Edited version of private ruling

Authorisation Number: 1011638327402

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Ruling

Subject: Assessability of Retained Earnings in Pension and Provident Preservation Funds

Question 1

Are you assessable on the increase in the value in your Preservation Pension Plans and Provident Preservation Funds in Country X under subsection 6-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The increase in the value in your Pension and Provident Preservation Funds is to be included in your assessable income pursuant to section 529 of the Income Tax Assessment Act 1936 (ITAA 1936) and ssubsection 6-10(4) of the ITAA 1997.

This ruling applies for the following period:

1 July 2009 to 30 June 2010

Relevant facts and circumstances

You are a resident of Australia for tax purposes.

Having previously lived and worked in Country X, you had accumulated 2 provident funds and 3 pension funds (similar to superannuation funds), membership of which had been mandatory with your previous employers. In conformance with the pension and tax laws of Country X, these funds have been rolled into Preservation Pension Plans and Preservation Provident Funds.

The Preservation Pension Plans and Preservation Provident Funds are not maintained by your employer.

You have not yet retired, and do not physically receive any income from these plans and funds.

You plan to leave the Preservation Pension Plans and Preservation Provident Funds in place until such time as you retire, at which time they would be converted into annuities which can be remitted to your bank account in Australia.

The operation of these plans and funds in Country X is as follows:

A Country X Pension fund (of which a Provident fund is a slightly different subset of a Pension Fund and a Preservation Fund is a further subset where contributions have ceased being made to the fund and it continues as a 'paid up investment') is similar to a Trust - in which assets are at all times under the control of the Trustees and are designated for the eventual benefit of a specified beneficiary of the Pension Fund, but are not (at the time the assets reside in the Pension Fund) assets of the beneficiary.

They are assets of the legal entity - the Pension Fund. All earnings and growth of the assets whilst in the Pension Fund are dealt with as assets of the Fund and are dealt with according to any from time to time prevailing tax applicable only to a pension fund.

The assets in the Pension Fund are totally protected from creditors of the beneficiary in the event of sequestration or insolvency again highlighting that they are at the time they are In the Pension Fund not assets of the designated beneficiary.

Only when such assets leave the Pension Fund and amounts are then paid to the beneficiary does income or capital so paid become subject to the taxation applicable in Country X to such income or capital payments from the fund and such taxation is different as to whether the payment is a withdrawal of the assets or a payment in respect of the beneficiaries retirement from the Fund.

Whilst the assets are in the Pension Fund, the eventual beneficiary has rights enabling them to specify where the assets are from time to time to be invested on behalf of the beneficiary, by the Trustees of the Pension Fund.

Similarly the eventual beneficiary is enabled to choose the retirement annuity income to be paid from time to time from the Funds during their retirement.

Only when money is physically paid to the beneficiary does it become the beneficiary's income or asset and only then is it for the first time ever in Country X subject to the applicable personal taxation at that date and according to the nature of the payment the rate of tax differs. Capital gains that accrued whilst the assets were in the Pension Fund are free of Capital Gains Tax in Country X.

Accordingly, there is no requirement for Pension Funds in Country X to Issue certificates showing from where any growth in the assets has been derived (dividends, interest or capital growth). They only issue statements showing the value of the investment at any requested date and any costs recovered.

When the taxpayer resides permanently outside of Country X and is no longer subject to tax on income in Country X, annuity payments are able to be retained in Country X or remitted to any other jurisdiction worldwide and the beneficiary is then regarded as being in receipt of that income in the jurisdiction where they then reside and is accordingly taxed on such income in that jurisdiction where they reside as taxpayers and are not taxed on that income in Country X.

The assets in your Preservation Pension Plans and Preservation Provident Funds are not considered part of your Estate in Country X, in terms of the Pension Fund Act, and are not subject to personal tax in Country X.

You are only considered to be the owner of these assets in the event of withdrawal from the fund, and will only be in receipt of income from the fund following retirement.

The total value of your interests in your Preservation Pension Plans and Preservation Provident Funds is in excess of A$50,000.

The scheme that is the subject of this Private Ruling as described above also incorporates the documents which you have provided.

These documents indicate that:

§ the objective of the Fund is to provide benefits for members on their retirement or upon the

§ death of such members, to provide benefits for their dependents and/or nominees;

§ the management, control and administration of the fund vest in the Board of Trustees of the Fund;

§ in pursuing its objectives, the Board shall take all reasonable steps to ensure that the interest of the members in terms of the rules and the provisions of the relevant Act are protected at all times. The Board is also required to act with due care, diligence and good faith in its duties;

§ the Board has the power to make investments, to realise, vary, reinvest or otherwise deal with securities;

§ the investment of assets of the Fund in a particular portfolio will be made in accordance with the election of the members of the Fund. Where a member fails to select a portfolio, the assets attributable to the applicable member will be allocated to a portfolio selected by the Board.

Relevant legislative provisions

Income Tax Assessment Act 1936

section 6(1)

section 470
subsection 481(1)
subsection 481(3)
subsection 483(2)
section 519

section 529

Income Tax Assessment Act 1997

section 6-10

subsection 6-10(4)

section 10-5

Does Part IVA apply to this ruling?

Part IVA of the ITAA 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The increase in the value in your Preservation Pension Plans and Preservation Provident Funds is to be included in your assessable income pursuant to section 529 of the ITAA 1936 and subsection 6-10(4) of the ITAA 1997.

Detailed reasoning

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Subsection 6-10(4) of the ITAA 1997 provides that the assessable income of an Australian resident includes statutory income from all sources, whether in or out of Australia.

Section 10-5 of the ITAA 1997 lists certain statutory amounts that form part of assessable income. Included in this list is section 529 of the ITAA 1936, which deals with the attributable income from foreign investment funds (FIFs).

Application of the FIF measures

The FIF measures are contained in Part XI of the ITAA 1936 (the operative provision being section 529). These measures apply to taxpayers who have an interest or interests in a FIF at the end of a year of income and were Australian residents at any time in that year of income. Australian resident taxpayers who have interests in foreign FIFs, may be subject to tax on an accruals basis on the growth in the value of their FIF.

To determine whether a taxpayer has an interest in a FIF, it is first necessary to establish whether a FIF exists.

According to subsection 481(1) of the ITAA 1936, an entity is a FIF at a particular time if, at that time, the entity is a 'foreign company' or a 'foreign trust'.

It is considered that the Preservation Pension Plans and Preservation Provident Funds established are not foreign companies as defined in section 481 of the ITAA 1936. However, each of the arrangements may constitute a 'foreign trust' as defined in subsection 481(3) of the ITAA 1936.

A 'foreign trust' is defined in subsection 481(3) of the ITAA 1936 accordingly:

A trust is a foreign trust at a particular time if:

(a) at that time the trust is neither an Australian trust nor a resident superannuation entity; and

(b) the trust did not result from:

(i)   a will, a codicil or an order of a court that varied or modified the provisions

of a will or a codicil, or

(ii) an intestacy or an order of a court that varied or modified the application, in relation to the estate of a deceased person, of the provisions of the law relating to the distribution of the estates of persons who die intestate.

The first requirement in the definition is that there is a 'trust'.

A 'trust' is defined in section 470 of the ITAA 1936 for the purposes of Part XI of the ITAA 1936 to mean:

(a) an entity in the capacity of trustee (including an entity that manages a trust if there is no trustee); or

(b) as the case requires, a trust or a trust estate.

In considering whether each of the Preservation Pension Plans and Preservation Provident Funds is a 'trust', consideration must be given as to whether the Board which manages, controls and administers each of the Funds is 'an entity in the capacity of trustee'.

For the Board which manages, controls and administers each of the Funds to be 'an entity in the capacity of trustee', it is necessary for it to come within the definition of 'trustee' and it must also be established that a trust relationship exists between the Board and the individual taxpayer.

'Trustee' is defined in subsection 6(1) of the ITAA 1936 as follows:

trustee in addition to every person appointed or constituted trustee by act of parties, by order, or declaration of a court, or by operation of law, includes:

(a) an executor or administrator, guardian, committee, receiver, or liquidator; and

(b) every person having or taking upon himself the administration or control of income affected by any express or implied trust, or acting in any fiduciary capacity, or having the possession, control or management of the income of a person under any legal or other disability.

'Trustee' is also defined in section 470 of the ITAA 1936 as 'in relation to a fund that has no trustee, means the person who manages the fund'.

'Person' is defined in subsection 6(1) of the ITAA 1936 to include a company.

French J in Harmer & Ors v. FC of T 89 ATC 5180; (1989) 20 ATR 1461 ( Harmer ) stated that a trust 'is notably a definition of a relationship by reference to obligations'. He went on to state that the four essential elements of a trust are:

1. the trustee who holds a legal or equitable interest in the trust property;

2. the trust property which must be property capable of being held on trust and which includes a chose in action;

3. one or more beneficiaries other than the trustee; and

4. a personal obligation on the trustee to deal with the trust property for the benefit of the beneficiaries, which obligation is also annexed to the property.

In the present case, there is an agreement between you and each of the Funds (or the Boards of the Funds who manage, control and administer the Funds) for each of the Funds to hold and invest certain property for your benefit and your nominated beneficiary.

Each of the Funds has legal ownership and possession of the relevant property. The terms of the agreement impose on the Boards of the Funds, a personal obligation to deal with the relevant property for your benefit and your nominated beneficiary.

Therefore, the Board which manages, controls and administers each of the Funds is a 'trustee' in relation to the relevant property.

The relevant property consists of the contributions made by you to each of the Funds (plus profits) and constitutes the 'trust property', because of the obligation owed by the Board which manages, controls and administers the Funds to you in relation to that property.

You are a 'trust beneficiary', as it is for your benefit that the trust property is held. Your nominated beneficiary is another class of potential trust beneficiary.

Having regard to the relationship between the Board which manages, controls and administers the Funds and you under the agreement, there is an express intention that the Board holds the property, not exclusively for itself, but subject to an equitable 'obligation'. Therefore, the relationship constitutes an express trust.

All four elements of a trust as outlined in Harmer are present so there is a 'trust' as required by subsection 481(3) of the ITAA 1936. The Board of each of the Funds, because it is acting as a trustee, is (under the definition of 'entity' in paragraph 470(c) of the ITAA 1936) 'a person in the capacity of trustee'.

The Board which manages, controls and administers each of the Funds is a 'trustee' in accordance with the definition in subsection 6(1) of the ITAA 1936, as it is a person having or taking upon itself the administration or control of income affected by any express or implied trust and is also acting in a fiduciary capacity. There is a clear trust relationship between the Board and you.

Note that, even if the Board was not a 'trustee' under the definition in subsection 6(1) of the ITAA 1936, the Board would be a 'trustee' as defined in section 470 of the ITAA 1936, because it would be 'the person who manages the fund'.

Having established that there is a trustee and a trust, the next requirement is for each of the Preservation Pension Plans and Preservation Provident Funds to be a 'foreign trust'. For this to be the case, each of the Preservation Pension Plans and Preservation Provident Funds must be neither an 'Australian trust' nor a 'resident superannuation entity'.

The Preservation Pension Plans and Preservation Provident Funds are neither an 'Australian trust' nor a 'resident superannuation entity'. They did not result from any of the means described in paragraph 481(3)(b) of the ITAA 1936, that is, such as resulting from a will or codicil, or an order of a court that varied or modified the provisions of a will or a codicil.

Accordingly, each of the Preservation Pension Plans and Preservation Provident Funds qualifies as a 'foreign trust' and is therefore a FIF at the end of the year of income under subsection 481(3) of the ITAA 1936.

Subsection 483(2) of the ITAA 1936 provides that a taxpayer has an 'interest' in the FIF that is the foreign trust where that individual has an:

(a) an interest in the corpus or income of the trust (including, in the case of a unit trust, an interest constituted by a unit in the unit trust); or

(b) an option, convertible note, or other instrument, that confers an entitlement to acquire an interest referred to in paragraph (a).

As the trust created by each of the Preservation Pension Plans and Preservation Provident Funds is 'a FIF that is a foreign trust', and you have an interest in the corpus or income of each of the trust, then you have 'an interest in a FIF that is a foreign trust' for the purposes of subsection 483(2) of the ITAA 1936.

Therefore, your interest in a foreign trust that is a FIF will be subject to attribution under Part XI of the ITAA 1936 unless one of the exemptions to the FIF rules applies.

Under section 519 of the ITAA 1936, a specific exemption is available for a natural person with an interest in a FIF that is an employer-sponsored superannuation fund. The FIF must be a superannuation fund maintained by the taxpayer's employer or an associate of the employer, for the benefit of their employees. Also, the taxpayer must be an employee or former employee of the employer.

In the present case, the interest in each of the Preservation Pension Plans and Preservation Provident Funds does not satisfy the requirements for the exemption from the FIF measures as the Preservation Pension Plans and Preservation Provident Funds Pension Preservation Fund are not maintained by your employer or an associate of the employer.

Therefore the increase in the value in your Preservation Pension Plans and Preservation Provident Funds is to be included in your assessable income pursuant to section 529 of the ITAA 1936 and subsection 6-10(4) of the ITAA 1997.

Other Matters for your consideration:

The following guidance is also provided in relation to the operation of the foreign investment fund (FIF) measures.

Methods of FIF taxation

There are three methods that can be used to determine the FIF income that have accrued to you in a particular income year. These are:

1. the market value method

2. the deemed rate of return method; or

3. the calculation method.

It is expected that the majority of taxpayers who will be liable to tax under the FIF measures will use the market value method to work out the FIF income to include in their assessable income.

The deemed rate of return method is used only where you are unable to establish a market value for your FIF interest and you have not elected to use the calculation method.

The calculation method may be used if you have access to the financial accounts of the FIF and are able to determine your share of the FIFs calculated profit or calculated loss. The calculation method uses a simplified version of our taxation law to work out the profit of your FIF that is then attributed to you and included in your assessable income.

If there has been a calculated FIF loss under the market value method or the calculation method from a previous year of income, you may use the loss to reduce the income of the same FIF in the year of income to which the Private Ruling relates.

To assist with the calculation of your FIF income, please refer to Chapter 4 of the publication Foreign Investment Funds Guide 2009 -10 (NAT 2130). The publication can be downloaded from our website at www.ato.gov.au. You should type 'foreign investment funds guide' in the search dialogue box.

Repeal of FIF measures

The FIF measures which are the subject of the Private Ruling were repealed as part of broader reforms to Australia's foreign source income anti-tax-deferral (attribution) rules that were announced as part of the 2009-10 Federal Budget. The repeal applies from the 2010-11 income year.

As the FIF measures have been repealed, unapplied FIF losses cannot be carried forward to be recouped from assessable income from the income year commencing 1 July 2010.

Relief from double taxation

A distribution made by a FIF to a taxpayer will be exempt to the extent that the distribution was paid out of profits which were previously attributed to the taxpayer. Notwithstanding the repeal of the FIF measures, amounts previously taxed under the FIF rules will continue to be exempt from further tax upon their subsequent distribution.