Terminal Illness benefits now tax free – but don’t forget to check the fine print! By Todd Riley | October 2007 Area of Expertise | Superannuation
Summary Lump sum superannuation member benefits paid to terminally ill members are tax free from 12 September 2007. The Government aims to make all necessary changes to relevant legislation by 1 July 2008. In the meantime, the ATO has modified the treatment of such benefits using a legislative instrument effectively making them tax free. The timing of the modification’s introduction, its simplistic approach, and its limited shelf life (only applies up to 30 June 2008 pending legislative amendments) have raised a number of practical questions. To address these questions, the ATO has answered a number of FAQs on the topic.
Who Does This Impact? RSE Licensees who offer terminal illness benefits. Group Life Insurers who offer terminal illness cover.
What Action Should be Taken? Review trust deeds to ensure there is power to implement the Instrument. Review group life insurance policies and compare terminal illness definitions against the Instrument. Review systems and procedures to ensure that the rate of tax withheld from relevant payments is “nil”. Identify any payments of lump sum superannuation member benefits to terminally ill members after 11 September 2007 where tax was withheld under relevant legislation, and deal with withheld amounts as appropriate. Update PDSs and other member communication material.
Background On 11 September 2007 the Federal Government announced that people with a terminal illness would not be taxed on their lump sum benefits. To achieve this, the Government asked the Australian Tax Office (ATO) to change the rate of withholdings to nil for such benefits. On 25 September 2007 the ATO released an instrument that removed the requirement to withhold amounts from lump sum benefits to terminally ill members (the Instrument).1 This is an interim measure to apply to 30 June 2008 to allow the Government time to introduce appropriate legislative amendments. The purpose of this TurkAlert is to summarise the Instrument and the ATO’s answers to its frequently asked questions (FAQs), and to suggest some issues coming out of the introduction of the Instrument.
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Terminal Illness benefits now tax free – but don’t forget to check the fine print! by Todd Riley
Summary of the ATO’s Instrument2 The Instrument, commencing 12 September 2007 and ending 1 July 2008, sets the amount required to be withheld from the following payments to nil: •
payments to superannuation members of lump sum benefits (ie. does not apply to income streams or to any type of death benefit); and
•
payments that meet the payment standards under the Superannuation Industry (Supervision) Act 1993 (SIS Act);3 and
•
where the member is “terminally ill” (see below).
“Terminally ill” is defined as follows: A [member] will be taken to be terminally ill if it is certified by two medical practitioners (at least one of these a specialist) that they are suffering from an illness which in the normal course would result in death within a period of 12 months.
Summary of ATO’s FAQs about the Instrument The ATO released answers to a series of FAQs concerning the Instrument on 19 October 2007. In addition to the information contained in the Instrument and its accompanying Explanatory Statement, the answers to the FAQs set out the following: •
the ultimate tax liability of a terminally ill member in receipt of a lump sum benefit will be dependent on the passage of the legislation;
•
trustees will not be required to give payment summaries to terminally ill members in receipt of lump sum benefits;
•
a member must meet an existing condition of release under the Superannuation Industry (Supervision) Regulations 1994 (SIS Regulations);
•
the Instrument applies to all lump sum benefits, and applies even where the following conditions exist: • • •
•
refunds of amounts withheld from terminal illness lump sum benefits paid on or after 12 September 2007 should be made as follows: • •
•
payment is made from an unfunded defined benefit fund; payment is made from an element taxed and/or an element untaxed in a fund; or no tax file number is held for the member.
if it is still held by the fund – make a tax free payment directly to the member for the amount of the tax withheld; and if it is no longer held by the fund – revise any activity statement necessary or request a refund of overpaid amounts from the ATO4; and
members will not be required to declare terminal illness benefits received on or after 12 September 2007 (on the assumption that amendments will be made to relevant legislation prior to 1 July 2008).
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Terminal Illness benefits now tax free – but don’t forget to check the fine print! by Todd Riley
Issues for Consideration The Explanatory Statement states “[t]he announced law changes will ensure that no tax will be payable on the relevant payments when an assessment of income tax is made”. This statement assumes that amendments to legislation will be passed prior to 1 July 2008, which would adjust a member’s tax liability to nil. The Instrument is limited to doing away with the need to withhold amounts from terminal illness benefit payments (i.e. the current legislation imposes a tax liability on certain terminal illness benefit payments). As a result of the Federal election, the usual timetable for the introduction and consideration of legislation has been interrupted. If all relevant changes to legislation are not made in time, a member may end up with tax liability for lump sum terminal illness benefits despite the relief given to superannuation trustees from withholding amounts from such benefits. It is anticipated that in such a situation, further relief would be issued by the ATO. In other words, the superannuation industry should “watch this space” for further developments.
TRUST DEEDS AND INSURANCE POLICIES Trustees should review their governing rules to ensure there is sufficient power to deal with the Instrument (e.g. refunding of withheld amounts to members). In addition, if trustees have already paid withheld amounts to the ATO, they should review their trust deeds to determine if they have power to apply to the ATO for a refund and to credit members’ accounts. Where a trustee does not have power to deal with refunds of withheld amounts or apply to the ATO for a refund, it is anticipated that the ATO will reconcile all amounts as appropriate. If the definition of terminal illness in the governing rules or insurance policy differs from that contained in the Instrument, trustees should carefully consider whether to continue withholding amounts from payments, or amending their governing rules and/or insurance policies so the definition is consistent with the instrument.
MEMBER COMMUNICATIONS AND DISCLOSURE DOCUMENTS Member communication material, such as Product Disclosure Statements (PDSs), will need updating to reflect the revised taxation arrangements. In addition, it is likely that the Instrument is a material change that would require communicating to members in accordance with the requirements of section 1017B of the Corporations Act 2001.
INTEREST ON WITHHELD AMOUNTS The Instrument and the Government’s press release do not address the question of how to deal with interest (positive and negative) that applies to withheld amounts before being returned to members. In the current investment climate, it is unlikely that funds will be experiencing negative investment returns. In the absence of guidance from the ATO or the Government, trustees must determine how to deal with interest earned on withheld amounts. This will depend on how the trustee has dealt with the withheld amounts within the fund.
POLICIES AND PROCEDURES It may be timely for trustees to ensure that they have sound policies and procedures for dealing with terminal illness and death benefit claims. There is a higher chance of a member passing away while making an application for terminal illness benefits compared to applications for disability benefits. These policies and procedures should now extend to the refund of any withheld amounts that should be refunded in accordance with the Instrument.
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Terminal Illness benefits now tax free – but don’t forget to check the fine print! by Todd Riley
WHAT IS A “SPECIALIST”? The definition of “terminally ill” refers to a medical practitioner that is “a specialist”. There is no guidance on what is meant by the term “specialist” in this context. However, it is likely that the term will be interpreted as being a “specialist” in the illness from which the member suffers rather than any “specialist”.
CESSATION OF MEMBERSHIP Trustees should carefully consider how they will refund withheld amounts to members whose membership has ceased on being paid a terminal illness benefit and the member has subsequently died. Where the governing rules of a fund would not permit the reactivation of an account, trustees may consider paying withheld amounts to the ATO for it to reconcile with the member’s tax liabilities via his or her estate. Alternatively, if the member is still alive and cannot be located the trustee must determine whether to treat the withheld amount as unclaimed money.
Conclusion The minimalist approach of the Instrument does not accurately reflect its practical implications for the superannuation industry. The Instrument is a temporary reprieve from having to withhold amounts from terminal illness benefits only, with further legislative changes to come. Therefore, systems and processes will need to be adapted to the Instrument now, and then possibly adjusted again to the final form of legislative amendments presumably in the first half of 2008. Trustees will need to review their governing rules to ensure they have the powers to deal with withheld amounts as contemplated by the Instrument, its Explanatory Statement and the ATO’s answers to the FAQs. In addition, any existing definition of “terminal illness” in the governing rules of a fund or the terms of a group life insurance policy should be carefully compared to the definition of that term in the Instrument to determine if the Instrument will apply to a given fund. Trustees will need to address a number of practical issues where an amount has been withheld from a terminal illness benefit that should be returned (e.g. is the member alive, are they still a member of the fund, and how should any interest be dealt with). Member communications will also need updating. While the Instrument introduces changes that pale in comparison to those being wrought by the Simpler Super amendments and the Anti-Money Laundering and Counter-Terrorism Financing legislation, trustees should nevertheless turn their collective mind to the proper implementation of the Instrument.
Endnotes 1
The instrument is named the Taxation Administration Act – Variation to the rate of withholding for certain terminally ill recipients of lump sum superannuation member benefits (Instrument ID 2007/MEI/008), which was made under section 15-15 of Schedule 1 to the Taxation Administration Act 1953. 2 A copy of the Instrument is available from http://www.comlaw.gov.au. 3 In the case of a complying superannuation fund – s.31(1). In the case of an approved deposit fund – s.32(1). In the case of a retirement savings account – s.38(2). 4 The trustee, and not the member, would apply for the refund of withheld amounts from the ATO.
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Terminal Illness benefits now tax free – but don’t forget to check the fine print! by Todd Riley
For more information, please contact:
Todd Riley Senior Associate T: 03 8600 5031 todd.riley@turkslegal.com.au
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