Court determines taxation issues in invalidity payment case

The decision handed down by the Federal Court of Australia resolved three appeals under section 44 of the Administrative Appeals Tribunal Act 1975 (Cth), which were brought by the Commissioner of Taxation in relation to a decision by the Administrative Appeals Tribunal.

The decision relates to benefits received by three ex-servicemen: Mr Burns, Mr Walker and Mr Douglas. The benefits received by Mr Burns and Mr Walker were received pursuant to the MSB Act, while the benefits received by Mr Douglas were received under the DFRDB Act.

The principal argument of each respondent was that the invalidity benefits each had received was a superannuation lump sum within the meaning of s 307-65 because the payments received were not a superannuation income stream benefit within the meaning of s 307-70(1) of the ITAA 1997.

The basis of that argument was that the payments could not be a superannuation income stream benefit because such a benefit had to be a superannuation benefit which was specified in the regulations and that there was no such specification.

The respondents submitted that the benefit did not meet the definition of a superannuation income stream benefit because regulation 995-1.01(2) of the ITAR 1997 did not “even purport to be a specification at all”.

They also stated that the definition in reg 995-1.01(2) of the ITAR 1997 did not fit the numerical pattern of other specifications provided in the ITAR 1997.

If the invalidity benefits received were classified as superannuation lump sums, the tax concession would be greater than if the benefits were superannuation income stream benefits.

The commissioner acknowledged that regulation 995-1.01 was not well drafted.

“Some of the difficulty in determining whether or not it provides the requisite specification lies in the fact that it is, in its own terms, a definition provision. Generally, definition provisions are given a relatively narrow effect and are not normally viewed as having a substantive effect,” the court said.

However, the court stated that the construction of regulation 995-1.01 could not be divorced from relevant provisions of the parent act.

“Both the terms of the 2007 amendments to the ITAA 1997 and the accompanying extrinsic materials make clear that a primary purpose was to create a dichotomy between lump sum and income stream benefits in the superannuation context, the precise content of which was left to be supplied by the regulations,” it said.

The respondents did not deny the Parliament’s intention to create this dichotomy, but they contended that a lacuna was created by the executive’s failure to fulfil the task of specification contemplated by the primary legislation, at least until the 2018 Amendment Regulations were made which contained an explicit specification.

In brief, they submitted that there was no specification as contemplated by s 307-70 of the ITAA 1997 during the period from mid-2007 until the coming into force of the 2018 Amendment Regulations.

“Regulation 995-1.01 states in detail or gives specific character to a particular type of superannuation benefit, namely the superannuation income stream benefit as referred to in Subdivision 307-B of the ITAA 1997. Notwithstanding the poor drafting practice of using a definition to achieve a substantive effect, that is what has occurred here. The absence of explicit language of specification is not determinative,” the court stated.

“As to the matching numerical pattern of other specifications provided in the ITAR 1997, there is no statutory requirement for such patterning. Once again, good drafting practice might encourage the use of such a numerical pattern for the sake of consistency and ease of comprehension, but the failure to do that here does not stand in the way of construing the relevant regulation as achieving the requisite specification when consideration is given to the relevant principles of construction, particularly the need to give effect to the plain purpose of the provision.”

The court did, however, uphold the tribunal’s finding that the MSB Rules did not meet the standards of reg 1.06(9A)(b)(iii) or reg 1.06(2) of the SIS Regulations.

The commissioner contended that the MSB Rules met these standards. Mr Burns and Mr Walker contended that the MSB Rules did not meet these requirements because the statute permitted both a suspension and cancellation of entitlement to the invalidity pension.

They submitted that the payment of the pension was not made at least annually (SIS Regulations reg 1.06[9A]) and the pension was not paid at least annually throughout the life of the primary beneficiary: SIS Regulations regs 1.06(9A)(b)(iii) 1.06(2)(a).

The receipt of the invalidity pension was defeasible on reclassification to Class C (MSB Rule 23 and 29); or on a failure without reasonable cause to comply with a notice to attend a medical examination or provide information (MSB Rule 25); or on re-joining the Permanent Forces or the Reserves rendering full-time service and thereby again becoming a member (MSB Rule 36).

They also submitted that the size of payments of benefit in a year was not fixed, allowing only for variation as specified in the governing rules: SIS Regulations reg 1.06(9A)(b)(iii) and SIS Regulations reg 1.06(2)(b)(i). The exception in the case of a variation was not capable of describing a cancellation because a variation necessarily contemplated that something remains.

“It is tolerably clear that the statutory scheme of which the MSB Rules form a part was designed with a view to it providing invalidity benefits in the form of income stream benefits,” the court stated.

“However, it is a unique scheme which contains significant differences to those more obviously the intended subject of SIS Regulations reg 1.06. Assuming the legislature intended and intends the invalidity pension under the MSB Rules to constitute superannuation income stream benefit, which appears likely, it would not be difficult for the SIS Act or SIS Regulations to exempt them from the minimum standards or otherwise address the MSB Scheme separately.”

The court also determined that the invalidity pension payments made to each of Mr Burns and Mr Walker under the MSB Act were not a pension for the purposes of regulation 1.06(1) of the SIS Regulations.

An issue peculiar to Mr Douglas’s appeal was whether his receipt of an “arrears payment” was a superannuation lump sum because it was not a superannuation income stream benefit. The arrears payment was an amount paid to Mr Douglas reflecting the invalidity pay he would have been paid had he retired on medical grounds rather than administrative grounds.

Sometime after Mr Douglas’s retirement on administrative grounds, it was determined that he should have been retired on medical grounds and he thereafter became entitled to a catch-up payment.

The court found that the arrears payment is not taken to be a pension for the purposes of SIS Regulations reg 1.06(1) because it was not provided under rules of a superannuation fund which met the standards of SIS Regulations reg 1.06(9A) (Issue 13).

“It necessarily follows that the arrears payment did not satisfy subparagraph (a)(ii) of the definition of ‘superannuation income stream’ in reg 995-1.01(1) of the ITAR 1997,” the court said.