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Ruling

Subject: Annual amount of the undeducted purchase price (UPP)

Question

Are you entitled to a deductible amount in respect of the undeducted purchase price (UPP) of your foreign pension?

Ruling

Yes, the deductible amount has been calculated in accordance with subsection 27H(2) of the Income Tax Assessment Act 1936 (ITAA 1936).

This ruling applies for the following period

2011-12 financial year

2012-13 financial year

The scheme commenced on

On or after 1 July 1983

Relevant facts

· You receive a pension from a retirement fund established and managed outside Australia.

· There is no Taxation Ruling or Taxation Determination published which provides for an alternative calculation or Commissioner's discretion under section 27H of the Income Tax Assessment Act 1936 (ITAA 1936).

· The international tax agreement between Australia and the foreign country provides that the pension is taxable in Australia.

· Your assessable income includes your pension income.

· At the commencement of the pension you also received a lump sum.

· The pension became payable on or after 1 July 1983.

· The pension is payable for life, and on your death reverts to your spouse.

· All the pension is payable to you.

· The total amount of your contributions, other than employer contributions, paid to the retirement fund towards your total retirement benefits (pension and lump sum) was provided by you, supported by documentary evidence from the provider.

· The total amount of your contributions, other than employer contributions, as being paid to the retirement fund towards your retirement benefits (pension) has been determined by the Commissioner.

· Your pension entitlement in the first 12 months of commencement of your pension was provided

· The residual capital value of the pension is nil.

· Your pension is paid on a monthly basis.

· Your pension is indexed in accordance with cost of living increases.

· The level of reversion of your reversionary pension is 50%.

Relevant legislative and regulatory provisions

Income Tax Assessment Act 1936 Subsection 27A(1)

Income Tax Assessment Act 1936 Section 27H

Income Tax Assessment Act 1936 Subsection 27H(2)

Income Tax Assessment Act 1936 Subsection 27H(3)

Income Tax Assessment Act 1936 Subsection 27H(4)

Income Tax Assessment Act 1997 Section 960-50

Income Tax Regulations 1936 Regulation 9

Income Tax Assessment Regulations 1997 Regulation 960-50.01

Superannuation Industry (Supervision) Regulations 1994

Reasons for decision

Explanation

Please note that all references to 'pension' cover both pensions and annuities

Summary

Your annual deductible amount has been calculated and will apply for the relevant financial year and all subsequent years where the facts, as stated in the ruling do not change.

Subsection 27A(1) of the ITAA 1936 contains the definition of purchase price in relation to a superannuation pension. Subparagraph (a)(ii) of that subsection states that 'purchase price' means the total amount of contributions to a superannuation fund made to obtain superannuation benefits consisting of a pension and other benefits such as a lump sum.

Where a person is entitled to both a pension and a lump sum payment, it must be determined whether the personal contributions made to the fund are 'undeducted contributions' relating to the lump sum payment, or form part of the 'purchase price' relating to the superannuation pension.

Taxation Ruling Income Tax 2272 Eligible termination payments and superannuation pensions - determination of undeducted contributions and undeducted purchase price discusses the apportioning of the contributions made to obtain both a pension and lump sum. The Ruling states that where there is no apparent basis for allocating the contributions, the apportioning of the contributions made to obtain both a pension and lump sum is to be calculated on a pro-rata basis as follows:

Purchase of pension = B ; and

(A+B)

Purchase of lump sum = A , where:

(A+B)

A is the amount of the lump sum benefit received, and

B is the present value of the pension entitlement at the time when the lump sum benefit is received

The present value of the pension is calculated based on the amount of the pension entitlement during the first 12 months after commencement of the pension.

The present value is determined in accordance with Taxation Ruling Income Tax 2620 Assessment of eligible termination payments - determination of forgone benefit part of approved early retirement scheme payments and bona fide redundancy payments made to members of pension funds and is based on Schedule 1B of the Superannuation Industry (Supervision) Regulations 1994 (SISR), under the following formula:

Present Value = AV X PVF

AV = Annual Value of Pension (ie the amount of pension payable during the first 12 months)

PVF = Pension Valuation Factor which is based on the indexation rate of your pension and your age at the commencement of the pension and whether the pension is reversionary or not and the level of reversion.

Clause 6 of Schedule 1B states that the relevant factor into which the SISR falls is to be used when the pension is indexed to movements in a price index published by the Australian Statistician i.e. for Consumer price index (CPI) indexed pensions.

A price index in an overseas country is obviously not covered by this clause. However, using the SISR for foreign pensions that are indexed to a price index that is equivalent to the CPI does not seem inappropriate. A price index in a foreign country is roughly comparable to our own CPI.

In your case we have averaged the published Retail Price Indexation percentages for the relevant country for the years X to Y, and determined the appropriate level of indexation to be between above Z% and not less than W%.

Therefore, based on the information provided, your AV and your PVF have been determined by the Commissioner. Therefore the present value of your pension is calculated as follows:

Present Value = AV x PVF

You received both a lump sum payment and a pension from your pension provider on retirement. You paid personal contributions into the fund to obtain your total retirement benefits. Therefore, some of the personal contributions would have been allocated to the lump sum benefit and some would have formed part of the purchase price of your pension.

It is necessary to determine what proportion of the total personal contributions, have been made to obtain your pension. As there is no immediately apparent basis for allocating the personal contributions made to obtain both the pension and lump sum benefit, the proportion of the total personal contributions attributable to the pension from your pension provider is determined as follows:

Purchase of pension:

B

(A + B)

= 0.XXXX (or XX.XX%)

This percentage is applied to your total contributions paid to determine the purchase price of your pension benefit.

Therefore, the amount of personal contributions determined as being made by you to obtain your pension from your pension provider is the amount of personal contributions x this percentage.

Section 27H of the ITAA 1936 operates to include in assessable income the amount of any pension derived by a taxpayer during a year of income reduced by the deductible amount.

The deductible amount is deemed to be a return of part of your contribution towards the purchase of the pension.

The calculation of the deductible amount is based on the UPP of your pension.

The UPP is the amount you contributed towards the purchase price of your pension for which you did not claim, and were not eligible to claim, a tax deduction in Australia. Contributions made by an employer or by another person under an agreement to which the employer was a party, cannot form part of the UPP of the pension.

Under subsection 27H(2) of the ITAA 1936, the annual deductible amount of a superannuation pension is ascertained in accordance with the formula:

A (B - C)

D

where:

A = is the relevant share of the pension payable to the taxpayer in relation to the year of income (if all of the pension is payable to the taxpayer, A = 1)

B = is the amount of the UPP of the pension as calculated under IT 2272

C = is the residual capital value, and

D = is the relevant number in relation to the pension.

Under subsection 27H(4) of the ITAA 1936, when a pension is payable during the lifetime of a person, the 'life expectation factor' is to be used as the relevant number.

Regulation 9 of the Income Tax Regulations 1936 states that for the purposes of the definition of life expectation factor in subsection 27H(4) of the ITAA 1936, the Australian Life Tables published by the Australian Government Actuary are to be used.

The factors for determining the life expectancy are:

(1) the date when the pension first became payable, and

(2) your age when the pension commenced, and

(3) your spouse's age when the pension commenced.

By substituting your relevant information into the formula:

The annual deductible amount (rounded) is obtained.

Your annual deductible amount of the UPP will apply for the relevant and subsequent income years.

Paragraph 2 of Taxation Determination TD 2006/17 Income tax: is the deductible amount that is excluded from assessable income when a superannuation pension or annuity is paid reduced when the pension or annuity commences or finishes being paid to a taxpayer part-way through an income year?, states that where a pension has commenced or finished during an financial year, the deductible amount should be determined under subsection 27H(3) of the ITAA 1936. The deductible amount in these circumstances is the amount that would be calculated under subsection 27H(2) of the ITAA 1936 apportioned in accordance with the number of days the pension was payable to you in that year.

Therefore, the part year deductible amount has been apportioned for the relevant financial year:

For the 2003-04 and subsequent financial years, subsection 960-50(1) of the Income Tax Assessment Act 1997 (ITAA 1997) requires an amount in a foreign currency to be translated into Australian currency. Subsection 960-50(4) of the ITAA 1997 further requires any foreign currency elements in a calculation to be translated before the final amount is worked out.

In accordance with the currency translation rules contained in section 960-50 of the ITAA 1997 and clarified in Taxation Determination TD 2006/54 Income tax: how does a taxpayer work out the amount to be included in assessable income under section 27H of the Income Tax Assessment Act 1936 for a superannuation pension or annuity that is payable in a foreign country?, pensions received in foreign currency should be translated to Australian currency on the following basis:

(a) if the amount is received at or before the time when it is derived - the amount is to be translated to Australian currency at the exchange rate applicable at the time of receipt; or

(b) in any other case - the amount is to be translated to Australian currency at the exchange rate applicable when it is derived.

As a general rule, the deductible amount is translated to Australian currency using the same exchange rate applying to the pension.

Alternatively, regulation 960-50.01 of the Income Tax Assessment Regulations 1997 (ITAR 1997) and Schedule 2 to the ITAR 1997 allow pensions received in foreign currency and the deductible amount to be translated to Australian currency at the average exchange rate for the financial year. This is provided the conditions outlined in Schedule 2 to the ITAR 1997 are satisfied.

Where the pension is received as a series of payments over the course of the financial year, and provided the average exchange rate is considered a reasonable approximation of the exchange rates, the conditions outlined in Schedule 2 to the ITAR 1997 will be satisfied.

In your case, as your pension is paid monthly, you may use the average exchange rate to translate your pension income and the deductible amount of your UPP.

The average exchange rates are available from our superannuation information line on 13 10 20 or visit our website at www.ato.gov.au/super.

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