Where a client is permanently incapacitated, the tax law provides a tax concession to increase the tax-free component of a superannuation lump sum that is a disability superannuation benefit. This increase is commonly referred to as the tax-free uplift and is based on the future service period assuming the member had continued working. The increase in the member’s tax-free component and decrease in the taxable component can potentially reduce the client’s tax liability when they access their super. The increase in the tax-free component can also be beneficial for estate planning purposes.
The tax-free uplift is something advisers are familiar with and the general understanding is that it can apply to a lump withdrawal or a rollover benefit where the trustee of the fund has received valid medical certificates from the permanently incapacitated member. However, FirstTech has recently received a number of queries indicating that some super funds only apply the tax-free uplift where a permanently incapacitated member takes a lump sum withdrawal, but not when they rollover their super benefit to a different fund. This article looks at whether the tax law allows the tax-free uplift to apply to a rollover super benefit.
What is a lump sum disability benefit?
Section 307-145 of the Income Tax Assessment Act 1997 (ITAA 1997) states that the tax-free uplift can apply if a super benefit is a superannuation lump sum and a disability superannuation benefit.
A super lump sum is defined in the tax law1 as 'a superannuation benefit that is not a superannuation income stream benefit' whereas a disability superannuation benefit is defined as a super benefit if:
a) the benefit is paid to an individual because he or she suffers from ill-health (whether physical or mental); and
b) two legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the individual can ever be gainfully employed2 in a capacity for which he or she is reasonably qualified because of education, experience or training.
In summary, a lump sum disability superannuation benefit definition can be met if a lump sum super benefit payment (ie not an income stream benefit) is paid to the individual member due to permanent incapacity and the client has provided two valid medical certificates to the trustee of the super fund. Where this definition is met, the trustee of the super fund that makes the lump sum payment is required by tax law to increase the tax-free component of the lump sum disability benefit based on the legislative formula stated in section 307-145 of the ITAA 1997.
When a medical certificate is considered valid?
The ATO indicated in ATO ID 2015/19 that a medical certificate can be valid if the lump sums are paid “over a short period of time” since the certificate’s issue date, so that the lump sum can be considered a disability superannuation benefit. However this ’short period of time' was not defined.
Accordingly, the validity of the medical certificate is generally subject to the super fund’s governing rules in terms of how recently a medical certificate must be issued by a qualified medical practitioner.
What’s the confusion?
To meet the lump sum disability superannuation benefit definition (so that the tax-free uplift can be applied) it requires the super fund to pay a super benefit to the individual member due to permanent incapacity.
Where a disabled client takes a lump sum withdrawal, the benefit is generally paid directly to the individual client. As long as the lump sum benefit is paid while the relevant medical certificates provided to the fund are valid (based on the fund’s governing rules), it can be reasonably clear that the lump sum disability superannuation benefit definition can be met.
In comparison, when the disabled member requests to rollover their super benefit to a different fund, the member’s super benefit is paid to the receiving super fund rather than to the individual member. We have seen some super funds' comments suggesting that because the rollover benefit is not paid directly to the individual member, the disability superannuation benefit definition cannot be met and therefore the tax-free component of the rollover benefit cannot be increased by the tax-free uplift formula. However, FirstTech’s view is that this interpretation is incorrect and the tax-free uplift can apply to a rollover super benefit while the medical certificates are valid.
Why can the tax-free uplift apply to a rollover super benefit?
For the tax-free uplift to apply, a rollover super benefit must be:
1) a super lump sum, and
2) a disability superannuation benefit.
Section 306-10 of the ITAA 1997 clearly states that a rollover benefit is a lump sum benefit, therefore the requirement to be a super lump sum is met.
As mentioned above, a benefit can only be a disability superannuation benefit if the benefit is paid to the individual due to permanent incapacity, supported by valid medical certificates. Although a rollover benefit is paid to the receiving super fund rather than the individual member, section 307-15 (2) of the ITAA 1997 (ie payments for your benefit or at your direction or request) states that a payment is treated as being made to the member, or received by the member, if it is made:
a) for the member’s benefit; or
b) to another person or to an entity, at the member’s direction or request.
Section 307-15 then noted that paragraph (b) would cover, for example, a direction by the member 'that a payment be rolled over from the original super fund into another super fund'.
Accordingly, a rollover benefit is deemed to be a lump sum benefit paid to the member due to the application of section 307-15. As long as the rollover benefit is paid while the client’s medical certificates provided to the trustee of the original fund are valid, the rollover benefit can meet the lump sum disability superannuation benefit definition, and the tax-free uplift can be applied to the rollover super benefit.
What’s the ATO’s view?
In the NTLG (National Tax Liaison Group) Superannuation technical subcommittee meeting held on 4 September 2007, the ATO confirmed that 'section 307-145 of the Income Tax Assessment Act 1997 (ITAA 1997) is used to calculate the tax free component of a lump sum superannuation benefit that meets the requirements for a disability superannuation benefit even if the lump sum is rolled-over to another superannuation provider.'
Therefore, our FirstTech team’s view is consistent with the ATO’s view indicated in the above statement that a rollover super benefit can meet the definition of a lump sum disability superannuation benefit if the rollover is paid while the relevant medical certificates are valid, and the tax-free up lift calculation can be applied to the rollover disability benefit.
Which fund should perform the tax-free uplift calculation - the original fund or the receiving fund?
When the receiving fund receives a rollover benefit, the receiving fund is not making a lump sum disability payment and therefore the receiving fund cannot perform the tax-free uplift calculation. The fund that pays the lump sum disability superannuation benefit (ie the original fund) is required to calculate the tax-free uplift.
Where the rollover benefit is a disability superannuation benefit supported by valid medical certificates, the original fund should calculate the increased tax-free component based on the future service period and include the modified tax-free and taxable components in the rollover benefits statement provided to the receiving fund (via SuperStream or paper statement if the original fund is not able to send information electronically).
What advisers should be aware of?
When a permanently disabled client requests to take a lump sum withdrawal or rolls over their super benefit to a different fund while the medical certificates are valid, it is important to confirm with the original fund that they will calculate the tax-free uplift based on the section 307-145 formula to increase the tax-free component before implementing the rollover.
If the disability superannuation benefit has already been rolled over to a new fund but the original fund did not perform the tax-free uplift calculation, it is important to check with the original fund to find out the reason that the tax-free uplift was not calculated. If the original fund misinterpreted the disability benefit definition, advisers may want to quote section 307-15 and the ATO’s confirmation contained in the September 2007 NTLG super subcommittee meeting minutes that the tax-free uplift can be applied to a rollover super benefit by the original fund. The original fund can still re-calculate the tax-free component and provide an updated rollover benefits statement including the increased tax-free component to the receiving fund, even if the rollover has already been completed.
Endnotes
1. Section 307-65 of the ITAA 1997
2. Section 995-1 of the ITAA 1997
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The information contained in this update is based on the understanding Avanteos Investments Limited ABN 20 096 259 979, AFSL 245531 (AIL) and Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468 (CFSIL) has of the relevant Australian laws as at the article date. As these laws are subject to change you should refer to our website at www.cfs.com.au or talk to a professional adviser for the most up-to-date information. The information is for adviser use only and is not a substitute for investors seeking advice. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person, including AIL, nor CFSIL, accepts responsibility for any loss suffered by any person arising from reliance on this information. This update is not financial product advice and does not take into account any individual’s objectives, financial situation or needs. Any examples are for illustrative purposes only and actual risks and benefits will vary depending on each investor’s individual circumstances. You should form your own opinion and take your own legal, taxation and financial advice on the application of the information to your business and your clients.
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