Updated 06 January 2022
Key Points
- Don’t panic.
- Government will introduce legislation to reverse the Federal Court decision in Douglas.
- Veterans who were better off because of Douglas will receive a new non-refundable tax offset.
- Legislation has not been released. Minister has advised bill will be introduced in February 2022.
- 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.
Background
On 24 November 2021, the Assistant Treasurer Michael Sukkar MP and the Minister for Minister for Veteran Affairs Andrew Gee MP released a joint media release “Government Protecting Veterans’ Interests Following Court Decision”.
The media release announced the government was introducing legislation that reversed the effect of Douglas v Commissioner of Taxation on Defence Force Retirement and Death Benefits (DFRDB) and Military Super (MSBS) class A and B invalidity benefits which commenced after 20 September 2007.
(Note: in this document DFRDB and MSBS class A and B invalidity benefits will be called “invalidity pensions”).
The stated reason for this legislation is:
- More tax withheld each fortnight. Almost 6800 veterans would have had more tax withheld from their pension payments as a result of this court decision, meaning less money in their pockets every fortnight. In some cases this was up to $100 per fortnight.
- Tax debts going back to 2017. Thousands of veterans were also facing the prospect of being hit with a notice for back-taxes going back to 2017. It would have devastated so many vulnerable veterans.
The media release also announced a new non-refundable tax offset so that recipients of invalidity pensions who would be better off in a particular income year, if the invalidity pension were still treated as lump sums, would retain that tax benefit.
The media release says:
In a significant win for veterans across the country, the … Government has taken action to ensure no veteran will be made worse off due to a Federal Court decision.
This statement does not acknowledge that the Douglas decision has resulted in significant benefit to many veterans. Many veterans will likely be made worse off by the action the Government intends to take.
Using tax-offsets will leave veterans out of pocket. Making the legislation retrospective will leave them with debts.
DFWA cautions the government in the strongest terms, against passing legislation without fully exploring the consequences. Douglas is beneficial to many disabled veterans; veterans are disadvantaged because the Commonwealth Superannuation Corporation has failed to implement it in an effective or efficient manner.
DFWA has been advised this legislation will introduced as a bill, meaning it will need to pass both the House of Representatives and the Senate before it becomes law. This is good news, as it affords DFWA and other ex-service organisations an opportunity make comment on how the legislation will affect veterans.
According to Minister Gee’s officer, the legislation will be introduced in February 2022.
More tax withheld each fortnight
The effect of the Douglas decision was that DFRDB and MSBS invalidity pensions which commenced after 20 September 2007, are treated as superannuation lump sums rather than an income stream. Each fortnightly pension payment is a superannuation lump sum.
Having invalidity pensions classified as superannuation lump sums means that any veteran whose marginal tax rate would exceed 32% has the tax liability for their pension capped at 32%.
When a taxpayer lodges their tax return at the end of each financial year, the tax office looks at how much income you’ve received and works out the tax based on the individual tax rates.
However, when you receive income during the year—such as wages, pensions, lump sums—the payer must withhold tax and send that money to the tax office. For each type of payment, there is a table which tells the payer how much of your income they must withhold.
For superannuation lump sums, Schedule 12 – Tax Table For Superannuation Lump Sums details the withholding rates.
Because the table is designed to fit most financial circumstances, Schedule 12 generally has a higher withholding rate that that of normal salary or an income stream. This is to make sure that enough money is withheld so there isn’t a tax debt at the end of the year.
If nothing was done, many veterans whose pensions became superannuation lump sums were to have a larger amount of tax retained each fortnight; having to wait until the end of the financial year to claim back.
However, the Australian Taxation Office (ATO) worked with the Commonwealth Superannuation Corporation (CSC) to develop a “class withholding variation” to the Schedule 12 Tax Table for affected veterans. This minimised the amount of tax withheld each fortnight as much as possible, without putting individual veterans at risk of year end tax debts. The small number of veterans who still had an increase to the amount of tax withheld, could seek an individual variation for their circumstances. This was explained on the ATO website.
This problem should have been identified by CSC in early 2021. The problem was not with the Douglas decision, it was and is with CSC and its capacity to implement the change.
A simple honest explanation of the problem in August, and what CSC and the ATO were doing to address it, would have avoided all the unnecessary stress put on these vulnerable Veterans.
Tax debts going back to 2017
It is important to acknowledge that treating pension payments as superannuation lump sums rather than as income stream may negatively impact some tax arrangements such as low-rate cap, taxable plan cap, and some tax-offsets. In some cases, there are substantial negative consequences, and these must be addressed.
Disability Superannuation Benefit and Section 307.145
Many veterans who receive DFRDB and MSBS invalidity benefits can also have their pensions classified as disability superannuation benefit (DSB). For a veteran to have their pension classified as DSB means that two qualified medical practitioners have certified that:
the veteran is unable to be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.
Income Tax Assessment Act 1992 (Cth) s 995.1 – Definitions “Disability Superannuation Benefit”
Where an invalidity benefit is both a superannuation lump sum, and a disability superannuation benefit, there are additional tax benefits available under Section 307.145 of the Income Tax Assessment Act 1997 (Cth).
The main tax benefit of Section 307.145 is that a portion of their pension becomes tax free. The proportion depends on how long they had served and how long they were to compulsory retirement age. This tax benefit is a compensation element.
Because a portion of the pension is tax free, the veteran’s assessable income is also reduced. That means many veterans receiving invalidity benefits become eligible for the Family Tax Benefit (FTB), child care rebate, and for the low-income health care card.
Proposed non-refundable tax offset
The Government’s media release proposes a new non-refundable tax offset so that recipients of invalidity pensions who would be better off in a particular income year if the invalidity pension were still treated as lump sums.
It is not clear from the media release that the tax offset will only consider the benefit gained by the 32% tax cap on superannuation lump sum or whether it will include the benefit gained by Section 307.145.
The tax benefit from Section 307.145 in most cases is substantial. It is also an administratively complex offset to calculate—the tax impact being linked to each individual’s unique service history.
Not including the benefit of Section 307.145 would be a significant loss to eligible veterans. Making it retrospective will create devastating levels of tax debt.
Including the benefit of Section 307.145 in a tax-offset means those veterans who became eligible for all or part of the Family Tax Benefit (FTB) and the low-income health care card will lose eligibility. Making that tax-offset retrospective, will mean those affected veterans will be required to repay those benefits they have lost eligibility for.
DFWA Position
DFWA supports action that addresses those veterans who have been negatively impacted by the decision in Douglas; however, will absolutely oppose any action that removes any tax or other benefits flowing from the decision in Douglas and its application to Section 307.145 ITAA.
DFWA seeks proper scrutiny of the proposed legislation and the continued implementation of the class variation and other aspects of the Douglas decision by CSC. Separately, we also seek a review of CSC administration in this area, the mistakes of which predate Douglas, particularly in calculations of tax and withholding tax and the effects on other benefits dependant on taxable income.
For more information read the main article Veteran Invalidity Benefit Taxation here.