On 15 December 2010 the Australian Taxation Office (ATO) released draft Taxation Ruling TR 2010/D9 Income tax: deductibility under subsection 295-465(1) of the Income Tax Assessment Act 1997 of premiums paid by a complying superannuation fund for an insurance policy providing Total and Permanent Disability cover in respect of its members.
The draft Ruling sets out the ATO's views on the circumstances in which, and the extent to which, a complying superannuation fund will be able to claim a tax deduction for premiums paid to purchase total and permanent disability (TPD) insurance cover in the 2011-12 and later income years. This timing coincides with the end of the transitional relief which is available for TPD insurance premiums paid in the 2004-05 to 2010-11 income years.1
In its final form, the Ruling will be a key document for superannuation trustees and insurers.
Augmentation of superannuation benefits
Superannuation trustees often purchase life insurance cover which enables the trustee to augment the benefits paid from the fund in accordance with the trust deed, in the event of a fund member:
- dying, or suffering a "terminal medical condition" (as defined in reg 6.01A of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SIS Regulations))
- suffering "permanent incapacity" (as defined in reg 6.01(2) of the SIS Regulations), or
- suffering "temporary incapacity" (as defined in reg 6.01(2)).
In purchasing life insurance cover, the trustee needs to consider the following issues:
- whether purchasing the insurance cover is consistent with the "sole purpose" test in s 62 of the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act)
- the circumstances in which the proceeds of a claim under the insurance policy can be paid out of the fund, and
- whether, and if so to what extent, the fund (which is a separate entity for tax purposes) can claim a tax deduction for the insurance premiums.
In this update, we are particularly concerned with permanent incapacity, the superannuation concept, which is to be contrasted with TPD cover – an insurance concept which embraces a range of offerings.
Permanent incapacity – a superannuation concept
A member's preserved benefits in a regulated superannuation fund can only be cashed on or after the satisfaction by the member of a condition of release: SIS Regulations, reg 6.18(1). Permanent incapacity is a "condition of release": SIS Regulations, Sch 1, item 103.
"Permanent incapacity" is defined (in reg 6.01(2)) in the following terms:
"permanent incapacity, in relation to a member, means ill-health (whether physical or mental), where the trustee is reasonably satisfied that the member is unlikely, because of the ill-health, to engage in gainful employment for which the member is reasonably qualified by education, training or experience." (emphasis added)
Neither the SIS Act nor the SIS Regulations defines "gainful employment". However, a cognate expression, "gainfully employed", is defined (in reg 1.03(1)) in the following terms:
"gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment."
In some cases, the trust deed imposes additional requirements that must be satisfied before a permanent incapacity benefit can be paid from the fund. However, in most cases the trust deed simply incorporates by reference the SIS Regulation concept of "permanent incapacity" and does not impose any additional requirements.
TPD – an insurance concept
The concept of "permanent incapacity" in the SIS Regulations very loosely corresponds with the concept of "total and permanent disability" or "TPD" in life insurance.2 However, while "permanent incapacity" is a narrow concept with a fixed meaning (because it is defined in the SIS Regulations), the scope of "TPD" as a concept always depends on the actual words used in the particular policy being considered.
TPD insurance covers first developed outside the superannuation context3 and are still provided outside the superannuation context. It is therefore not surprising (as noted in TR 2010/D9, para 103) that there exists a broad range of insurance covers which are all called "TPD insurance". Put another way, insurance that in effect only covers "permanent incapacity" (as defined in the SIS Regulations) is just one kind of TPD insurance.
Some examples of total and permanent disability which are often covered by TPD insurance are:4
- a disability that is likely to result in an inability ever to work in any occupation for which the person is reasonably qualified by education, training or experience (called "any occupation" cover – this broadly corresponds with "permanent incapacity" in the SIS Regulations)
- a disability that is likely to result in an inability ever to work again in the person's own occupation (called "own occupation" cover)
- a disability that results in a substantial reduction in the person's capacity to do one or more daily activities without the assistance of another person, an animal or equipment that alleviates the effect of the disability (called "loss of independence" cover)
- in relation to a person who is engaged in home duties — a disability that is likely to result in an inability ever to engage in the majority of those home duties (called "home duties" cover), and
- a permanent loss of either or both of:
- the use of one or more limbs, feet or hands, or
- sight in one or both eyes.
(called "loss of limbs and/or sight" cover)
Where an insurer pays a TPD claim to a superannuation fund pursuant to the terms of the policy, but the member has not satisfied the "permanent incapacity" condition of release or some other condition of release, such as "retirement" (as defined in reg 6.01(7) of the SIS Regulations), the money must stay in the fund until a condition of release is satisfied.5 The trustee cannot simply pass on to the relevant member each and every TPD payment that it receives from the insurer.
Disability superannuation benefit – a tax concept
Former s 279 of the Income Tax Assessment Act 1936 (Cth) (ITAA36) allowed a tax deduction for premium paid, wholly or partly, in respect of a current or contingent liability of a superannuation fund to provide death or disability benefits for fund members. The definition of "death or disability benefit" in former s 267 of ITAA36 included (at para (b)) "a benefit provided to the member in the event of the permanent disability of the member". However, "permanent disability" was not defined. Not surprisingly, superannuation trustees and insurers generally interpreted the term according to its ordinary meaning, which did nothing to stop the proliferation of TPD definitions in insurance policies taken out by trustees for the benefit of fund members. The ATO understands that industry practice was to claim a full deduction for TPD premiums regardless of whether the policy covered any occupation, own occupation, loss of independence, home duties, or loss of limb and/or sight benefits: TR 2010/D9, para 108.
The provisions regarding the deductibility of TPD insurance premiums were rewritten and transferred from former s 279 of ITAA36 to Div 295 of the Income Tax Assessment Act 1997 (Cth) (ITAA97), with effect from the 2007-08 income year.
Critically – subject to the transitional relief already mentioned – TPD premiums are now only deductible where they relate, wholly or partly, to a "disability superannuation benefit": ITAA97, s 295-460(b). "Disability superannuation benefit" is defined (in s 995-1(1) of ITAA97) in the following terms:
"disability superannuation benefit means a superannuation benefit where:
(a) the benefit is paid to a person because he or she suffers from ill-health (whether physical or mental), and
(b) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training." (emphasis added)
"Gainfully employed" is in turn defined (in s 995-1(1)) in the following terms:
"gainfully employed means employed or self employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment."
It will be seen that the definition of "disability superannuation benefit" in ITAA97 differs from the definition of "permanent incapacity" in the SIS Regulations in that the latter requires that the trustee be reasonably satisfied as to the member's incapacity, whereas the former requires that 2 legally qualified medical practitioners give a certification as to the member's incapacity. In the ATO's view, the requisite degree of ill-health in each case is "identical" and the practical impact of the difference in wording is "at most negligible": TR 2010/D9, paras 141-2.
A deduction can be claimed for insurance premium that is specified in the policy as being wholly for the fund's liability to provide benefits that are superannuation disability benefits: item 5 in the table in s 295-465(1). A deduction can also be claimed for so much of other insurance premiums as are attributable to the fund's liability to provide benefits that are superannuation disability benefits: item 6 in the table in s 295-465(1). In the latter case, the apportionment of premiums must be supported by an actuary's certificate: s 295-465(3). 6
The net effect is that, subject to the transitional relief, a trustee can only claim a deduction for TPD insurance premiums to the extent that the TPD insurance cover relates to the fund's liability to pay a "disability superannuation benefit" (as defined in s 995-1(1) of ITAA97) – which in a practical sense, and provided that the requisite medical certification is obtained), means a benefit payable where a member suffers "permanent incapacity" (as defined in 6.01(2) of the SIS Regulations).
On 13 October 2009 the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP, responded to industry concerns about the deductibility of TPD insurance premiums by announcing an intention to provide transitional relief to complying superannuation funds until 30 June 2011. This transitional relief commenced on 1 December 2010.7 It allows complying superannuation funds to claim a deduction for insurance premiums commonly regarded as TPD insurance premiums for the 2004-05 to 2010-11 income years.
The transitional relief effectively deferred the commencement of the stricter regime for the deductibility of TPD insurance premiums from the 2007-08 income year until the 2011-12 income year.
Draft Ruling TR 2010/D9
Draft Ruling TR 2010/D9 sets out the ATO's preliminary views on the application of items 5 and 6 in the table in s 295-465(1) of ITAA97 to TPD insurance premiums.
The draft Ruling also discusses the deductibility of insurance premiums in the context of 8 TPD examples, as follows:
- own occupation
- any occupation and own occupation
- own occupation and loss of limbs and/or sight
- any occupation and domestic duties
- any occupation and loss of limbs and/or sight
- any occupation and loss of independence
- any occupation, and
- any occupation and death benefit.
The draft Ruling does not discuss:
- the deductibility of premiums paid for insurance which covers the death, terminal illness or temporary disablement of a member, or
- the transitional relief which is available for TPD insurance premiums paid in the 2004-05 to 2010-11 income years.
The draft Ruling is a substantial document which runs to 35 pages. It provides a useful introduction to this complex area of the law and contains some illuminating background information.
Take away point
Trustees of complying superannuation funds will not be able to claim a full tax deduction for premiums paid for broadly worded TPD insurance covers in the 2011-12 and later income years. They will want to review their TPD insurance covers in the light of the draft Ruling and take appropriate steps, in the short time that remains before 30 June 2011.
In the superannuation context, the days of "own occupation" and other broadly worded TPD insurance covers appear to be numbered.
1. This transitional relief is contained in the Superannuation Legislation Amendment Act 2010 (Cth) No 117, 2010, Schedule 2; the Income Tax (Transitional Provisions) Act 1997 (Cth) No 40, 2007, s 295-466; and the Income Tax (Transitional Provisions) Regulations 2010 (Cth) SLI 2010 No 302. The transitional relief commenced on 1 December 2010.
2. TPD insurance is a kind of "continuous disability policy" and therefore a "life policy" for the purposes of the Life Insurance Act 1995 (Cth): ss 9(1)(e) and 9A.
3. In National Mutual Life Association of Australasia Ltd v Federal Commissioner of Taxation  HCA 6; (1959) 102 CLR 29 at 49 Windeyer J noted that policies that included a TPD benefit (called "permanent total disability benefit") had been commonly issued in America since 1910. In National Mutual itself, 3 of the 4 kinds of life policy considered included a TPD benefit. One of these 3 kinds of policy had been issued in connection with staff superannuation schemes, but was no longer issued by the company.
4. These examples are taken from the Income Tax (Transitional Provisions) Regulations 2010 (Cth) SLI 2010 No 302, reg 4(3)(a) to (e). See also the Explanatory Memorandum to the Superannuation Legislation Amendment Bill 2010 (Cth), para 2.6.
5. Nowadays, trust deeds usually provide, in effect, that no insured benefit is payable from the fund unless the trustee has been paid by the insurer.
6. A fund can also choose not to deduct amounts under s 295-465 in an income year but to instead deduct amounts based on its future liability to pay benefits: ss 295-465(4) and 295-470.
7. See n 1 above.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.