Understanding the Decision about Taxation of Invalidity Benefits
Recently, the Full Federal Court of Australia handed down an influential decision in the matter of Commissioner of Taxation v Douglas  FCAFC 2020 regarding the proper taxation treatment of invalidity benefits.
This decision will have major implications for Commonwealth Superannuation Corporation (CSC) payments in the future and may also enable veterans to recover some tax paid on incapacity payments in the past.
The decision concerned an appeal from three decisions of the Administrative Appeals Tribunal involving three separate taxpayers.
At the heart of each of the matters was the proper characterisation of CSC payments received from CSC under the Military and Superannuation Benefits (MSB) and Defence Force Retirement and Death Benefits (DFRDB) schemes. The taxpayers contended that both payments of lump sum amounts backdated to their deemed date of medical discharge and their ongoing fortnightly pension payments were not ‘superannuation income stream benefits’ but rather superannuation lump sums.
This was important as the former are wholly taxable payments and the later, paid on account of disability, are partially tax free as set out in section 307-145 of the Income Tax Assessment Act 1997 (Cth). The age of the veteran at the time of their retirement and number of days of service in the armed services also factored into the formula under the Act.
Matters on appeal
The central issue on appeal was the definition of a superannuation lump sum in the Income Tax Assessment Act 1997 (Cth). In essence, a superannuation lump sum is any superannuation benefit (which payments under the MSB and DFRDB schemes are) that does not meet the definition of a superannuation income stream benefit.
Two of the taxpayers successfully argued that the CSC payments did not meet the definition of a superannuation income stream benefit. As such, the payments from the CSC could be partially tax free. For one of the taxpayers, his payments were found to be superannuation income stream as they commenced prior to 20 September 2007.
Invalidly benefits moving forward
From this decision, there is a number of taxation implications. This will include:
- Payments under the DFRDB and MSB schemes that commenced after 20 September 2007 will become partially tax free. The exact proportion of these payments will depend upon a veteran’s period of service in the armed forces and date of discharge;
- The part of the incapacity payments not treated as tax free will likely still have to be taxed in the year in which it was received; and
- Tax assessed on what ought to have been the tax free component of past fortnightly payments will have to be amended to by objection to the Australian Tax Office (ATO) for each relevant veteran resulting in a refund of tax, subject to the Commissioner’s ultimate position on this issue.
It is important to note that as of the date of this article, the ATO are yet to confirm their position on the administrative treatment of incapacity payments.
The team at Butlers Business Lawyers have worked with veterans for years to deal with the tax implications of their CSC payments and are very familiar with and have a detailed understanding of the decision in this case. We would be happy to work with any veterans achieve the best tax treatment of their incapacity payments, including payments taxed in the past as wholly taxable.