House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 2 - Taxation of benefit payments and employment termination payments

Outline of chapter

2.1 This chapter makes some minor additions to the law to clarify or complement the operation of the superannuation benefit taxation provisions in the Tax Laws Amendment (Simplified Superannuation) Bill 2006 (main Bill). For example, tax withholding and payment summary requirements are clarified, now that superannuation benefits paid from a taxed source to a person aged 60 or over will be tax-free.

2.2 It also covers the abolition of the old superannuation benefit taxation law, including reasonable benefit limits (RBLs) and the concept of eligible termination payments (ETPs).

2.3 Updates to references in other Acts to repealed superannuation benefit taxation law are also covered, to clarify policy intent going forward.

Additions to the law created by the main Bill

Withholding arrangements

2.4 Superannuation funds are no longer required to withhold tax from superannuation benefits paid from a taxed source to a person aged 60 or over, or provide payment summaries to these individuals. The withholding and payment summary requirements for other wholly not assessable not exempt (ie, tax-free) payments are also removed to minimise compliance costs. [Schedule 1, item 373; Schedule 3, items 63 to 65]

2.5 In addition, the child support legislation is amended to ensure that these amendments do not result in any change to the sources of funds from which child support can be collected. [Schedule 3, items 4 to 7]

Cashing of death benefits

2.6 Under Simplified Superannuation , from 1 July 2007, superannuation pensions are no longer able to revert to a non-dependant on death; rather, death benefit payments to non-dependants must be made as lump sums. The governing rules of a superannuation fund must not allow the benefits of a deceased member to be cashed otherwise than in accordance with the regulations. The regulations override and invalidate the governing rules of a fund to the extent of any inconsistency with the regulations. [Schedule 1, items 279 and 361]

Superannuation guarantee opt out provisions

2.7 Currently, employees with accumulated superannuation entitlements in excess of the pension RBL may elect not to receive superannuation contributions from their employers. As RBLs are abolished, from 1 July 2007, these elections will no longer be able to be made. As these elections were irrevocable, existing elections will remain in force. [Schedule 1, items 349 and 350]

Superannuation and bankruptcy

2.8 Currently, under the Bankruptcy Act 1966 , a bankrupt's interest in a superannuation fund up to the bankrupt's pension RBL is protected from being divisible amongst creditors. A bankrupt's superannuation interest in excess of the pension RBL automatically vests in the bankruptcy trustee.

2.9 The amendments remove references to RBLs from the Bankruptcy Act 1966 to ensure consistency with the new Simplified Superannuation rules which abolish RBLs with effect from 1 July 2007. This means that, from 1 July 2007, a bankrupt's entire interest in a superannuation fund is protected from being divisible amongst creditors. [Schedule 3, item 1]

2.10 Related provisions in the Bankruptcy Act 1966 that set out methods of apportionment and valuation of the interest of the bankrupt in the fund, for the purposes of the vesting provisions, are also removed. [Schedule 3, item 2]

2.11 The above protection provided to superannuation interests is subject to new provisions contained in the Bankruptcy Legislation Amendment (Superannuation Contributions) Bill 2006, introduced into Parliament on 6 December 2006. The Bankruptcy Bill amends the Bankruptcy Act 1966 to provide that bankruptcy trustees can recover superannuation contributions made on or after 28 July 2006 with the intention to defeat creditors. For further details, see the explanatory memorandum to the Bankruptcy Legislation Amendment (Superannuation Contributions) Bill 2006.

2.12 The amendments in this Bill take into account changes to the wording of provisions that will be made by the Bankruptcy Bill and will apply from 1 July 2007. [Schedule 3, items 1 to 3]

2.13 In addition, amendments in this Bill clarify that amounts paid out of a superannuation fund pursuant to provisions in the Bankruptcy Bill are not subject to further taxation. [Schedule 3, item 37, paragraph 307-10(ab) of the Income Tax Assessment Act 1997]

Tax rates

2.14 Under Simplified Superannuation , amounts received as superannuation benefits in excess of the untaxed plan cap and amounts received as employment termination payments in excess of the employment termination payment cap, are taxed at the top marginal tax rate (plus the Medicare levy) to ensure the tax concessions provided to superannuation are targeted appropriately.

2.15 Amounts to be taxed at the top marginal tax rate (plus the Medicare levy) are classed as special types of taxable income - the superannuation remainder of taxable income and the employment termination remainder of taxable income. [Schedule 1, items 3, 6, 7, 9, 14, 16, 17, 20, 22 to 24, 33 and 34 of the Income Tax Rates Amendment (Superannuation) Bill 2007]

Property transfers

2.16 A superannuation lump sum can be (or include) a transfer of property. If the superannuation lump sum is a transfer of property, the value of the benefit is the market value of the property. The market value is reduced by the value of any consideration given for the transfer of the property. The definition of 'market value' is contained in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997). [Schedule 3, item 10]

2.17 The provisions ensuring that an employment termination payment can be a transfer of property are clarified to ensure that all, or part, of the payment can be a transfer of property. [Schedule 3, items 8 and 9]

Other amendments

2.18 A number of other amendments have been made to provisions introduced by the main Bill to clarify the provisions and to better reflect the policy intent. These amendments:

•

restrict the ability to treat contributions as untaxed benefits, if they are paid out within a year, to public sector superannuation schemes in existence before 5 September 2006 [Schedule 3, items 38 to 41];

•

ensure the $1 million limit on the amount of a transitional employment termination payment that can be rolled over into superannuation is reduced by the taxable component of every transitional employment termination payment made, rather than the entire amount of the payment [Schedule 1, item 269, section 306-10 of the Income Tax (Transitional Provisions) Act 1997];

•

clarify references to an inability to perform normal employment duties for the purposes of temporary disability payments to ensure these payments can be made to the self-employed [Schedule 3, item 36];

•

ensure that roll-overs within the same superannuation plan are not counted against the untaxed plan cap [Schedule 1, item 225; Schedule 3, item 44];

•

apply the new pension arrangements to recipients of an income stream from a taxed source who are already over the age of 60 as at 1 July 2007 [Schedule 1, item 270];

•

clarify the method for calculating the tax-free component of an income stream that is commuted [Schedule 1, item 271];

•

recognise that income streams which commenced before 1 July 1994 already receive pre-July 1983 amounts tax-free [Schedule 1, item 272];

•

clarify the method statement determining what portion of the taxable component of a lump sum payment from a public sector superannuation scheme is an element untaxed in the fund [Schedule 3, items 42 and 43]; and

•

clarify the note to subsection 305-65 of the ITAA 1997 as the concept of a vested amount is not relevant to lump sums received within six months after Australian residency [Schedule 1, item 224].

2.19 The remaining provisions introduced by the main Bill ensure that the correct tax treatment applies to a range of payments. Specifically:

•

benefits (including non-cash benefits) received from superannuation funds in breach of statutory requirements are taxed at marginal rates [Schedule 3, item 35];

•

amounts released pursuant to transitional release authorities are tax-free up to the amount specified in the release authority and assessable income if above that amount [Schedule 1, items 219 and 269, section 304-15 of the Income Tax (Transitional Provisions) Act 1997];

•

foreign and Australian superannuation arrangements which have certain grandfathered arrangements applied under current law maintain their existing taxation treatment [Schedule 1, items 41, 51 to 56, 220, 221, 267 and 268; Schedule 3, item 37, paragraph 307-10(a) of the ITAA 1997];

•

amounts transferred from foreign superannuation schemes continue to be taxed in the same way as if they were paid from a foreign superannuation fund [Schedule 1, items 222 and 223];

•

employee share scheme payments are excluded from being employment termination payments [Schedule 1, items 184 and 185]; and

•

the deemed dividend exclusion is expanded so that amounts that are a deemed dividend under any provision of the Income Tax Assessment Act 1936 (ITAA 1936) or the ITAA 1997 are excluded from being an employment termination payment [Schedule 1, item 183].

Consequential amendments

Repeals

2.20 The existing provisions imposing tax on superannuation benefits, including RBLs and the previous rebate for superannuation pensions, are repealed. This removes significant complexity from the taxation arrangements that apply to superannuation benefits. [Schedule 1, items 2 to 4, 6, 7, 181 and 405]

2.21 The existing provisions imposing tax on employment termination payments are also repealed. The tax treatment of these payments is currently linked to the tax treatment of superannuation lump sums. [Schedule 1, items 2 to 4, 6 and 7]

2.22 In both cases, existing provisions which are retained in the new regime are rewritten in a simplified and modernised form to improve the readability of the law.

Changes to cross-references

Pensions and annuities

2.23 Currently, section 27H of the ITAA 1936 includes amounts of annuities or superannuation pensions in assessable income. From 1 July 2007 revised taxation arrangements apply to Australian-sourced superannuation income streams, but section 27H continues to apply to other income streams (including foreign sourced benefits and non-superannuation annuities). There is no intention to modify the operation of this provision for foreign-sourced benefits or non-superannuation annuities. [Schedule 1, items 59 to 64, 226 and 227]

2.24 Definitions for 'residual capital value', 'undeducted purchase price' and 'purchase price' are inserted into section 27H. These definitions are based on the existing definitions in subsection 27A(1) of the ITAA 1936 which are repealed. [Schedule 1, items 65 to 68]

2.25 References to the taxation treatment, or definition, of pensions and annuities are updated to reflect the new provisions in the ITAA 1997 and the updated provisions in section 27H of the ITAA 1936. [Schedule 1, items 10 to 12, 20, 90, 92 to 97, 239, 241, 247, 248 and 367 to 369]

Eligible termination payments (ETPs)

2.26 The previous ETP concept covered lump sum payments both from superannuation entities and those arising from employment arrangements. The previous concept is now covered by two new concepts - a 'superannuation lump sum', which covers such payments from superannuation entities, and an 'employment termination payment', which refers to those instances where a payment is made, otherwise than from a superannuation fund, in consequence of the termination of employment.

2.27 In some instances references to ETP are updated to refer to both new concepts. [Schedule 1, items 20, 37, 81 to 83, 91, 92, 96, 144, 176, 180, 182, 246, 249, 367 to 369 and 377]

2.28 Where the application of the law is clearly intended to only apply to certain types of 'eligible termination payment', only the relevant term is substituted. [Schedule 1, items 17 and 97]

2.29 As well as updating references to ETPs, the provisions ensuring capital gains tax (CGT) does not apply to superannuation lump sums and employment termination payments, are consolidated into the CGT provisions of the ITAA 1997. [Schedule 1, items 194 and 197]

2.30 In addition, references to 'rolled over amounts', 'retained amounts' and other similar terms are updated to reflect the new arrangements under which employment termination payments can not be rolled over into superannuation (with a limited exception for certain entitlements as at 9 May 2006). The existing meaning of 'rolled over amounts' is maintained for provisions which refer to events occurring prior to 1 July 2007. [Schedule 1, items 237, 238, 240, 257, 269, 351 and 375; Schedule 3, item 51]

Terminology describing other payments

2.31 Some defined terms were omitted in the rewrite of the superannuation provisions into the ITAA 1997, with the substance of the defined term instead spelled out in the operative rule. The affected terms are 'eligible resident non-complying superannuation fund', 'eligible non-resident non-complying superannuation fund', 'exempt non-resident foreign termination payment' and 'exempt resident foreign termination payment'. [Schedule 1, items 20, 43 to 46, 135 and 136]

2.32 From 1 July 2007, the 'upper limit' calculated under section 159SG of the ITAA 1936 ceases to have effect. This threshold set the amount of a payment taxed at zero per cent where the recipient of an ETP was aged 55 or over. Where provisions not related to the taxation of lump sums:

•

relied on this reference to provide them with a value, the reference has been updated to the relevant new concept, the 'low rate cap amount' [Schedule 1, items 13 to 15]; or

•

modified the treatment of income which is taxed at zero per cent, the reference has been updated to reflect income to which this tax arrangement applies [Schedule 1, items 9 and 122].

2.33 Sections 26AC and 26AD of the ITAA 1936 dealt with the tax treatment of (and relevant definitions associated with) payments made in lieu of unused annual leave and unused long service on the termination of employment. References to these sections, or to the definitions of these types of leave, are updated to capture the relevant new provisions in the ITAA 1997. [Schedule 1, items 20, 73, 75, 80, 176, 180, 182, 246, 249, 346, 367 to 369 and 377]

2.34 Whilst the superannuation contributions surcharge has been abolished, members with surcharge debt accounts and members of untaxed superannuation schemes are liable for superannuation contributions surcharge when their superannuation benefit is paid. As a result, references to the new term 'superannuation benefit' are inserted into the Superannuation Contributions Tax (Assessment and Collection) Act 1997 and the Superannuation Contributions Tax (Members of Constitutionally Protected Superannuation Funds) Assessment and Collection Act 1997 . [Schedule 1, items 328 to 338]

Social security and Veterans' Affairs consequential amendments

2.35 A number of definitions in the Social Security Act 1991 and the Veterans' Entitlements Act 1986 are updated. [Schedule 1, items 289, 290, 395, 396 and 401]

2.36 The definition of 'residual capital value' is replaced. The residual capital value of an income stream is defined as the capital amount payable on the termination of the income stream. An account based income stream will not have a residual capital value. [Schedule 1, items 291, 293, 397 and 399]

2.37 The definition of 'superannuation fund' is updated to ensure that, for income support purposes, the concessional treatment of assets held in superannuation funds is restricted to Australian superannuation funds. In particular, the new definition ensures that a superannuation pension from a 'foreign superannuation fund' (formerly a 'non-resident superannuation fund') is assessable income under these Acts; but that no deductions are allowed. A corresponding amendment is also made to the definition of superannuation fund in the Veterans' Entitlements Act 1986 . [Schedule 1, items 292 and 398]

2.38 Both the general definition of 'liquid assets', and a similar definition for the purposes of the Financial hardship (Carer Payment), are updated to ensure that amounts which would otherwise be liquid assets are not liquid assets when they are either a roll-over superannuation benefit (within the meaning of the ITAA 1997), a superannuation lump sum that is a contributions-splitting superannuation payment or a directed termination payment (within the meaning of the Income Tax (Transitional Provisions) Act 1997 ). [Schedule 1, items 294 to 296]

2.39 In addition to updating definitions, the income maintenance period provisions contained in the various rate calculators are updated.

2.40 For certain social security payments, where a person receives a lump sum termination payment the amount is apportioned over the period it represents and is maintained as ordinary income for that period. Currently, where a person rolls over (as provided in the ITAA 1936) a termination payment into a certain type of fund or annuity, the amount is not maintained as ordinary income. These arrangements are maintained for directed termination payments (within the meaning of the Income Tax (Transitional Provisions) Act 1997 ).

2.41 Amendments are made to payments which are currently subject to the income maintenance period provisions: disability support pension (except for people who are permanently blind), newstart allowance, youth allowance, austudy, widow allowance, sickness allowance, partner allowance, mature age allowance and parenting payment. The amendments commence from 1 July 2007. It is not intended that any amount rolled over under the old rules prior to 1 July 2007 should be subject to the new rules and therefore counted as ordinary income upon commencement of the amendments. [Schedule 1, items 297 to 324]

Other consequential amendments

2.42 Other consequential amendments:

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update references to the superannuation and employment termination taxation provisions in the ITAA 1997 [Schedule 1, items 42, 47, 103, 105, 106, 140, 149, 244, 245 and 376];

•

insert or update definitions of commonly used terms in section 6 of the ITAA 1936 and section 995-1 of the ITAA 1997 [Schedule 1, items 26, 35, 36, 250, 251, 259 and 260];

•

update references to departing Australia superannuation payments or their taxation treatment [Schedule 1, items 38, 112, 113, 137 to 139, 370 to 372 and 374; Schedule 1, items 1 and 2 of the Income Tax Amendment Bill 2007];

•

update or omit a range of other definitions throughout a number of Acts [Schedule 1, items 145, 146 and 284 to 286];

•

update guide material in the ITAA 1997 [Schedule 1, items 151, 152, 155 to 158, 160, 161, 169 to 173 and 175]; and

•

technical corrections are made to improve the wording of some provisions in the main Bill and to remove incorrect references to employment termination payments in the definition of an 'early retirement scheme payment' [Schedule 4, items 1, 2, 4 to 6 and 9 to 11].

Application provisions

2.43 The amendments outlined in this chapter apply from on or after 1 July 2007, except for the social security and Veterans' Affairs amendments in paragraphs 2.35 to 2.38 (first four only) which apply from the 2007-08 and later income years. [Schedule 1, item 406; Schedule 3, item 66; Schedule 1, item 35 of the Income Tax Rates Amendment (Superannuation) Bill 2007]