Tax Changes to Invalidity Pensions

A change to the treatment of military invalidity benefits following federal court decision

12 Apr 2022

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Key points
  • A Federal Court case in December 2020 changed the tax treatment of some military invalidity payments and this has flow-on impacts to other payments
  • Legislative changes being considered have not yet proceeded and so CSC must now proceed to fully implement the law as set by the Federal Court
  • CSC’s role is limited to withholding amounts each fortnight as required
  • Some people will receive more in the hand each fortnight, others will receive less
  • The changes will be implemented on 19 May 2022

Why some DFRDB and MilitarySuper invalidity benefit payments are being treated differently

The tax treatment of some invalidity super benefit payments has changed due to the Full Federal Court decision in Commissioner of Taxation v Douglas [2020] FCAFC 220.

The decision means MilitarySuper and DFRDB invalidity pensions that commenced on or after 20 September 2007 should have been taxed as super lump sums instead of as a superannuation income stream.

The decision made by the Federal Court in December 2020 has different outcomes for different veterans. Depending on a range of individual circumstances (age, amount of benefit, HECS debts, other income, other payments received etc.) there are hundreds of different outcomes possible. These outcomes are in relation to a lot of things, including:

  • the overall tax a person would pay at the end of the financial year (calculated by the ATO);
  • the amount that CSC had to withhold each fortnight (in accordance with set specifications outside of CSC’s control); and
  • the flow-on impacts to other payments, such as DVA, Centrelink and child support payments.

Why CSC paused implementation

As a result of the numerous possible outcomes, not all veterans would consider themselves “better off” as a result of the decision.

In November 2021 the Federal Government publicly announced their desire to prevent any veteran being worse off as a result of the Federal Court decision and they immediately started a process that would look at changes to legislation that would achieve this.

CSC paused implementing withholding changes once this was announced.

CSC is now implementing withholding changes in accordance with the Federal Court decision

On 11 April 2022, the Federal Government announced that it will legislate early next Parliament to ensure no veteran is left worse off. It also clarified that the Government legislation will affirm the Federal Court’s decision. The Government’s position can be found here.

This means that CSC must now fully apply the law as it currently stands. Accordingly, CSC will apply withholding to all impacted pensions as if they are lump sums.

For CSC, our role is limited to withholding amounts from fortnightly payments as required in accordance with withholding specifications. We do not set these withholding specifications – we just apply them.

In applying the withholding specifications some veterans will receive “more in the hand” each fortnight and some veterans will receive “less in the hand” each fortnight.

CSC is not responsible for taxing your invalidity benefit

In simple terms, the ATO asks CSC to withhold tax for invalidity benefits. This is not actually taxing you. By law CSC can’t tax you – only the ATO can do this.

What CSC does is comply with our “withholding obligations” – this is a legal obligation. “Withholding” is the process where CSC withholds amounts from fortnightly pension payments and remits these to the ATO as part of the ‘pay as you go’ (PAYG) tax system.

The changes will be implemented on 19 May 2022

CSC will implement the technical changes to our pension payment system on 2 May 2022, meaning you will see a change to your fortnightly pension payment on 19 May 2022.

We will send you an email or letter that tells you what the change means for you and what your fortnightly pension amount will be. You do not need to contact us or do anything as a result of this change.

Options if you end up receiving less in the hand each fortnight

If you are one of the veterans who will see your withholding increase, meaning you’ll have less in the hand each fortnight, there are some options for you to consider, including:

  • claiming the Medicare levy exemption
  • claiming the tax free threshold
  • claiming the disability super tax benefit (DSB)

If you would like a different withholding arrangement you can contact CSC to increase your withholding or you can seek a private determination from the ATO to decrease it. CSC cannot decrease the amounts withheld, only the ATO can direct CSC to do this, after you have applied to the ATO for a private determination.

Payments from other agencies are impacted

If you receive or are subject to other payments - from DVA, Centrelink or Child Support, for example - these payments may also be impacted.

If your other payments are impacted, it is our understanding that those agencies will contact you to explain what it means for you. You do not need to take any specific action right now.

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Latest Questions and Answers

Where is my PAYG Payment Summary? 

CSC has been recently requested by the ATO to change the way we report PAYG Payment Summaries for Military Invalidity benefits that commenced on or after 20 September 2007 as a result of a Federal Court decision.

If you are in receipt of a military invalidity benefit and you are not claiming the Disability Superannuation Tax Benefit (DSB) you should have received your payment summary prior to 14 July 2021.

If you are in receipt of a military invalidity benefit and you are claiming the Disability Superannuation Tax Benefit (DSB) CSC is currently adjusting the annualised figures in your PAYG payment summary. In these instances, CSC is hoping to have PAYG payment summaries uploaded and sent to you, and reported to the ATO, by mid-August.

What does 'withholding' mean? 

'Withholding' is the process where CSC withholds amounts from fortnightly pension payments and remits these to the ATO as part of the pay-as-you-go (PAYG) system.  

Withholding amounts are amounts that are meant to be 'paid as you go', so that when you finalise your tax return with the ATO, you don’t have to pay all of your tax at once.

What is a ‘disability superannuation benefit’?

A disability superannuation benefit is a tax term that refers to a benefit being paid to a person:

  • Because of ill-health; and
  • Where two legally qualified medical practitioners have certified that, due to ill-health, it is unlikely the person can ever work in a job they are reasonably qualified for.

Both income streams and lump sums can be classed as a disability superannuation benefit for tax purposes. How concessional tax treatment is applied will depend on whether your benefit is regarded as an income stream or lump sum for tax purposes. 

  • Income streams will attract a 15% offset on the taxable-taxed component of the pension before preservation age.
  • Lump sums will include additional tax-free treatment using a calculation based on your period of membership and your CRA. 

It’s important to note that not all invalidity pensions will qualify as a disability superannuation benefit. This is because a disability superannuation benefit is dependent on the recipient being totally and permanently incapacitated, whereas ADF invalidity pensions are based on varying levels of incapacity.

 

How do I have my invalidity pension treated as a disability superannuation benefit?

CSC must confirm your invalidity pension meets the definition of a disability superannuation benefit under the Income Tax Assessment Act 1997. If the medical evidence you’ve provided confirms your pension meets the definition, we’ll advise the ATO of an ‘effective date’ to apply this tax treatment from.

If you’ve previously received this confirmation from CSC, you don’t need to do anything. This information will be reported to the ATO on your behalf, which they will take into account for any remediation being performed. 

If you haven’t previously obtained this confirmation from CSC, you will need to provide us with medical evidence. 

What medical evidence do I need to provide?

You will need to provide CSC with certification (i.e. medical certificates) from two qualified medical practitioners stating that, because of ill-health, it is unlikely you can ever be gainfully employed in a capacity for which you are reasonably qualified because of education, experience or training. Your doctor should also specify the date they consider you satisfied this criteria and were unable to work.

Your evidence can be sent via email or post, and must include your full name (including any middle names), service number and date of birth. It’s also helpful if you confirm your current contact details (email, phone and postal address). 

Email: invaliditytaxation@csc.gov.au 
Post: GPO Box 2252, Canberra ACT 2601

After reviewing your medical evidence, we will advise you of the outcome in writing.

What is the ‘effective date’?

The effective date is the date your invalidity pension is regarded as having met the requirements of a disability superannuation benefit. The effective date will depend on whether your doctor specifies the date they consider you were unable to work from. If they don’t specify a date, we’ll look at the dates the certificates were issued.
If your medical evidence specifies an effective date If your medical evidence does not specify an effective date
The effective date will be the latest date specified in the evidence. The effective date will be the latest date of the evidence.
Example:

Certificate 1 states the member was TPI with effect from their date of discharge on 23 August 2010.

Certificate 2 states the member was TPI with effect from a date the retirement condition worsened, being 1 October 2013.

The effective date for the disability superannuation benefit classification would be 1 October 2013.
Example:

Certificate 1 is dated 30 March 2021, but makes no reference to an effective date.

Certificate 2 is dated 13 April 2021, and again doesn’t make reference to an effective date.

The effective date for the disability superannuation benefit classification would be 13 April 2021.

Can the disability superannuation benefit tax treatment be backdated?

Yes, provided evidence is supplied with a retrospective effective date. While CSC can advise the ATO of a retrospective effective date, CSC is not involved in any remediation action that follows. Any retrospective amendments to your tax affairs will be a matter between you and the ATO. 

Will my invalidity pension count towards the low rate cap?

Any superannuation lump sum paid to you from a taxable-taxed source will count towards the low rate cap between preservation age, and age 60. If you reach to low rate cap between these ages, further benefits will be taxed at a higher rate until age 60. More information on the low rate cap can be found here

Will my invalidity pension count towards the untaxed plan cap?

Any superannuation lump sum paid to you from a taxable-untaxed source will count towards the untaxed plan cap. If you reach the untaxed plan cap, further benefits will be taxed at a higher rate. More information on the untaxed plan cap can be found here.

Can my invalidity pension still be subject to a family law split?

Yes, superannuation splitting under the Family Law Act 1975 does not rely on the very specific definition of “superannuation income stream” and “pension” under Regulation 1.06 of the Superannuation Industry (Supervision) Regulations 1994 which were considered in the Douglas matter.

As such, the outcome of the Douglas matter has not affected the Family Courts’ power to split an invalidity pension, or the way in which CSC has complied with validly made Family Court Orders and Agreements previously. CSC will continue to comply with its obligations under the Family Law Act to implement Family Court Orders and Agreements splitting superannuation benefits.

Frequently asked questions

What will change following the Federal Court decision?

CSC will contact you via mail or email to let you know what your new fortnightly benefit amount will be.

You will first see the change to your fortnightly benefit on 19 May 2022.

What is CSC doing to implement the changes?

Since the decision, we have worked closely with the ATO to clearly understand what our new withholding obligations are. Those obligations have been confirmed and CSC now needs to make changes to our pension benefit payment system and inform customers of what, if any, changes there will be to their fortnightly benefit payment.

The ATO has told CSC which withholding schedule to apply to the different types of payments – this is how we calculate the amounts that will be withheld (see below for more information on “withholding schedule” means).

What exactly is CSC responsible for and what is the ATO responsible for?

In simple terms, CSC is required to withhold amounts from invalidity benefits. This is not actually taxing you. By law CSC can’t tax you – only the ATO can do this.

What CSC does is comply with our “withholding obligations” – this is a legal obligation. 

“Withholding” is the process where CSC withholds amounts from fortnightly pension payments and remits these to the ATO as part of the pay-as-you-go (PAYG) system.  

Withholding amounts are amounts that are meant to be “paid as you go” per the PAYG system, so that when you finalise your tax return with the ATO, you don’t have to pay all of your tax at once. 

The decision was handed down in December 2020, why is this taking so long?

In February 2021, the ATO informed CSC that we would need to withhold amounts in accordance with the lump sum withholding schedule (Schedule 12). This was a change from the existing withholding schedule for income streams (Schedule 13).

We immediately commenced work on making the benefit payment system changes needed to implement Schedule 12. However, during this implementation it became clear that Schedule 12 would adversely impact the vast majority of invalidity payments and would increase the amounts that CSC would be expected to withhold.

This would leave the majority of our impacted customers with less in the hand in the short term as their fortnightly payments would be reduced. We expressed this concern to the ATO and requested that they review the changes that were made to Schedule 12.

In November 2021 the Federal Government publicly announced their desire to prevent any veteran being worse off as a result of the Federal Court decision and they immediately started a process that would look at changes to legislation that would achieve this. CSC paused implementing withholding changes once this was announced.

On 11 April 2022, the Federal Government announced that it will legislate early next Parliament to ensure no veteran is left worse off. It also clarified that the Government legislation will affirm the Federal Court’s decision.

This means that CSC must now apply the law as it currently stands. Accordingly, CSC will apply withholding to all impacted pensions as if they are lump sums.

How will I know if I’m impacted by this decision?

CSC will contact you via mail or email in early May 2022 to let you know what your new fortnightly benefit amount will be.

So, I’m not actually paying any more tax?

Regardless of when CSC commences withholding at the lump sum withholding rate, we will report all payments that qualify to be considered superannuation lump sum payments to the Australian Taxation Office (ATO) so they can apply the right tax to customers’ tax returns. If the amount CSC has remitted to the ATO over the year is larger than the tax you’re liable to pay, the ATO will refund any excess amounts as part of the tax return process. 

But, my fortnightly benefit in future might change?

Your fortnightly benefit amount might either be increased or reduced depending on your individual circumstance and we will advise you of this change by mid-May 2022.

When will this change start and when might I see a change to my invalidity benefit?

CSC will contact you via mail or email to let you know what your new fortnightly benefit amount will be.

You will first see the change to your fortnightly benefit on 19 May 2022.

I’ve heard a lot about “Schedule 12” and “Schedule 13” – what are they and how do they relate to this change?

Withholding obligations are contained in ‘schedules’ administered by the ATO that set out how withholding applies to all types of payments. 

For invalidity pension payments, CSC used to withhold as per obligations set out in the ATO’s Schedule 13 which applies to superannuation income streams (you can look at this on the ATO website under Schedule 13). 

Since the decision, invalidity pension payments that commenced or changed on or after 20 September 2007 need to be treated as superannuation lump sum payments for withholding purposes (Schedule 12).

Why is there talk about getting medical certificates?

Individuals receiving military invalidity benefits may qualify for those benefits to be treated as disability superannuation benefits. The two concepts are different. 
If you receive an invalidity super benefit it does not mean you automatically qualify for this to be treated as a disability super benefit.

If your invalidity benefit is also a disability super benefit, you may qualify for the disability super concession – see ATO information about this here: 

How would I be eligible for my benefit to also be a disability super benefit?

To be eligible for this, you must meet the additional requirements of tax legislation.

Your benefit will be treated as a disability super benefit if:

  • you experience physical or mental ill health, and
  • two qualified medical practitioners have certified that you meet the permanent incapacity definition.

Medical certificates evidencing permanent incapacity

To be eligible for the disability concession, you’ll need two qualified medical practitioners to certify that it’s unlikely that you can ever be gainfully employed in a capacity for which you are reasonably qualified because of education, experience or training. Medical certificates that don’t address your ability to work in the future are not sufficient. 

Where this evidence has been supplied to CSC during your invalidity assessment process, we will treat your benefit as a disability super benefit and will also report this to the ATO so that the ATO can tax your benefit appropriately. 

Once our systems are updated to reflect the Federal Court’s decision, we’ll also be able to adjust the withholding amount that we withhold from your payments to reflect the concession.  

If you have not provided two medical certificates to us that specifically state that you meet the permanent incapacity definition, you can provide them at any time. We will then treat your benefit as a disability super benefit going forward and will inform the ATO so that they can ensure you have been and will be taxed correctly. 

Further questions?

If you have any further questions, you can email our dedicated email address for this issue pensions@contact.csc.gov.au or call our dedicated phone number 1300 001 877.

 

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