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Focus: Changes to deductibility of TPD insurance costs for superannuation funds

22 June 2011

In brief: Recent amendments to the Income Tax Assessment Act 1997 establish a simplified regime for regulated superannuation funds wishing to claim tax deductions for the cost of total and permanent disablement insurance for the 2011-12 and later income years. The scope of the current transitional relief that applies for the income years from 2004-05 to 2010-11 has also been expanded to cover self-insured funds. Partner Mark Cerché (view CV), Senior Associate Larissa Macpherson and Lawyer Brendan Wood report.

• Background
• Transitional relief extended to self-insured funds
• Deductible percentages to be specified in regulations
• Next steps

Background

In 2004 the Income Tax Assessment Act 1936 (Cth) (the ITAA 36) was amended to permit deductions in respect of the liabilities of complying superannuation funds relating to 'death or disability benefits', including benefits provided in the event of a member's permanent disability. The concept of 'death or disability benefits' was not defined, and industry practice developed to treat TPD insurance premiums as fully tax deductible where they were insuring against some form of permanent disablement.

As part of the Federal Government's Better Super reforms in 2007, the relevant provisions of the ITAA 36 were repealed and moved to the Income Tax Assessment Act 1997 (Cth) (the ITAA 97). As part of this process, refinements were made to the deductibility rules.

These refinements sought to clarify that a superannuation fund is only entitled to claim a full or partial tax deduction to the extent that insurance premiums are attributable to a liability of the fund to provide 'disability superannuation benefits'. A new definition of 'disability superannuation benefit' was inserted into the ITAA 97 requiring certification by two qualified medical practitioners that the member is unlikely to ever be gainfully employed in a capacity for which they are reasonably qualified by education, experience or training. This narrow definition arguably means that funds are not entitled to a full deduction for TPD insurance costs where eligibility for benefits may be assessed on the basis of a member being unable to work in their 'own occupation', or merely physical matters such as a member's loss of limbs or sight.

In order to claim a partial deduction in relation to TPD insurance where the concept of permanent disablement is broader than the definition of 'disability superannuation benefits' or where the insurance includes other types of cover, the trustee is required to obtain an actuarial certificate as to the proper apportionment of deductibility (unless the appropriate part of the premium is specified in the policy itself).

In 2009, the Australian Taxation Office (the ATO) noted that, despite these legislative changes, industry practice continued to be to claim full deductions for the cost of TPD premiums without any assessment of the extent to which the cover relates to a liability of the fund to pay 'disability superannuation benefits' to members.

Concerns were raised by industry that the ATO's interpretation of the deductibility rules did not accord with industry practice. In October 2009, the Government announced that retrospective transitional relief would be provided for the income years from 2004-05 to 2010-11. The position for the 2011-12 income year and later years would then revert to premiums only being deductible to the extent the insurance policy is referable to a liability of the fund to provide 'disability superannuation benefits'.

Transitional relief extended to self-insured funds

Amendments to give effect to this transitional relief were made in November 2010. The relief broadens the meaning of 'disability superannuation benefits' (ITAA 1997) and 'death or disability benefits' (ITAA 1936) for the income years from 2004-05 to 2010-11. These terms are deemed to include any benefit that is conditional on the member suffering a disability of the type specified in the regulations and the trustee or insurer is required to obtain reasonable medical evidence of the member's disablement.

The regulations specify eight types of disability that are broadly aligned with the insured events that are covered under 'any occupation', 'own occupation', 'activities of daily living', 'home duties', 'loss of limbs and/or sight', 'cognitive impairment' and 'terminal illness' TPD policy definitions.

However, this transitional relief did not address the deductibility by self-insured superannuation funds of the notional cost of obtaining insurance cover to provide TPD benefits.

The June 2011 income tax amendments rectify this oversight by providing specifically for self-insured funds to rely on the expanded meanings of 'disability superannuation benefits' and 'death or disability benefits' for the income years from 2004-05 to 2010-11.

Deductible percentages to be specified in regulations

In addition to the existing ITAA 97 deductibility rules, a simplified regime for claiming a partial deduction for the cost of TPD insurance (including self insurance) will be available from 1 July 2011.

The June 2011 amendments make provision for the income tax regulations to specify the proportion of a premium for specific types of TPD insurance policies that may be treated as being attributable to a liability to provide 'disability superannuation benefits'.

If an insurance policy held by a superannuation fund is of a type specified in the regulations, the fund may deduct the specified proportion of the premium. Where the fund claims a deduction in accordance with the regulations, an actuary's certificate will not be required.

Self-insured funds will still be required to engage an actuary to calculate the amount the fund could reasonably expect to pay in an arm's length transaction to obtain insurance covering its liability to provide 'disability superannuation benefits'. However, the fund will then be able to determine the deductible proportion of that amount by using percentages specified in the regulations without needing to obtain further actuarial certification.

It is noted that funds (whether self-insured or not) are not required to have recourse to the percentages specified in the new regulations and may instead rely on the existing ITAA 97 provisions which require actuarial certification prior to any apportionment of deductibility.

Next steps

On 16 June 2011, Treasury released a Consultation Paper setting out the proposed percentages to be specified in the income tax regulations for different types of TPD insurance. The closing date for submissions on the Consultation Paper is 1 July 2011.

The Consultation Paper proposes to address four types of TPD insurance cover:

• any occupation: insurance against a disability that is likely to result in an inability ever to work in any occupation for which the member is reasonably qualified by education, training or experience;
• own occupation: insurance against a disability that is likely to result in an inability ever to work in the member's own occupation;
• activities of daily living: insurance against a disability that is likely to result in a substantial reduction in the member's capacity to perform two or more specified activities of daily living (such as eating, drinking, dressing, toileting or showering);
• loss of limbs/sight add-on: an additional component that insures against a permanent loss of either or both of the use of one or more limbs or the sight in one or more eyes.

It is proposed that funds will be able to deduct the percentages specified in the table below if they have TPD definitions (under an insurance policy or trust deed for self-insured funds) that are at least as restrictive as the corresponding definitions set out in the regulations.

The Consultation Paper acknowledges that not all possible TPD definitions are captured by the proposed regulations, nor are the proposed regulations as broad as the current transitional relief.

Should the final form of the regulations reflect these proposals, superannuation funds with TPD definitions that do not sit squarely with any of the four definitions set out in the regulations may need to consider the feasibility of other options, such as relying on the existing ITAA 97 provisions (which require actuarial certification prior to any apportionment of partial deductibility) or amending their insurance policy or trust deed definitions.

In addition, given that the current transitional relief is due to expire on 30 June 2011, trustees that are likely to only be entitled to partial deductibility may also need to give consideration to the possibility of recouping the tax cost to the fund arising from its inability to continue claiming a full deduction for the cost of TPD insurance. This may raise significant questions such the appropriateness of allocating such costs to members, as well as 'cross-subsidisation' issues in funds where not all members hold or are eligible for TPD benefits, and issues regarding the timing of any such allocation (for example, having regard to how frequently premiums are payable under the relevant policy).

For further information, please contact:

• Mark CerchéPartner, Melbourne
  Ph: +61 3 9613 8872
  Mark.Cerche@allens.com.au