Edited version of private ruling

Authorisation Number: 1011864529349

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Ruling

Subject: Salary sacrifice and undeducted purchase price

Question

Is a salary sacrifice contribution to a foreign superannuation fund considered to be a personal contribution for the purposes of determining the undeducted purchase price (UPP) of the foreign pension where fringe benefits tax has been paid?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 1998

Year ended 30 June 1999

Year ended 30 June 2000

Year ended 30 June 2001

Year ended 30 June 2002

Year ended 30 June 2003

Period 1 July 2003 to 31 March 2004.

The scheme commences on:

1 July 1997.

Relevant facts and circumstances

Your client was previously a resident of a foreign country, and is now living and working in Australia.

When your client commenced working in Australia over a decade ago, they became a resident of Australia for tax purposes.

At this time your client was employed by an entity based in the foreign country. You state that in accordance with Australian superannuation guarantee legislation, the foreign employer was required to pay superannuation benefits.

The foreign employer continued to make contributions to a pension fund in the foreign country for your client's benefit, as to cease these contributions and surrender the policy would have resulted in financial disadvantage to your client in the future.

Your client's total remuneration package was structured so the fringe benefits tax (FBT) payable by the foreign employer on these contributions was taken out of their total salary package, which in turn reduced the net cash in hand your client received.

You advise that as a result of your client's salary sacrifice arrangement, the amount incorporated as part of the remuneration package was effectively double the amount which was actually contributed by the foreign employer to the pension fund due to the operation of the FBT legislation. You state that your client has borne the liability to taxation upon the contribution to the pension fund, rather than the foreign employer.

You further advise that assuming a contribution was made to the foreign superannuation fund, FBT would be payable on the contribution based on a FBT gross-up of a specified percentage and a tax rate of 48.5%. You also state that your client's remuneration package therefore would have been reduced by the amount of the contribution plus the amount of the FBT that was payable.

Your client commenced working for an Australian employer several years ago, and after this time future superannuation contributions were made to an Australian resident superannuation fund.

Any contributions made in the 12 month period prior to your client commencing employment with the Australian employer were reimbursed by your client to the foreign employer. You advise that these contributions can be included in the calculation of the deductible amount under subsection 27H(2) of the Income Tax Assessment Act 1936 (ITAA 1936) and are not the subject of this application. Hence the period during which contributions were made to the foreign pension fund for which clarification is being sought is the period stated in the Notice of Private Ruling.

Your client first received a pension payment from the foreign pension fund in an income year that commenced after 1 July 2007. You state that the pension is taxable in your client's hands because your client is an Australian resident, in accordance with the applicable Double Tax Agreement (DTA) between Australia and the foreign country. You advise that if your client was to return to the foreign country and cease being an Australian resident, the payments your client received from the pension fund would not be taxed in Australia.

You state that as a result of this treatment, the payments your client is receiving from the foreign pension fund have been taxed at two points. Extending the example set out above where a contribution was made to the foreign superannuation fund, when the amount of the contribution was returned to your client as a pension payment and is included in their assessable income, tax would be paid on this payment at a rate of 46.5% (including Medicare levy). You assert that the overall tax paid would equal the FBT that was paid plus the income tax payable on the pension, and that the overall effective tax rate on the pension is more than three times the relevant tax rate.

No entity has included the contributions made to the foreign pension fund as an allowable deduction, and will not include the contributions as an allowable deduction in the future, because the employer is a foreign entity based in the foreign country.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 27A(1).

Income Tax Assessment Act 1936 Subsection 27A(5C).

Income Tax Assessment Act 1936 Paragraph 27A(5C)(a).

Income Tax Assessment Act 1936 Section 27H.

Income Tax Assessment Act 1936 Subsection 27H(1).

Income Tax Assessment Act 1936 Paragraph 27H(1)(a).

Income Tax Assessment Act 1936 Subsection 27H(2).

Income Tax Assessment Act 1936 Subsection 27H(3).

Income Tax Assessment Act 1936 Subsection 27H(3A).

Income Tax Assessment Act 1936 Subsection 27H(4).

Income Tax Assessment Act 1936 Subsection 27H(5).

Reasons for decision

Summary

The contributions made to the foreign superannuation fund by the foreign employer under a salary sacrifice arrangement (SSA) are considered to be employer contributions made for your client's benefit and are not considered to be personal contributions.

Employer contributions are specifically excluded from the definition of 'purchase price'.

Accordingly, the employer contributions made to the foreign superannuation fund under the SSA do not form part of the undeducted purchase price of the pension paid.

The Commissioner cannot exercise the discretion to determine a deductible amount for the pension which includes the employer contributions made to the foreign fund.

Detailed reasoning

Taxation of foreign superannuation pensions prior to 1 July 2007

Before 1 July 2007, section 27H of the Income Tax Assessment Act 1936 (ITAA 1936) included in assessable income amounts of annuities or superannuation pensions, including pensions paid from a foreign superannuation fund (or eligible non-resident non-complying superannuation fund, as they were referred to then). The annuity and pension payments received by a person in each year (reduced by the deductible amount in the case of purchased annuities and pensions) were included in the person's assessable income for that year and were taxed at marginal rates.

Prior to 1 July 2007 the term 'annuity' was defined under subsection 27H(4) of the ITAA 1936 as:

annuity includes:

(a) a superannuation pension; and

(b) a pension or annuity paid from a fund that is an eligible non-resident non-complying superannuation fund when the payment is made;

but does not include an annuity that is a qualifying security for the purposes of Division 16E.

Subsection 27H(1) of the ITAA 1936 provided that a person's assessable income in a year of income included the amount of any annuity received during the year of income after excluding, in the case of a purchased annuity, the 'deductible amount' in relation to the annuity for that year of income. Any supplement to the annuity, whether voluntary or not, was also included in the taxpayer's assessable income.

Subsection 27H(2) of the ITAA 1936 sets out the formula for calculating the deductible amount of an annuity that is excluded from assessable income in accordance with paragraph 27H(1)(a). The formula applies both before and after 1 July 2007. The deductible amount calculated by this formula represents the undeducted purchase price (UPP) of the annuity reduced by its residual capital value (RCV), if any, and apportioned over the term for which the annuity was to be paid or could reasonably be expected to be paid.

If the Commissioner considers that the deductible amount calculated under subsection 27H(2) of the ITAA 1936 is inappropriate, he may substitute another amount. The circumstances and manner in which the Commissioner will exercise this discretion are set out in subsections 27H(3) and 27H(3A).

Purchase Price and UPP

The term 'purchase price' for the purposes of section 27H of the ITAA 1936 is defined in former subsection 27A(1) and is the starting point for determining the UPP of an annuity. Former subsection 27A(1) defined 'purchase price' as meaning:

(a) in relation to a superannuation pension - the sum of-

(i) contributions made by any person to a superannuation fund to obtain superannuation benefits consisting only of the superannuation pension; and

(ii) so much as the Commissioner considers reasonable of contributions made by any person to a superannuation fund to obtain superannuation benefits including the superannuation pension; and

…

However, this definition was subject to modification by former subsection 27A(5C) of the ITAA 1936, which applied to contributions made to a superannuation fund after 23 May 1985.

Former subsection 27A(5C) of the ITAA 1936 states that in the definition of 'purchase price' in former subsection 27A(1):

(a) a reference to contributions made by any person to a superannuation fund to obtain superannuation benefits does not include a reference to contributions made to a superannuation fund by an employer, or by another person under an agreement to which the employer is a party, for the purpose of providing superannuation benefits for, or for dependants of, an employee of the employer; and

(b) a reference to payments made to purchase, or solely to purchase, an annuity does not include a reference to payments made by an employer, or by another person under an agreement to which the employer is a party, to purchase, or solely to purchase, an annuity for, or for dependants of, an employee of the employer.

Consequently, as a result of the application of former paragraph 27A(5C)(a) of the ITAA 1936, only the member's contributions to a superannuation fund will qualify as forming the purchase price of a pension paid by a superannuation fund (foreign or domestic).

Former subsection 27A(5C) of the ITAA 1936 was applicable to the income years up to and including the 2006-07 income year. From 1 July 2007, this former provision was replaced by subsection 27H(5) of the ITAA 1936.

Contributions made under a salary sacrifice arrangement

Under your client's SSA with the foreign employer, the foreign employer made contributions to a pension fund in a foreign country for your client's benefit.

The Commissioner has issued Taxation Ruling TR 2001/10 which deals with SSAs. In paragraph 21, the Commissioner defines an effective SSA as involving the employee agreeing to receive part of their total remuneration as benefits before the employee has earned the entitlement to receive that amount as salary or wages. In this case, the SSA under which the foreign employer made the contributions was an integral part of your client's employment contract. Consequently, your client's SSA was an effective SSA.

In paragraph 34 of TR 2001/10 the Commissioner states that superannuation contributions made by an employer under an effective SSA are properly considered as employer contributions to the superannuation fund or retirement savings account for the purposes of the Superannuation Guarantee (Administration) Act 1992. This applies whether the employer derives assessable income or is engaged in a business, or does not derive assessable income or is not engaged in a business.

In light of paragraph 34 of TR 2001/10, a salary sacrifice superannuation contribution is considered to be an employer contribution, not an employee contribution. As such, the contributions made to the foreign pension fund under the SSA are not considered to be personal contributions made by your client. Rather, these contributions are considered to be contributions made by the foreign employer for your client's benefit.

Notwithstanding that fringe benefits tax may have been paid by your client in relation to these contributions, the contributions are considered to be employer contributions.

Commissioner's discretion under subsection 27H(3) of the ITAA 1936

The discretion available under subsection 27H(3) of the ITAA 1936 is to be used where the Commissioner is of the opinion that the deductible amount ascertained under subsection 27H(2) is inappropriate.

Subsection 27H(3) of the ITAA 1936 states:

Subject to subsection (3A), where the Commissioner is of the opinion that the deductible amount ascertained in accordance with subsection (2) is inappropriate having regard to:

(a) the terms and conditions applying to the annuity; and

(b) such other matters as the Commissioner considers relevant,

the deductible amount in relation to the annuity derived by the taxpayer during the year of income is so much of the annuity as, in the opinion of the Commissioner, represents the undeducted purchase price having regard to:

(c) the terms and conditions applying to the annuity;

(d) any certificate or certificates of an actuary or actuaries stating the extent to which, in the opinion of the actuary or actuaries, the amount of the annuity derived by the taxpayer during the year of income represents the undeducted purchase price; and

(e) such other matters as the Commissioner considers relevant.

As can be seen the discretion operates to vary the deductible amount that would otherwise be determined under subsection 27H(2) of the ITAA 1936. It does not allow the Commissioner to vary, or substitute another amount for, the UPP.

Accordingly, the Commissioner is unable accede to your request to exercise the discretion in subsection 27H(3) of the ITAA 1936 to include the salary sacrifice contributions as part of the UPP of the foreign pension.

Subsection 27H(3A) of the ITAA 1936 authorises the Commissioner to reduce the deductible amount that would otherwise be excluded from an annuity or pension upon assessment. The reduction may take place only following a partial commutation of a larger annuity or pension of which the annuity or pension being assessed forms a part. Therefore, subsection 27H(3A) would have no application in this case.

Conclusion

In view of all the above, the contributions made to the foreign pension fund by the foreign employer under your client's SSA are not considered to form part of the UPP of the foreign pension. This is because former paragraph 27A(5C)(a) provides that employer contributions made to a foreign superannuation fund are not included in the purchase price of the pension.

Further, the Commissioner cannot accede to your request to exercise the discretion in subsection 27H(3) of the ITAA 1936 and determine a deductible amount for the pension which includes the employer contributions made to the foreign fund.