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Veteran Invalidity Benefit Taxation

Veterans' Superannuation Invalidity Benefit Taxation

Invalidity benefits paid through Defence Force superannuation schemes are generally taxed at a higher rate than invalidity benefits paid through civilian superannuation insurance schemes.

What are Defence Force Superannuation Invalidity Benefits?

Veterans who were medically discharged, or should have been medically discharged, may be entitled to receive invalidity benefits through the Defence Force superannuation scheme they contributed to, or were covered by, while they served.

The condition that caused the medical discharge, or should have caused it, does not need to have been related to service to receive an invalidity benefit. For instance, a veteran may have been medically discharged due to injuries sustained during a leave period. A veteran may be entitled to superannuation invalidity benefits, but not entitled to military compensation administered by DVA.

The superannuation scheme will depend on when the veteran joined the Defence Force, and whether they elected to change to a newer scheme, if they were given the opportunity to do so. Those schemes are:

  • Defence Force Retirement Benefits (DFRB). Open from 1948 to 30 September 1972.
  • Defence Force Retirement and Death Benefits (DFRDB). Open from 01 October 1972 to 30 September 1991.
  • Military Superannuation and Benefits Scheme (MSBS). Open from 01 October 1991 to 30 June 2016.
  • Australian Defence Force Cover (ADF Cover). Provides consistent superannuation invalidity benefit coverage to ADF members, enabling member choice of superannuation fund. Open from 1 July 2016.

Under each scheme, medically discharged veterans are classified according to their level of incapacity for civilian employment:

  • Class A – incapacity of 60% or more.
  • Class B – incapacity of 30% or more, but less than 60%.
  • Class C – incapacity of less than 30%.

Veterans with a Class A or B invalidity will receive a benefit paid as a pension. The amount of pension varies between schemes and is based on several factors such as the class of invalidity, age, length of effective service, and final salary or final average salary. Generally, a Class B pension is 50% of a Class A pension.
Invalidity benefits may be reviewed up to age 55. This means, for example, that a veteran receiving a Class A pension, may have it reduced to a Class B pension or to no pension at all. It is also possible that a veteran may receive an increase from a Class B to Class A pension.

Taxation

The Commonwealth Superannuation Corporation (CSC) which administers the four schemes, decided that invalidity pensions paid under the schemes are superannuation income stream benefits and has reported the payments as such to the Australian Taxation Office (ATO). This means that the taxable component of the pension is taxed at the veteran’s marginal tax rate.

In contrast, generally, civilian superannuation invalidity insurance benefits are reviewable until the condition stabilises, and then the benefits become permanent. Military Invalidity Benefits are reviewable for life with DFRDB and up to age 55 for MSBS.

The Superannuation Industry (Supervision) Regulations 1994 (Cth) defines the criteria that determines the nature payments. Military superannuation invalidity benefits do not meet the criteria necessary to be classified as a superannuation income stream benefit, primarily because they are not lifetime pensions. Invalidity benefits are not guaranteed to be paid throughout the lifetime of the Veteran because under DFRDB and MSBS rules the benefit can be varied or ceased due to a review and other factors.

Under the legislation, if it does not meet the criteria of a superannuation income stream benefit, by default, payments received are to be treated and taxed as lump sum payments.

So What is Happening?

Three veterans have challenged the superannuation income stream benefit classification of their invalidity benefits, paid under DFRDB and MSBS, through requests for reasons, taxation private rulings, objections and through the administrative appeals tribunal. Given the significance of the cases, the ATO has granted test case litigation funding, in order to completely deal with the issues in question – and arrive at a binding decision. The outcome of their cases may have significant positive financial impact to thousands of veterans who receive Class A and B invalidity pensions.

DFWA has maintained an active interest in these cases and has supported the veterans where possible. The Queensland Branch Honorary Legal Advisory Firm, Cleary Hoare Solicitors, has been heavily involved, representing the veterans who are the test cases.

DFWA will provide updates as and when they occur.

Updates

ComSuper To Finally Implement Douglas Decision

On 12 April 2022, the Commonwealth Superannuation Corporation (CSC) announced that it would follow the law and implement the tax changes following the 2020 Federal Court Douglas decision. The changes will be implemented for the 19 May 2022 pay-day.
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Disability Superannuation Benefits

If you are receiving a Defence Force Retirement and Death Benefits (DFRDB) or Military Super (MSBS) Class A or B Invalidity Benefit, you may be able to pay less tax if you have your benefits classified as Disability Superannuation Benefits. In some cases, the tax savings are substantial.
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Proposed Legislation Reversing the Decision in Douglas v Commissioner of Taxation

The government intends to introduce legislation to reverse the Federal Court decision in Douglas. The intention is to ensure that no veteran is worse off because of Douglas; however, this is a complex matter that needs scrutiny. DFWA and other ESOs will absolutely oppose any legislative change that removes any tax or other benefits flowing from the decision in Douglas, particularly in relation to pensions classed as Disability Superannuation Benefits.
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No Appeals in Veteran Invalidity Benefit Taxation Cases

The deadline for lodging appeals in the invalidity benefit taxation cases has passed. No appeals were lodged and so litigation of the matter has now ended. There is currently uncertainty within the veteran community as to what will happen next. DFWA is calling upon both CSC and the ATO, to outline how they will approach implementing the decision.
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