HOUSE OF REPRESENTATIVES

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon. John Dawkins, M.P.)

Chapter 3 - Superannuation pensions and roll-over annuities

Summary of proposed amendments

Purpose of amendment:

•

To introduce a new 15% rebate on superannuation pensions paid from taxed superannuation funds and on annuities purchased wholly with rolled-over eligible termination payments (ETPs) to replace the existing rebate arrangements. The rebate will apply to all such superannuation pensions and roll-over annuities payable to taxpayers who are aged 55 or more, regardless of when the pension or annuity commenced to be payable.

•

To limit the undeducted purchase price (UPP) for rebatable superannuation pensions and rebatable ETP annuities to the post-June 1983 undeducted contributions.

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To include in the definition of an ETP the unused undeducted purchase price (UUPP) of a commuted superannuation pension or roll-over annuity and the UUPP of the residual capital value of a superannuation pension or roll-over annuity so that UUPP can be rolled-over.

•

To extend the meaning of pensions and annuities to ensure that appropriate tax treatment is given to allocated pensions and allocated annuities.

Date of Effect: The amendments extending the meaning of pensions and annuities apply to pension payments made after the date of Royal Assent and to annuities purchased after that date. The other changes apply from 1 July 1994.

Background to the legislation

Rebate on Superannuation Pensions and Roll-over Annuities

A rebate of tax is available under Subdivision AAB of Division 17 of Part III of the Income Tax Assessment Act 1936, comprising sections 159SJ to 159SY, in respect of superannuation pensions paid from taxed superannuation funds and annuities purchased wholly with rolled-over eligible termination payments (ETPs). The rebate applies to such pensions and annuities provided they first became payable after 1 July 1988 to a person aged 55 or more. The rebate is intended to be a quid pro quo for the fact that, from 1 July 1988, income tax is imposed on superannuation funds and on the superannuation business of life insurance companies and registered organisations.

The rebate applies to the post-June 1983 portion of the pension or annuity. The level of rebate depends on when the pension or annuity first becomes payable. If the pension or annuity is purchased with the roll-over of ETP moneys where the recipient had an option to take a pension or annuity at an earlier time, the level of rebate is based on the first payment date of the underlying pension or annuity. The rebate does not apply to that part of a superannuation pension covered by a section 159SS notice, which effectively allows a taxed superannuation fund to transfer tax on last minute contributions to the member, or to superannuation pensions paid from untaxed superannuation funds. The level of rebate for pensions and annuities which first commence to be payable after I July 1992 is 15% of the post-June 1983 proportion of the pension or annuity. These arrangements are very complex and in some cases produce anomalous results.

The Bill will repeal the existing rebate arrangements and replace them with a new simplified rebate. The rebate will apply to superannuation pensions paid from complying superannuation funds and to qualifying annuities (as defined in subsection 27A(1)) purchased wholly with rolled-over ETPs. The new rebate will apply to all pensions and annuities which:

•

are paid from a taxed source; either:

(a)

are received by taxpayers who are aged 55 or more, regardless of when the pension or annuity commenced to be payable; or

(b)

are death or disability benefits; and

•

are within the recipient's reasonable benefit limits (RBrs).

Therefore, if the pension or annuity commences to be paid before a taxpayer turns 55 years of age, the rebate will apply but only to pension and annuity payments made after the taxpayer turns 55. The rebate will also apply to pensions and annuities that commenced to be paid before 1 July 1988.

Pensions and annuities in excess of the RBLs can continue to be taken as non-rebatable pensions or annuities. Currently such amounts must be commuted and taken as a lump sum.

The level of rebate is 15% of the amount of the pension or annuity included in assessable income; that is, 15% of the pension received less the deductible amount. However, the rebate will not apply to superannuation pensions covered by a section 15955 notice (which has the effect of transferring the liability on taxable employer contributions from the superannuation fund to the member) or to superannuation pensions paid from an untaxed source.

Definition of Undeducted Purchase Price

Section 27H includes in assessable income the whole of any superannuation pension or annuity reduced by the deductible amount. The deductible amount is, broadly speaking, the undeducted purchase price (UPP) divided by the term of the pension or annuity. UPP is defined in subsection 27A(1) to mean the sum of:

•

so much of the purchase price of the pension or annuity made prior to 1 July 1983 for which the taxpayer did not get a tax deduction or a rebate; plus

•

so much of the purchase price of the pension or annuity made after 1 July 1983 for which the taxpayer did not get a tax deduction (ie, undeducted contributions). However, if the pension or annuity is purchased with a rolled-over ETP, the UPP does not include the post-June 1983 component of the rolled-over ETP.

Purchase price is defined in subsection 27A(1) to mean, in relation to a superannuation pension, contributions made to a superannuation fund to obtain the pension and, in relation to an annuity, amounts paid to purchase the annuity. However, superannuation contributions made by an employer, or by an another person under an agreement with the employer, are not included in the purchase price of a superannuation pension. Similarly, amounts paid by an employer, or by another person under an agreement with the employer, to purchase an annuity are not included in the purchase price of an annuity (subsection 27A(5C)).

A major problem resulting from the current definition of UPP is that, generally speaking, the definition results in a higher UPP for an immediate annuity purchased with a rolled-over ETP than for a superannuation pension of the same amount. Therefore, a person with a superannuation pension entitlement can often increase their UPP by commuting that entitlement and rolling-over the resulting ETP to purchase another superannuation pension or an immediate annuity.

It is proposed to amend the definition of UPP so that, for rebatable superannuation pensions and rebatable ETP annuities that first commence to be payable after July 1994, UPP will be contributions made after 30 June 1983 for which the taxpayer did not get an income tax deduction (ie, undeducted contributions). Therefore, the UPP for both rebatable superannuation pensions and rebatable ETP annuities will be limited to the undeducted contributions component of an ETP.

Unused Undeducted Purchase Price

Unused Undeducted Purchase Price (UUPP) is defined in subsection 27A(1) to mean essentially UPP reduced by any amount that has been used up as deductible amounts in respect of pension or annuity payments in terms of section 27H. An ETP received on commutation of a pension or annuity, or representing the residual capital value of a pension or annuity, is reduced by UUPP (see definition of ETP in subsection 27A(1)). However, unlike the undeducted contributions component of an ordinary ETP (which has essentially the same character as UUPP, being a return of capital which has not received any tax concession), UUPP cannot be rolled-over.

To remove the distinction between the treatment of undeducted contributions and UUPP it is proposed to amend the definition of an ETP in subsection 27A(1) so that UUPP is no longer excluded from an ETP received on the commutation, or as the residual capital value, of a pension or annuity. UUPP will be included in the definition of undeducted contributions and, consequently, can be rolled-over.

Definition of Pension and Annuity

In the Treasurer's 'Security in Retirement - Planning for Tomorrow Today' statement it was announced that minimum standards for pensions and annuities will be introduced. Those standards are included as part of the proposed amendments to the Occupational Superannuation Standards Act 1987 (OSS Act) outlined in Chapter 7.

One of the fundamental purposes of developing minimum standards for pensions and annuities is to provide guidelines for certain products on the market which are account based and provide variable income streams. These products are commonly referred to as allocated (or variable) annuities and allocated pensions. Allocated annuities are not annuities within the common law meaning of that term. Taxation Ruling IT2480 outlines the features of an annuity and indicates that allocated annuities are not acceptable for income tax purposes. In addition, it is questionable whether allocated pensions are pensions within the ordinary meaning of that term because they are account based and are not payable for life. All the risk with such products lies with the investor rather than with the pension provider.

Therefore, it is proposed to amend the Income Tax Assessment Act to ensure that allocated pensions and allocated annuities which satisfy the minimum standards for pensions and annuity:

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are taxed as pensions and annuities in the recipient's hands;

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qualify as rebatable ETP annuities or rebatable superannuation pensions; and

•

are appropriately taxed in the hands of the providers.

Explanation of proposed amendments

Rebate on Superannuation Pensions and Roll-over Annuities

A new rebate will apply to certain superannuation pensions and annuities. A rebatable superannuation pension will be a superannuation pension paid from fund which is a complying superannuation fund at the time the pension first became payable. The rebate will also apply to pensions which commenced to be paid before 1 July 1988 from funds which, at the time the pension first became payable, were the equivalent of a complying superannuation fund. In addition, the pension must not be first payable to the trustee, in their capacity as trustee, of the fund paying the pension. This condition is necessary because annuity policies vested in the trustee of a superannuation fund are included in the

definition of superannuation pension so that payments under such policies in respect of fund members are treated as pensions rather than annuities [Clause 19, subsection 159SJ(1)].

Superannuation pensions paid from untaxed superannuation funds are not rebatable (subsection 159SM(2)) Nor are superannuation pensions covered by a notice from the fund transferring the tax liability on last minute employer contributions from the fund to the member, ie section 159SS notices [Clause 22, new subsection 159SM(1)].

A rebatable ETP annuity is a qualifying annuity (as defined in subsection 27A(1)) purchased wholly with a rolled-over ETP. In addition, the annuity must not be a superannuation pension. This ensures that the definitions of rebatable superannuation pension and rebatable ETP annuity do not overlap in the case of those annuities which are vested in the trustee of a superannuation fund and which are deemed to be pensions [Clause 19, subsection 159SJ(1)].

The new rebate will apply to rebatable 27H amounts. A rebatable 27H amount is the amount of the pension or annuity which is included in the recipient's assessable income under section 27H where the recipient is aged 55 or more, regardless of when the pension or annuity commenced to be payable. If the recipient turns 55 years of age during the year of income, it is only that amount of the pension or annuity that is attributable to payments after the recipient's 55th birthday that qualifies for the rebate [Clause 19, subsection 159SJ(1)].

Example

Hugo retired from employment at age 50 and immediately became entitled to receive a pension from his employer's complying superannuation fund. Hugo turns 55 years of age on 15 August 1994. He received assessable pension payments of $3 500 in respect of the period from 1 July 1994 to 15 August 1994. Hugo's assessable pension for the 1994-95 year of income is $32 000. Therefore, $28 500 of the pension is attributable to payments after Hugo's 551h birthday and qualifies as a rebatable 27H amount.

A rebatable 27H amount also includes a death and disability benefit. It is proposed to change the definition of a death and disability benefit so that a person is considered to be disabled if 2 legally qualified medical practitioners certify that the disability is likely to result in the person being unable ever to be employed in a capacity for which they are reasonably qualified because of education, training or experience. This changes places the onus of establishing disability on to legally qualified medical practitioners rather than the fund trustee and is consistent with the definition of a disability superannuation pension in the RBL provisions (see section 140C) [Clause 19, subsection 1595J(1)].

The rebate of tax for rebatable superannuation pensions is worked out using the formula:

Reduced 27H amount * Rebatable proportion of pension * 15%


The reduced 27H amount is the rebatable 27H amount reduced by the amount of pension covered by section 15955 notices [Clause 22, new subsection 159SM(1)].

The rebate for rebatable ETP annuities is worked out using the formula:

Reduced 27H amount * Rebatable proportion of annuity * 15%


[Clause 24, new section 159SU]

The rebatable proportion of the pension or annuity is the factor worked out under new section 140ZQ, which is contained in the RBL provisions. The Commissioner of Taxation will determine the rebatable proportion of a pension or annuity when making an RBL determination in relation to the pension or annuity and will notify the recipient accordingly. [New subparagraphs 140R(1)(d)(ii) and 140 T(1) (d) ai)]

The rebatable proportion is 1 if the rebatable superannuation pension or rebatable ETP annuity:

•

does not count towards the recipient's RBL; or

•

is not an amount in excess of the recipient's RBL.

[New subsection 140ZQ(1)]

The rebatable proportion is 0 if: the payer has notified the Commissioner that the superannuation pension or annuity is payable and the Commissioner has not made a final RBL determination in relation to the pension or annuity;

•

the whole of the rebatable superannuation pension or rebatable ETP annuity is in excess of the recipients RBL; or

•

the recipient's tax file number is not notified to the Commissioner [New paragraph 140T(2)(b)].

[New subsections 140ZQ(2) and 140ZQ(3)1

If part of the rebatable superannuation pension or rebatable ETP annuity is excessive, the rebatable proportion is worked out using the formula:

(RBL amount- Excessive amount) / RBL amount


where:

•

the RBL amount is the amount worked out in new sections 140ZH to 140ZN; and

•

the excessive amount is that part of the RBL that the Commissioner has determined to be in excess of the RBLs.

[New Subsection 140ZQ(4)]

Example

Victor is entitled to an assessable superannuation pension of $85 000 per annum. No part of the pension is covered by a section 159SS notice. The capital value of that pension for RBL purposes is $1 000 000. The RBL amount is $800 000. Therefore the excessive amount is $200 000. The rebatable proportion of the pension will be:

($1 000 000 - $200 000) /$1 000 000 = 80%


Victor will be entitled to a rebate of tax of:

$85000 * 80% * 15% =$10200


The proposed amendments remove a significant number of complex provisions in the Subdivision which are no longer relevant for the purpose of working out the new rebate entitlements. However, some of these provisions are relevant to the pre-July 1988 funding credit provisions which apply to exempt superannuation funds from tax on certain superannuation contributions. The proposed amendments therefore re-locate and re-order the existing section 1595L, together with some associated definitions, to Part IX [New section 275C].

Definition of Undeducted Purchase Price

The proposed amendments will replace the definition of undeducted purchase price (UPP). The UPP will remain unchanged for:

•

superannuation pensions and annuities which do not qualify for the new rebate; and

•

superannuation pensions and annuities which are paid in respect of a period that commences before 1 July 1994.

In these circumstances UPP is the sum of:

•

so much of the purchase price of the pension or annuity that was paid before 1 July 1983 and did not receive a tax deduction or rebate; and

•

so much of the purchase price of the pension or annuity that was paid after 1 July 1983 and did not qualify for a deduction reduced, in the case of a pension or annuity purchased with a rolled-over ETP, by the post-June 83 component of the ETP.

The UPP for rebatable superannuation pensions and rebatable ETP annuities that are paid in respect of a period which commences after 1 July 1994 will be limited to so much of the purchase price of the pension or annuity that was paid after 30 June 1983 which did not qualify for a deduction reduced, in the case of a pension or annuity purchased with a rolled-over ETP, by all the components of the ETP other than the undeducted contributions

[Section 27A(1)].

Example

Harriet received an ETP of $500 000 on 1 August 1994. $50 000 of the ETP is undeducted contributions. Harriet rolls-over the whole of the ETP to purchase an annuity. UPP will be limited to the undeducted contributions of $50 000.

Unused Undeducted Purchase Price

The proposed amendments remove the exclusion of UUPP for ETPs representing the commutation or residual capital value of a pension or annuity. Consequently UUPP is part of the ETP and can be rolled-over.

The amendments also insert a new definition of undeducted contributions to include UUPP in the undeducted contributions component of an ETP [Section 27A(1)].

It is also proposed to amend subsection 27AB(3) which is used to determine the taxed element of the post-June 83 component of an ETP payable as the result of the death of a taxpayer. The proposed changes to include UUPP as part of the ETP mean that the existing subparagraph 27AB(3)(b)(i) is no longer necessary. The amendments therefore remove the existing subparagraph 27AB(3)(b)(i) [New paragraph 27AB(3)(b)I.

Definition of Pensions and Annuities

It is proposed to insert a definition of pension and annuity in relevant provisions of the Act to ensure that pensions and annuities which satisfy the minimum standards outlined in the OSS Act are recognised as pensions and annuities for income tax purposes.

To ensure that allocated annuities can only be purchased with ETP moneys, it will be necessary to introduce Income Tax Regulations to specify annuity standards which must be satisfied for annuities to qualify as eligible annuities for the purposes of subsection 27A(1). It is expected that the necessary Regulations will be introduced shortly after the Bill receives Royal Assent.

As a result of these changes allocated pensions and allocated annuities will be taxed as pensions or annuities in the hands of the recipient. That is, such products will be assessable as pensions and annuities under section 27H. The deductible amount for the purposes of section 27H of pensions and annuities which are not payable for a specified period will be based on the life expectancy of the recipient or, in the case of a reversionary pension or annuity, the life expectancy of the recipient or the reversionary recipient, whichever is longer. Allocated pensions and allocated annuities will also qualify as rebatable superannuation pensions or rebatable ETP annuities.

The changes to section 221A ensure that appropriate tax instalment deductions are made from allocated pensions and allocated annuities.

The amendments also ensure that the providers of allocated pensions and allocated annuities receive appropriate tax treatment.