Private ruling: Tax treatment of invalidity pensions
Date of advice: 31 March 2017
Published: September 2017
Ruling period: Income year ending 30 June 2017 | Income year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Are the payments of the invalidity pension paid to you under the rules of the Military Superannuation and Benefits Scheme (MSBS) established by trust deed under the Military Superannuation and Benefits Act 1991 (MSBA) superannuation benefits as that term is defined in section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | 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.

Relevant facts and circumstances: As a member of the ADF, you became a member of the MSBS. The MSBS is a scheme which was established to provide benefits that are payable when an individual retires from the ADF. Amongst other things, the MSBS 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 MSBS 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: rule 22 MSBS Rules. Under that rule, an individual is assessed as having a Class A, Class B or Class C incapacity for civil employment. The MSBS 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 MSBS 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 MSBS Rules. However, no invalidity pension is payable to a person whose incapacity for civil employment is classified as Class C: rule 31 MSBS 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 MSBS Rules sets out the rules for the calculation of the employer benefit for some members, including a person who is retired from the ADF because of invalidity. Schedule 5 to the MSBS 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 MSBS Rules require an individual to undergo periodical reviews of their level of incapacity for civil employment: rule 25 MSBS Rules. The MSBS 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 MSBS Rules. However, an individual who has reached the age of 55, cannot be reclassified to Class C incapacity for civil employment: subrule 23(2) MSBS Rules. Upon becoming entitled to receive an invalidity pension under the MSBS, an amount equal to the funded employer benefit is paid by the CSC to the Commonwealth and the invalidity pension is payable to the individual by the Commonwealth from the Relevant Revenue Fund: section 13 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 MSBA. The CSC is currently withholding amounts from your invalidity pension on the basis that each fortnightly payment of the pension is a superannuation income stream benefit that you are liable to include in your assessable income. You are under your preservation age. 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 subsection 307-5(1) Income Tax Assessment Act 1997 section 307-10 Income Tax Assessment Act 1997 paragraph 307-10(a) Income Tax Assessment Act 1997 paragraph 307-70 Income Tax Assessment Act 1997 section 307-145 Income Tax Assessment Act 1997 subdivision 307-B Income Tax Assessment Act 1997 subsection 995-1(1) Income Tax Assessment Regulations 1997 subregulation 995-1.01(1) Income Tax Assessment Regulations 1997 subregulation 995-1.01(2) Income Tax Assessment Regulations 1997 regulation 995-1.03 Income Tax Assessment Regulations 1997 subparagraphs 995-1.03(a)(i)-(iv) Superannuation Industry (Supervision) Act 1993 section 10 Superannuation Industry (Supervision) Regulations 1994 subregulation 1.06(1)


Reasons for decision: Detailed Reasoning - Question 1: Are the payments of the invalidity pension paid to you under the rules of the Military Superannuation and Benefits Scheme (MSBS) established by trust deed under the Military Superannuation and Benefits Act 1991 (MSBA) superannuation benefits as that term is defined in section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Detailed Reasoning - Answer 1: 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 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 (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 Relevant 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. | 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 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's degree of incapacity must be such that first, the individual is retired from the ADF. 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 MSBS Rules. We consider the MSBS 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 MSBS pensions are superannuation income streams, an 'income stream' 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 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. | 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 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). Accordingly a person in receipt of an MSBS 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.