Senate

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)

CHAPTER 6 - Superannuation - various amendments to the income tax law

Overview

6.1 The amendments contained in Parts 4 to 7 of Schedule 3 and Part 5 of Schedule 10 of the Bill amend the Income Tax Assessment Act 1936 (ITAA) and the Taxation Laws Amendment (Superannuation) Act 1992 to clarify the operation of the law and overcome some technical anomalies relating to a range of superannuation matters.

6.2 This chapter explains the amendments as they affect the income tax law in relation to:

•

superannuation pensions and roll-over annuities (part 1);

•

employer superannuation contributions (part 2); and

•

rolling-over eligible termination payments (ETPs) received before 1 July 1994 (part 3).

Part 1 - Superannuation pensions and roll-over annuities

Summary of the amendments

Purpose of the amendments

6.3 The purpose of the amendments is to ensure that the taxation arrangements for superannuation pensions and roll-over annuities operate as intended so that:

•

the deductible amount of a life time superannuation pension or annuity is calculated based on life expectancy at the beginning of the period in respect of which the pension or annuity is payable; and

•

taxpayers in receipt of disability pensions prior to 1 July 1994 retain their entitlement to a rebate.

6.4 In addition, the amendments ensure that the undeducted purchase price (UPP) that applies to pensions and annuities purchased prior to 1 July 1994 will also apply to pensions and annuities purchased wholly with an ETP representing the commutation or residual capital value of a pension or annuity that commenced prior to 1 July 1994.

Date of effect

6.5 The first amendment applies from the date of introduction of the Bill. The remaining amendments will apply from 1 July 1994 as they clarify the operation of the income tax law and remove some anomalies.

Background to the legislation

6.6 A superannuation pension or annuity is included in assessable income under section 27H of the ITAA. The assessable amount of the pension or annuity is reduced by the deductible amount. Generally, the deductible amount is the UPP of the pension or annuity divided by the term the pension or annuity is expected to be payable.

6.7 In addition, pensions and annuities which are paid from a taxed source may qualify for a rebate of tax of 15% of the assessable pension or annuity. The rebate applies to pensions and annuities paid to a person who is aged 55 years or more or who is in receipt of a death or disability benefit.

6.8 The Bill makes amendments affecting:

•

the time the deductible amount is calculated;

•

retaining the UPP of pension and annuities that commenced to be payable prior to 1 July 1994; and

•

disability superannuation pensions.

Time the deductible amount is calculated

6.9 The deductible amount allowed under section 27H in respect of a life time pension or annuity is calculated on the basis of the life expectation factor of the recipient (or, in the case of a pension or annuity that continues to be payable to a dependant on the death of the recipient, the life expectation factor of the recipient or the reversionary beneficiary, whichever is longer). The life expectation factor is determined by the Australian Life Tables at the time the pension or annuity commences to be payable.

6.10 Section 27H applies to pensions and annuities payable after 30 June 1983. Pensions and annuities that first became payable before that date are entitled to a similar concession under the former section 26AA.

6.11 It has always been considered that the time a pension or annuity commences to be payable is the beginning of the period in respect of which the pension or annuity is payable.

6.12 However, recently some pension and annuity providers have argued that the deductible amount should be calculated at the time the first pension or annuity is actually paid. This alternative approach results in the use of a slightly shorter life expectancy, and hence a higher deductible amount, than the life expectancy at the commencement of the period in respect of which the pension or annuity is payable.

6.13 The purpose of the deductible amount concession is to allocate the capital value of the pension which has not received a tax concession during the accrual phase over the whole of the period that the pension or annuity is expected to be payable.

6.14 In addition, the determination of the deductible amount of a pension or annuity at the beginning of the period in respect of which the pension or annuity is payable is consistent with the determination of other factors relating to pensions and annuities. For example, from 1 July 1994 the following factors are all determined at the beginning of the period in respect of which the pension or annuity is payable:

•

the measurement of the pension or annuity for reasonable benefit limit purposes;

•

the calculation of the rebatable proportion of the pension and annuity; and

•

the calculation of the minimum and maximum payment levels for allocated pensions and annuities.

Retaining the UPP of pension and annuities that commenced to be payable prior to 1 July 1994

6.15 Another effect of the change in the definition of UPP is that the UPP for superannuation pensions purchased with a rolled-over ETP and roll-over annuities was reduced. That is, if such a pension or annuity commenced to be paid prior to 1 July 1994, the UPP consists of the whole of the ETP reduced by the post-June 1983 component of the ETP. If the pension or annuity commences to be paid after 30 June 1994, the UPP consists only of the undeducted contributions component of the ETP.

6.16 Therefore, taxpayers who have a superannuation pension purchased with a rolled-over ETP or a roll-over annuity that commenced to be payable prior to 1 July 1994 are to some extent locked into their current pension or annuity provider because, if they commute their pension or annuity entitlement and roll-over the resulting ETP to purchase a new pension or annuity, the new lower definition of UPP will apply to the new pension or annuity. That is, as a result of changing the pension or annuity provider the UPP will be reduced and a higher amount of the pension will be included in the taxpayer's assessable income.

Disability superannuation pensions

6.17 One of the changes made to the income tax law associated with the introduction of the new superannuation pension and roll-over annuity rebate provisions related to the conditions which apply to categorise a benefit as a disability pension.

6.18 A benefit qualified as a disability benefit in accordance with the previous definition of death and disability benefit in section 159SJ if the benefit was provided to the person because of the permanent disability of the person. The payer of the benefit (usually the trustee of the superannuation fund) had to be satisfied that the person was permanently disabled. The new test of disability requires certification by two legally qualified medical practitioners that the disability is likely to result in the person being unable ever to be employed in a capacity for which the person is reasonably qualified because of education, training or experience.

6.19 A problem which arises as a result of this change is the impact on pensions paid in circumstances which satisfied the previous test of disability but which fail to satisfy the new test of disability. Prior to 1 July 1994 those pensions would have qualified for a rebate on the post-June 1983 portion of the capital value of the pension. However, from 1 July 1994 a rebate will no longer be available in respect of those pensions.

6.20 In addition, disability pensions which commenced prior to 1 July 1994 may satisfy the new test of disability but recipients of such pensions will be forced to go to the cost and inconvenience of seeking appropriate certification from two legally qualified medical practitioners in order to continue their entitlement to a rebate.

Explanation of the amendments

Time the deductible amount is calculated

6.21 The definition of life expectation factor in subsection 27H(4) will be amended so that the deducible amount of a lifetime superannuation pension or annuity is determined at the beginning of the period to which the first payment of the pension or annuity relates. [Item 31]

6.22 The amendment will apply to superannuation pensions or annuities where the first payment of the pension or annuity is made after the date of introduction of the Bill. [Item 32]

6.23 The amendment will ensure that all pension and annuity providers will have to use the same basis for working out the deductible amount. In particular, people who receive pension or annuity payments 12 months in arrears, for example, will not receive an unjustifiable advantage over people who receive more regular payments.

Retaining the UPP of pension and annuities that commenced to be payable prior to 1 July 1994

6.24 Paragraph (a) of the definition of undeducted purchase price in subsection 27A(1) will be extended to include an annuity or superannuation pension that commences to be paid on or after 1 July 1994 provided that new section 27AAAA applies to the annuity or pension. That is, the UPP of such an annuity or pension will consist of the whole of the ETP rolled-over to purchase the annuity or pension reduced by the post-June 1983 component. [Items 39 and 40; new sub-subparagraph (a)(ii)(C) of the definition of undeducted purchase price in subsection 27A(1)]

6.25 An annuity or superannuation pension will come within new sub-subparagraph (a)(ii)(C) of the definition of UPP in section 27A(1) if:

•

the annuity or superannuation pension has one or more underlying commutation ETPs; and

•

the commencement day of each of those underlying commutation ETPs that is an original underlying commutation ETP was before 1 July 1994.

[Item 41; new subsection 27AAAA(1)]

6.26 New section 27AAAA only applies to annuities and superannuation pensions purchased with commutation ETPs. An ETP is a commutation ETP if it represents:

•

the commutation of the whole or a part of a superannuation pension or annuity (that is, a paragraph (d) or (g) ETP); or

•

the residual capital value of a superannuation pension or annuity (that is, a paragraph (e), (f), (h) or (j) ETP).

[Item 41; new subsection 27AAAA(2)]

6.27 The commencement day of an annuity or superannuation pension is the first day of the period to which the first payment of the annuity or pension relates. [Item 41; new subsection 27AAAA(6)]

6.28 A commutation ETP is an underlying commutation ETP if the purchase price of the current annuity or superannuation pension consists only of the whole or a part of the commutation ETP (or the whole or a part of two or more commutation ETPs). [Item 41; new paragraph 27AAAA(3)(a)]

6.29 Similarly, a commutation ETP is an underlying commutation ETP if this condition is satisfied in respect of another annuity or superannuation pension and that other annuity or pension gave rise to a commutation ETP that is subsequently an underlying commutation ETP of the current annuity or pension. That is, if a taxpayer has a series of annuities and pensions that are, in turn, commuted and rolled-over to purchase a new pension or annuity, each of the commutation ETPs will be an underlying commutation ETP of the current pension or annuity. [Item 41; new paragraph 27AAAA(3)(b)]

6.30 An important part of the test to determine an underlying commutation ETP is that the current annuity or superannuation pension must be purchased only with one or more commutation ETPs. Therefore, if an ETP from another source (such as a complying superannuation fund, an approved deposit fund (ADF) or a deferred annuity) is joined with a commutation ETP to purchase the current annuity or pension, the current annuity or pension will not come within new section 27AAAA .

6.31 Similarly, if a commutation ETP is rolled-over into a complying superannuation that does not immediately commence to pay a pension or into a deferred annuity (that is, it re-enters the accrual phase), the purchase price of any subsequent annuity or pension will consist partly of a commutation ETP and partly of earnings in the superannuation fund or deferred annuity. Therefore, the subsequent annuity or pension will not come within new section 27AAAA . This situation will not change even if an amount equivalent to those earnings are extracted and taken as a lump sum ETP.

6.32 An underlying commutation ETP is an original underlying commutation ETP if the annuity or superannuation pension that gave rise to it has no underlying commutation ETP. That is, the original underlying commutation ETP is the initial underlying annuity or pension in a series of annuities and pensions. [Item 41; new subsection 27AAAA(5)]

6.33 An annuity or superannuation pension gives rise to a commutation ETP if:

•

the commutation ETP results from the commutation of the whole or a part of the annuity or pension; or

•

the commutation ETP is a payment of the residual capital value of the annuity or pension.

[Item 41; new subsection 27AAAA(4)]

6.34 The consequence of the amendments is that, if a taxpayer who started receiving an annuity or superannuation pension prior to 1 July 1994 decides to commute that annuity or pension and roll-over the resulting ETP to purchase a new annuity or pension, the UPP of the new annuity or pension will be the whole of the ETP reduced by the post-June 1983 component. The deductible amount for the new annuity or pension will be worked out ordinarily under section 27H. If the new annuity or pension is payable for life, the deductible amount will be worked out on the basis of the relevant life expectancy at the time of commencement of the new annuity or pension.

6.35 The amendments apply to the calculation of the UPP of an annuity or superannuation pension where the commencement day of the annuity or pension is on or after 1 July 1994. [Item 42]

Example 1

6.36 Gavin received an ETP of $240 000 on 30 June 1993. Gavin's eligible service period was 20 years (10 of which occurred prior to 1 July 1983). Gavin's ETP contained the following components:

•

undeducted contributions - $40 000

•

pre-July 1983 component - $120 000

•

post-June 1983 component - $80 000

6.37 On 30 June 1995 Gavin rolled-over the whole of his ETP to purchase a reversionary allocated pension. Therefore, the UPP in relation to the pension is $160 000 (ie, $40 000 + $120 000). Gavin's wife was aged 57 and her life expectancy was 25.22 years. Consequently the deductible amount in relation to the pension was $6 344 per annum. Gavin took pension payments of $15 000 per annum.

6.38 On 30 June 1995 Gavin elected to commute his allocated pension and roll-over the whole of the resulting commutation ETP of $220 000 to purchase a reversionary allocated annuity from a different provider. The components of the ETP were:

•

undeducted contributions - $36 828

•

pre-July 1983 component - $100 000

•

post-June 1983 component - $83 172

6.39 As Gavin's allocated annuity has an underlying commutation ETP and the sole original underlying commutation ETP commenced before 1 July 1994, new section 27AAAA will apply to Gavin's annuity. Therefore, the UPP in respect of the annuity will be $136 828. Gavin's wife now has a life expectancy of 23.50 years. Consequently the deductible amount in respect of the annuity will be $5 823 per annum.

Example 2

6.40 Tracey purchased a roll-over annuity on 1 April 1993. She also started to receive a superannuation pension on 15 March 1994. On 30 November 1995 Tracey decides to commute both the roll-over annuity and the superannuation pension.

6.41 Tracey elects to roll-over the whole of the ETP she receives on the commutation of the annuity and 50% of the ETP received on commutation of the superannuation pension to purchase a new immediate annuity. The balance of the ETP is taken as a lump sum. On 16 July 1996 Tracey decides to commute the annuity. The whole of the ETP she receives is rolled-over to purchase another immediate annuity.

6.42 Tracey's new annuity has a series of underlying commutation ETPs. The whole of the purchase price of the new annuity consisted of underlying commutation ETPs. As the original underlying commutation ETPs (that is, Tracey's original roll-over annuity and superannuation pension) both commenced prior to 1 July 1994, new section 27AAAA will apply to Tracey's new annuity.

Example 3

6.43 Ivan purchased a roll-over annuity on 12 February 1994. On 25 August 1994 he purchased a separate immediate annuity by rolling-over an ETP he received from an ADF. On 2 October 1995 he commutes both entitlements and rolls-over the resulting commutation ETPs to buy a single new immediate annuity. new section 27AAAA will not apply to Ivan's new annuity because the original underlying commutation ETPs did not all commence to be paid prior to 1 July 1994.

Example 4

6.44 Helen purchased an allocated pension on 1 April 1994. On 16 November 1994 she decided to commute the allocated pension and elected to roll-over the resulting commutation ETP into a deferred annuity. On 17 July 1996 Helen started receiving an immediate annuity. new section 27AAAA will not apply to Helen's immediate annuity because the purchase price did not consist wholly of an underlying commutation ETP. Rather, the purchase price was the sum of the underlying commutation ETP and earnings in the deferred annuity between 16 November 1994 and 17 July 1995.

Death or disability superannuation pensions

6.45 The definition of death or disability benefit in subsection 159SJ will be omitted and substituted with a new definition of death or disability annuity/pension . The new definition will ensure that:

•

if the first payment date of the annuity or pension was before 1 July 1994, the annuity or pension will be a death or disability annuity/pension if it was provided to the person because of the permanent disability of the person; and

•

if the first payment date of the annuity or pension was after 30 June 1994, the annuity or pension will be a death or disability annuity/pension if it is provided to the person because of the disability of the person, where two legally qualified medical practitioners have certified that the disability is likely to result in the person unable to be employed in a capacity for which the person is reasonably qualified because of education, training or experience.

[Item 37]

6.46 The first payment date is defined in subsection 159SJ(1) and, so far as is relevant, means the first day of the period to which the first payment of the pension or annuity relates.

6.47 A consequential amendment will be made to the definition of rebatable 27H amount in subsection 159SJ(1). [Item 36]

6.48 The amendment will ensure that disability pensions which qualified for a rebate under the arrangements in place before 1 July 1994 will continue to qualify for a rebate under the new arrangements. That is, the new 15% rebate will apply to such pension or annuities. In addition, the test for disability will only have to be satisfied at the time of the first payment date for the annuity or pension to qualify as a rebatable 27H amount .

6.49 The amendments will apply to payments of annuities and pensions made on or after 1 July 1994 [item 38] . This will ensure that the new provisions operate as intended in respect of assessments for the 1994-95 financial year.

Part 2 - Employer superannuation contributions

Summary of the amendments

Purpose of the amendments

6.50 The purpose of the amendments is to remove any doubt that deductions for employer superannuation contributions are available only if they are made to a superannuation fund established primarily for the benefit of an employee.

Date of effect

6.51 The amendments will apply to contributions made by an employer on or after the date of introduction of the Bill. [Item 34]

Background to the legislation

6.52 Section 82AAC of the ITAA allows an employer a deduction for contributions to an eligible superannuation fund for the purpose of making provision for superannuation benefits for, or for dependants of, an eligible employee.

6.53 The clear intention of section 82AAC is to allow a deduction for employer superannuation contributions made for the benefit of an employee or, in the event of the employee's death, for the benefit of dependants of an employee. However, it has recently become apparent that some employers are claiming that a deduction is available for contributions made to a superannuation fund established primarily for the benefit of a spouse or another dependant of an employee.

6.54 To allow deductions for employers in these circumstances would encourage income splitting and effectively allow an employee and his or her dependants to obtain a greater reasonable benefit limit.

6.55 Moreover, there is no justification for allowing tax concessions to encourage the provision of superannuation support for a person with whom the employer has no actual employment relationship.

Explanation of the amendments

6.56 Amended paragraph 82AAC(1)(a) will restrict deductions for employer superannuation contributions to contributions made to a superannuation fund established for the benefit of an eligible employee (whether or not the benefits are payable to a dependant of the employee in the event of the employees death). [Item 33]

6.57 The amendment ensures that a deduction is not available to an employer for contributions to a superannuation fund established directly for the benefit of a spouse or any other dependants of an employee.

6.58 The purpose of the amendment is to remove any doubt about the intention of the existing law and does not affect the interpretation of the former paragraph 82AAC(1)(a) or any other provision of the ITAA. [Item 35]

Part 3 - Rolling-over eligible termination payments received before 1 July 1994

Summary of the amendments

Purpose of the amendments

6.59 The purpose of the amendment is to ensure that the 90 day roll-over period applies to eligible termination payments (ETPs) received before 1 July 1994.

Date of effect

6.60 The amendment will apply to ETPs made on or after 1 July 1994.

Background to the legislation

6.61 Taxation Laws Amendment (Superannuation) Act 1992 amended the income tax law to implement a number of the announcements made by the former Treasurer in the Security in Retirement statement.

6.62 One of the amendments related to the replacement of the 90 day roll-over period that applied to ETPs with a requirement that ETPs be rolled-over directly from the payer of the ETP to the roll-over fund. Associated with the new arrangements, the Superannuation Industry Supervision Act 1994 was introduced and allows superannuation funds and roll-over funds to retain moneys in the fund until the member decides how they want to deal with their entitlement.

6.63 The amendment removing the 90 day roll-over period applies to ETPs paid to a roll-over fund on or after 1 July 1994. As a consequence people who received ETPs between 1 April 1994 and 30 June 1994 have been denied access to both the full 90 day roll-over period and the facility which allows funds to retain moneys while the member decides how to invest their entitlement.

Explanation of the amendments

6.64 New section 49 of the Taxation Laws Amendment (Superannuation) Act 1992 will ensure that the amendments relating to the abolition of the 90 day roll-over period apply to ETPs paid on or after 1 July 1994. [Item 9 in Part 5 of Schedule 10]

6.65 The amendment will ensure that a taxpayer who received an ETP between 1 April 1994 and 30 June 1994 will have 90 days, or such longer period as the Commissioner of Taxation allows, to roll-over his or her ETP.