have a tax free component (which is not taxed) and the untaxed element of the taxable component (which is taxed) would be reduced by the amount of the tax free component. The amount of tax free component is worked out using the formula in section 307-145 of the ITAA 1997. The formula takes into account the length of your service and the days until you would normally have been expected to retire. | You may apply for another ruling on these or any other matters. | Other relevant comments | Tax treatment of the invalidity pension payments that are superannuation income stream benefits | As you are under your preservation age of 57, the answers we have provided above mean that the tax treatment of the pension payments that are taxed as superannuation income stream benefits will be as follows: | • Any taxable component - untaxed element is assessable income (in accordance with section 301-120 of the ITAA 1997) | • Any taxable component - taxed element is assessable income. However, you are entitled to a tax offset equal to 15% of the taxable component - taxed element as the superannuation benefit you received is also a disability superannuation benefit (in accordance with section 301-40 of the ITAA 1997) | Tax treatment of the invalidity pension payments that are superannuation lump sums | This is applicable where you make an election under regulation 995-1.03 of the ITAR before a particular payment is received (see question 4 of the private ruling). | As you are under your preservation age of 57, the answers we have provided above mean that the tax treatment of the pension payments that you elect to have taxed as superannuation lump sums will be as follows: | • The amount of the tax-free component of the lump sum will be increased as the superannuation benefit you received is also a disability superannuation benefit (in accordance with section 307-145 of the ITAA 1997) | • Any taxable component - untaxed element is assessable income. However, you are entitled to a tax offset that ensures the rate of income tax on the taxable component - untaxed element does not exceed 30% provided that the amount does not exceed your untaxed plan cap amount for the superannuation plan at the time you receive the benefit (in accordance with section 301-115 of the ITAA 1997). | • Any taxable component - taxed element is assessable income. However, you are entitled to a tax offset that ensures that the rate of income tax on the taxable component - taxed element does not exceed 20% (in accordance with section 301-35 of the ITAA 1997).

Reasons for decision: Summary: Are the payments of the invalidity pension paid to you under the rules of the Relevant Superannuation Scheme (XXXX) established by trust deed under the Relevant Benefits Act 1991 (XXXX) superannuation benefits as that term is defined in section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? Yes | Detailed Reasoning - 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 that subsection 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 Relevant Superannuation Scheme 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 XXX, 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 (DFRDB Act). That Act also provides for certain invalidity benefits to retired service personnel. Section 125 of that Act, 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 Relevant Superannuation Scheme invalidity pensions are superannuation benefits as defined in section 307-5 of the ITAA 1997. | Detailed Reasoning - Question 2: If yes to the previous question, are the payments of the invalidity pension paid to you excluded by section 307-10 of the ITAA 1997 from the definition of superannuation benefit in section 307-5 of the ITAA 1997? | Detailed Reasoning - Answer 2: No | Detailed Reasoning - Reasons: Paragraph 307-10(a) of the ITAA 1997 excludes from the definition of 'superannuation benefit' amounts payable under an income stream because of the person's temporary inability to engage in gainful employment. The Relevant Superannuation Scheme invalidity pension is paid because a member is retired from the XXX 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 Relevant Superannuation Scheme occurs when there is a permanent, not temporary incapacity. An individual's degree of incapacity must be such that first, the individual is retired from the XXX. Secondly, the degree of incapacity that is necessary for an individual to be paid an invalidity pension is such that it has diminished the individual's capacity to undertake the kinds of civil employment which a person with the vocational, trade and professional skills, qualifications and experience the particular individual has and that they might reasonably undertake: see for example, rules 22 and 23 of the Relevant Superannuation Scheme Rules. We consider the Relevant Superannuation Scheme invalidity payments do not relate to temporary disability or temporary incapacity and they are therefore not excluded from being superannuation benefits by paragraph 307-10(a) of the ITAA 1997. | Detailed Reasoning - Question 3: If no to the previous question, does the invalidity pension constitute a superannuation income stream as that term is defined in section 307-70 of the ITAA 1997 and regulation 995-1.01(1) of the Income Tax Assessment Regulations 1997 (ITAR)? | Detailed Reasoning - Answer 3: Yes | Detailed Reasoning - 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 relevantly '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 Relevant Superannuation Scheme 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 SIS Act in accordance with subregulation 1.06(1) of the Superannuation Industry (Supervision) Regulations 1994 or 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 Relevant Superannuation Scheme amounts to such a series of fortnightly payments. Having examined the terms under which the invalidity pension is payable under the Relevant Superannuation Scheme and Relevant Superannuation Scheme, 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 Relevant Superannuation Scheme 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 benefits paid from their superannuation fund are 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. | Detailed Reasoning - Question 4: If yes to the previous question, 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? | Detailed Reasoning - Answer 4: Yes | Detailed Reasoning - 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 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 Relevant Superannuation Scheme 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 Relevant Superannuation Scheme 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). Accordingly a person in receipt of a Relevant Superannuation Scheme invalidity pension may make an election under regulation 995-1.03 or the ITAR 1997 in respect of a payment provided they make the election before the payment from their pension is made. | Detailed Reasoning - Question 5: Is the invalidity pension payable to you under the rules of the Relevant Superannuation Scheme an employment termination payment? | Detailed Reasoning - Answer 5: No | Detailed Reasoning - 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 Relevant Superannuation Scheme invalidity pension meet the first of these two conditions, under paragraph (a) of section 82-135 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 paragraph 82-135(a) of the ITAA 1997. Further, paragraph 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 Relevant Superannuation Scheme invalidity pension. Consequently, all of the fortnightly pension payments received by you are also excluded from the definition of employment termination payment under paragraph 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. | Detailed Reasoning - Question 6: Is the invalidity benefit paid from the Relevant Superannuation Scheme paid in respect of an interest that is a defined benefit interest under section 291-175 of the ITAA 1997? | Detailed Reasoning - Answer 6: Yes | Detailed Reasoning - 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 Relevant Superannuation Scheme, 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 Relevant Superannuation Scheme is a defined benefit interest under subsection 291-175(1) of the ITAA 1997. Further, as a member of the Relevant Superannuation Scheme 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 Relevant Superannuation Scheme 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 but 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 YYY. 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.