Graeme Colley explains how the streamlining of deductions for the cost of permanent disability insurance through superannuation provides greater clarity around taxation issues.
Treasury recently released a consultation paper on streamlining deductions for the cost of permanent disability insurance through superannuation.
The paper appears to give greater clarity to the amount that may be claimed by the fund as a tax deduction. This heralds the near end of a relatively chequered history for ‘all occupation’ disability premiums since the commencement of the Better Super changes in 2007.
Prior to the introduction of the 2007 changes, the general understanding of the tax legislation throughout the superannuation industry was that a deduction could be obtained for all insurance premiums on policies, which insured against any form of total and permanent disablement (TPD).
This was based on industry’s understanding that the deduction related to premiums for an insured permanent disability where a person was unable to work in their ‘own’ occupation.
However, after the introduction of the Better Super legislation in 2007 it was considered that the rules changed and the deduction for premiums was available for a premium for a disability that prevented the person from being engaged in any occupation whatsoever. This stricter application of the law meant a lower deduction for the premium paid.
In view of the difference between the interpretation of the rules before and after the change, the Government consulted with industry to determine the course of action to be taken.
This resulted in transitional measures, which allowed the deduction for premiums to continue for any form of TPD until 30 June 2011. From 1 July 2011 amendments to the tax law mean that only the portion of the premium payable for policies where a person could not engage in any employment are tax deductible.
The change in the law resulted in the Australian Taxation Office publishing Draft Taxation Ruling 2010/D9 in mid December 2010, which discusses the deductibility of TPD cover for fund members under section 295-465 of the Income Tax Assessment Act 1997 (ITAA97).
The ruling indicates that if the insurance premium for the TPD policy is connected with a current or contingent liability to provide a disability superannuation benefit, then all or part of the premium will be deductible.
A disability superannuation benefit is potentially payable where a person is suffering from physical or mental ill-health, and two qualified medical practitioners certify that due to the ill-health that the person is unable to be gainfully employed in a job for which they are reasonably qualified by education, experience or training.
To date, no final version of the ruling has been published.
One issue that arises with the deduction for the TPD premium is the proportion of the premium that is to be tax deductible.
The Government released draft regulations indicating that after 1 July 2011 trustees of super funds may be required to obtain an actuarial certificate to determine the amount of deduction available to the super funds.
It is proposed that the amount of deduction will be based upon the actuarial calculation of the component of a TPD premium that would result in the fund being liable to provide a ‘disability superannuation benefit’.
As an alternative to requirement of obtain an actuarial certificate a consultation paper issued by the Government proposes a simplified process. It permits a fund to claim a tax deduction for all or part of TPD premiums by using a set percentage of the premium depending on the type of permanent disability covered in the particular policy.
The deductible percentages in the consultation paper that are proposed to be included in the regulations are shown in figure 1.
The use of these prescribed percentages as proposed is optional.
It will still be open for funds to retain the ability to engage an actuary to determine the tax-deductible portion of their TPD premiums if they wish to do so.
In addition to the possible change for some funds to determine the deductible amount of TPD premium, it may also be necessary to modify TPD definitions in the fund’s trust deed to align with the ‘disability superannuation benefit’ definition.
This will assist to ensure the full or partial tax deductibility of the premium.
Before doing so, the reduced likelihood of receiving a payment from the policy should also be considered.
One issue that came to light during the deliberations over the fund’s tax deductibility of TPD premiums was whether the deduction claimed by an employer or individual for superannuation contributions would be affected in any way.
It should be made clear to clients that the change affects only the deduction claimed by the fund, and may have a minor effect on the returns due to a greater part of the premium not being eligible for a tax deduction.
On the benefit payment side of things the amount payable to the individual as a TPD benefit will depend on the provisions of the particular fund’s trust deed.
However, the modification to the tax free and taxable components of the benefit as calculated in terms of section 307-145 of the ITAA97 apply only to circumstances which meet the definition of a disability superannuation benefit which is described above.
Case study
Let’s look at a case study, which displays the difference between the rules that apply to own-occupation policies prior to 1 July 2011 compared to a premium paid from that time.
The Sparky Super Fund pays insurance premiums to cover its liabilities to pay benefits to members in the event of permanent disability.
The insurance policy defines ‘permanent disability’ as the member’s ability to undertake his or her occupation as qualified by education, training or experience.
There is no indication in the policy of the components of the policy that relate to death or various disabilities.
Under the rules that were in force until 30 June 2011, the fund is required to obtain an actuarial certificate that determines the proportion of the premium relating to the own-occupation component so the relevant tax deduction can be determined.
From 1 July 2011, if the proposed percentages as published in the consultation paper are adopted the Sparky Super Fund will be able to deduct that percentage of the premium paid for own-occupation insurance as published in the regulations. This means that the fund can claim a deduction equal to 60 per cent of the premium paid without the need to obtain a certificate from an actuary.
Graeme Colley is national technical manager at OnePath.
