Edited version of your private ruling

Authorisation Number: 1012117731914

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Lump sum payment from a foreign fund

Questions

1. Is any part of the lump sum payment paid to your client from a foreign retirement fund included as assessable income under section 305-70(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Does the foreign annuity include a deductible amount?

Answers

1. Yes.

2. Yes.

This ruling applies for the following period

For the year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Over 20 years ago, your client became a member of a retirement annuity policy with an overseas retirement annuity fund (Overseas Fund 1).

Prior to relocation to Australia, your client and the overseas employer made contributions to Overseas Fund 1.

All premiums paid on the policy were funded from your client's after tax personal income. In the overseas country, at maturity, your client would be entitled to take one-third in cash tax free and the remaining two-thirds would constitute an annuity and include tax.

In the third quarter of the 2001-02 income year, your client and your client's family came to Australia and became an Australian resident for tax purposes (the residency day). Prior to this date your client was a resident of the overseas country.

Your client's total benefits as at a date shortly after your client became a resident of Australia has been provided.

Prior to becoming an Australian resident your client made regular monthly premiums (contributions) to Overseas Fund 1 whilst living in the overseas country and made several additional lump sum contributions during this time (collectively the overseas contributed amount).

Since becoming an Australian resident, your client continued to pay regular monthly contributions to Overseas Fund 1 (post-residency contributed amount).

Under the rules of Overseas Fund 1 it provides benefits to be made to a member:

· after attaining age 55;

· on attaining their normal retirement date at age 60;

· as a result of the member's total and permanent disablement; or

· upon death.

In 2008, the rules of Overseas Fund 1 were amended such that if a person has formally emigrated from the overseas country and the policies have not yet matured, on maturity, the full value of the policy less tax, could be remitted overseas.

As required by the overseas exchange control authorities these payments would be paid directly into a bank account in the overseas country after tax had been deducted.

In the second quarter of the 2009-10 income year, your client elected to take out one-third cash commutation of benefits and purchased an annuity with the remaining balance of benefits with quarterly payments being made in advance each year to your client.

In the second quarter of the 2009-10 income year, a lump sum payment was made to your client from Overseas Fund 1 with an amount of tax withheld.

During the second quarter of the 2009-10 income year, the fund underwriter confirmed that your client's benefits were paid to Overseas Fund 2 and that they would be responsible for all future payments. The payments may be greater than the total retirement benefits and amount taken in cash, less the tax amount withheld.

In the fourth quarter of the 2010-11 income year, the overseas fund underwriter issued a document which confirmed an amount, with a small charge being deducted, was transferred from Overseas Fund 2 to Overseas Fund 3 in the second quarter of the 2009-10 income year to purchase an annuity product. This product commenced paying an annuity that appears to be payable annually in the second quarter of each income year.

A submission of an overseas Income Tax Return for the 2010 income year to the overseas country's taxation authority was required with the assessment issuing to your client in the third quarter of the 2010-11 income year.

Your client's tax certificate from the overseas country shows the value of the retirement benefit with an amount of tax withheld.

Your client's life expectancy is based on your client's age at the time the annuity commenced.

Assumptions

The Tax Office accepts that the transfer value in respect of your client's benefits in Overseas Fund 1 as at the residency date, is the same amount as shown a few days later.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 27H.

Income Tax Assessment Act 1936 Subsection 27H(2.

Income Tax Assessment Act 1997 Subsection 295-95(2).

Income Tax Assessment Act 1997 Subdivision 305-B.

Income Tax Assessment Act 1997 Section 305-70.

Income Tax Assessment Act 1997 Section 305-75.

Income Tax Assessment Act 1997 Subsection 305-75(2).

Income Tax Assessment Act 1997 Subsection 305-75(3).

Income Tax Assessment Act 1997 Division 770.

Income Tax Assessment Act 1997 Subsection 770-10(1).

Income Tax Assessment Act 1997 Section 770-75.

Income Tax Assessment Act 1997 Subsection 960-50(1).

Income Tax Assessment Act 1997 Subsection 960-50(4).

Income Tax Assessment Act 1997 Subsection 995-1(1).

Superannuation Industry (Supervision) Act 1993 Section 10.

Superannuation Industry (Supervision) Act 1993 Section 19.

Superannuation Industry (Supervision) Act 1993 Section 62.

Question 1

Summary

A portion of the benefits your client received from Overseas Fund 1 is assessable as 'applicable fund earnings'.

The amount calculated under the formula as the applicable fund earnings is to be included in your client's assessable income for the 2009-10 income year and will be subject to your client's marginal rate of tax.

Detailed reasoning

Lump sum payments from foreign superannuation funds

The applicable fund earnings in relation to a lump sum payment from a foreign superannuation fund that is received more than six months after a person has become an Australian resident will be assessable under section 305-70 of the Income Tax Assessment Act 1997 (ITAA 1997).

The applicable fund earnings is subject to tax at the person's marginal rate. The remainder of the lump sum payment is not assessable income and is not exempt income.

The applicable fund earnings is the amount worked out under either subsection 305-75(2) or (3) of the ITAA 1997. Subsection 305-75(2) applies where the person was an Australian resident at all times during the period to which the lump sum relates. Subsection 305-75(3) applies where the person becomes an Australian resident after the start of the period to which the lump sum relates.

Before determining whether an amount is assessable under section 305-70 of the ITAA 1997, it is necessary to ascertain whether the payment is being made from a foreign superannuation fund. If the entity making the payment is not a foreign superannuation fund then section 305-70 will not have any application.

Foreign superannuation fund

A foreign superannuation fund is defined in subsection 995-1(1) of the ITAA 1997 as follows:

(a) a superannuation fund is a foreign superannuation fund at a time if the fund is not an Australian superannuation fund at that time; and

(b) a superannuation fund is a foreign superannuation fund for an income year if the fund is not an Australian superannuation fund for the income year.

Subsection 295-95(2) of the ITAA 1997 defines Australian superannuation fund as follows:

A superannuation fund is an Australian superannuation fund at a time, and for the income year in which that time occurs, if:

(a) the fund was established in Australia, or any asset of the fund is situated in Australia at that time; and

(b) at that time, the central management and control of the fund is ordinarily in Australia; and

(c) at that time either the fund had no member covered by subsection (3) (an active member) or at least 50% of:

(i) the total market value of the fund's assets attributable to superannuation interests held by active members; or

(ii) the sum of the amounts that would be payable to or in respect of active members if they voluntarily ceased to be members;

is attributable to superannuation interests held by active members who are Australian residents.

Accordingly, the definitions of a 'foreign superannuation fund' and Australian superannuation fund both incorporate the requirement of being a 'superannuation fund'.

The effect of these definitions is that if Fund 1 is not a 'superannuation fund', it will not be an Australian superannuation fund or a foreign superannuation fund. Nor can the amount paid to your client be a 'superannuation lump sum' and subdivision 305-B of the ITAA 1997 will not apply.

Therefore, we are first required to determine if Fund 1 is a superannuation fund under the ITAA 1997.

Superannuation fund

'Superannuation fund' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 10 of the Superannuation Industry (Supervision) Act 1993 (SISA).

Subsection 10(1) of the SISA provides that:

superannuation fund means:

(a) a fund that:

(i) is an indefinitely continuing fund; and

(ii) is a provident, benefit, superannuation or retirement fund; or

(b) a public sector superannuation scheme.

Provident, benefit, superannuation or retirement fund

The High Court examined both the terms superannuation fund and fund in Scott v Commissioner of Taxation of the Commonwealth (No. 2) (1966) 10 AITR 290; (1966) 40 ALJR 265; (1966) 14 ATD 333 (Scott). In that case, Justice Windeyer stated:

…I have come to the conclusion that there is no essential single attribute of a superannuation fund established for the benefit of employees except that it must be a fund bona fide devoted as its sole purpose to providing for employees who are participants money benefits (or benefits having a monetary value) upon their reaching a prescribed age. In this connexion "fund", I take it, ordinarily means money (or investments) set aside and invested, the surplus income therefrom being capitalised. I do not put this forward as a definition, but rather as a general description.

The issue of what constitutes a provident, benefit, superannuation or retirement fund was discussed by the Full Bench of the High Court in Mahony v Commissioner of Taxation (Cth) (1967) 41 ALJR 232; (1967) 14 ATD 519 (Mahony). In that case, Justice Kitto held that a fund had to exclusively be a 'provident, benefit or superannuation fund' and that 'connoted a purpose narrower than the purpose of conferring benefits in a completely general sense…". This narrower purpose meant that the benefits had to be 'characterised by some specific future purpose' such as the example given by Justice Kitto of a funeral benefit.

Furthermore, Justice Kitto's judgement indicated that a fund does not satisfy any of the three provisions, that is, 'provident, benefit or superannuation fund', if there exist provisions for the payment of benefits 'for any other reason whatsoever'. In other words, though a fund may contain provisions for retirement purposes, it could not be accepted as a superannuation fund if it contained provisions that benefits could be paid in circumstances other than those relating to retirement.

In section 62 of the SISA, a regulated superannuation fund must be 'maintained solely' for the 'core purposes' of providing benefits to a member when the events occur:

· on or after retirement from gainful employment; or

· attaining a prescribed age; and

· on the member's death. (this may require the benefits being passed on to a member's dependants or legal representative).

Notwithstanding the SISA applies only to 'regulated superannuation funds' (as defined in section 19 of the SISA), and foreign superannuation funds do not qualify as regulated superannuation funds as they are established and operate outside Australia, the Commissioner views the SISA (and its attendant regulations) as providing guidance as to what 'benefit' or 'specific future purpose' a superannuation fund should provide.

In view of the legislation and the decisions made in Scott and Mahony, the Commissioner's view is that for a fund to be classified as a superannuation fund, it must exclusively provide a narrow range of benefits that are characterised by some specific future purpose. That is, the payment of superannuation benefits upon retirement, invalidity or death of the individual or as specified under the SISA.

Therefore, in order for the lump sum payment from Fund 1 to be considered a payment from a foreign superannuation fund as defined in subsection 995-1(1) of the ITAA 1997, it must also satisfy the requirements set out in subsection 295-95(2). This means that it should not be an Australian superannuation fund as defined in that subsection but must be a provident, benefit, superannuation or retirement fund as discussed above.

The purpose of the Overseas Fund

It is evident that the payer of the lump sum payment made by the fund underwriter, in respect of Overseas Fund 1 is established outside of Australia. Similarly, the central management and control is outside of Australia. The documentation as provided in relation to the terms and conditions of Fund 1 states that 'retirement' takes place on the selected retirement date or any date from which the member elects to start receiving benefits subject to the provision that payment of benefits cannot commence before attainment of age 55.

Therefore, on the basis of the information provided, the Commissioner considers the lump sum payment your client received from Overseas Fund 1 is from a foreign superannuation fund as defined in subsection 995-1(1) of the ITAA 1997.

Applicable fund earnings

Your client became a resident of Australia for tax purposes in the third quarter of the 2001-02 income year and received, that is, became entitled to, the lump sum payment in respect of Overseas Fund 1 in the second quarter of the 2009-10 income year. As this was more than six months after your client became an Australian resident, section 305-70 of the ITAA 1997 applies to include the 'applicable fund earnings' in their assessable income.

The 'applicable fund earnings' are worked out under section 305-75 of the ITAA 1997. As mentioned earlier, subsection 305-75(3) applies where the person becomes an Australian resident after the start of the period to which the lump sum relates.

Subsection 305-75(3) of the ITAA 1997 states:

If you become an Australian resident after the start of the period to which the lump sum relates, the amount of your applicable fund earnings is the amount (not less than zero) worked out as follows:

(a) work out the total of the following amounts:

(i) The amount in the fund that was vested in you just before the day (the start day) you first became an Australian resident during the period;

(ii) the part of the payment that is attributable to contributions to the fund made by or in respect of you during the remainder of the period;

(iii) the part of the payment (if any) that is attributable to amounts transferred into the fund from any other foreign superannuation fund during the period;

(b) subtract that total amount from the amount in the fund that was vested in you when the lump sum was paid (before any deduction for foreign tax);

(c) multiply the resulting amount by the proportion of the total days during the period when you were an Australian resident;

(d) add the total of all previously exempt fund earnings (if any) covered by subsections (5) and (6).

In short, your client is assessed only on the income earned (the accretion) in respect of Overseas Fund 1 less any contributions made since your client became a resident of Australia. Further, any amounts representative of earnings during periods of non-residency, and transfers into the paying fund do not form part of the taxable amount when the overseas benefit is paid.

Foreign currency conversion

Subsection 960-50(1) of the ITAA 1997 states that an amount in a foreign currency is to be translated into Australian dollars. The applicable fund earnings is the result of a calculation from two other amounts and subsection 960-50(4) states when applying section 960-50 to amounts that are elements in the calculation of another amount you need to:

· first, translate any amounts that are elements in the calculation of other amounts (except special accrual amounts); and

· then, calculate the other amounts.

Amounts to be used in calculation

From the information provided by the overseas fund underwriter you have agreed with an amount specified as the value of your client's benefits as at the date your client became a resident. This will be used as the amount for the day before your client became a resident of Australia. One third of this amount, is converted into Australian dollars (AUD).

The Australian Taxation Office (ATO) website provides a historical list of daily, average monthly and average yearly exchange rates in respect of various foreign currencies, at www.ato.gov.au. Alternatively, they may be obtained by calling our information helpline on 13 10 20.

Daily and monthly average exchange rates are listed for the 2003-04 income year onwards. For the 1996-97 to the 2002-03 income years only monthly average exchange rates are listed.

Consequently, the average monthly exchange rate for the month your client became a resident will be used in the absence of a valid daily exchange rate.

Information provided by your client shows that, since your client became a resident, your client made contributions to Overseas Fund 1. These contributions comprised monthly payments which your client made to Overseas Fund 1 (post-residency contributed amount).

The average monthly exchange rates is used for that period to convert the post-residency contributed amount to AUD. One third of this amount will be used in the formula to calculate the applicable fund earnings.

No amounts were transferred into the foreign fund from other foreign superannuation funds after your client became a resident of Australia.

In the second quarter of the 2009-10 income year, your client was entitled to a specified retirement benefit of which one third was paid as a lump sum payment into your client's overseas bank account. As required under the overseas country's legislation at the time, the remaining amount was used to purchase a personal retirement annuity.

The lump sum payment is converted into AUD at the exchange rate that applied on that day.

'The period' for the purposes of paragraph 305-75(3)(c) of the ITAA 1997 commences on the day on which the person first became an Australian resident and ceases on the day the lump sum is paid. In your client's case, that period is from the day your client became an Australian resident to the date the payment was made and your client was a resident for the whole of that period. Therefore, the Australian resident days and the total days are the same, and so the proportion to be used in the calculation is 1.

There are no previously exempt fund earnings in relation to the lump sum.

Calculation of the assessable amount of the payment from foreign superannuation fund

In accordance with subsection 305-75(3) of the ITAA 1997 the amounts determined at subparagraphs 305-75(3)(a)(i), (ii) and (iii) are added together.

This total is then subtracted from the amount determined under paragraph 305-75(3)(b) of the ITAA 1997.

The resultant figure is then multiplied by the proportion of the total days determined under paragraph 305-75(3)(c) of the ITAA 1997 - in this case, '1'

To this figure we add the amounts determined under paragraph 305-75(3)(d) of the ITAA 1997 - in this case, nil.

The amount calculated under subsection 305-75(3) of the ITAA 1997 is the applicable fund earnings relating to your client's benefits in the foreign fund. This amount is to be included in your client's assessable income for the 2009-10 income year.

Question 2

Summary

The annual deductible amount in relation to the annuity your client received for the full year is the amount ascertained in accordance with the formula.

In the year your client was in receipt of the annuity for only part of the income year a pro rata annual deductible amount will apply.

Detailed reasoning

The deductible amount

Subsection 27H(2) of the Income Tax Assessment Act 1936 (ITAA 1936) allows a deduction in respect of the undeducted purchase price (UPP) of a foreign pension or annuity. The deduction, or deductible amount as it is referred to in subsection 27H(2), represents the UPP of the pension apportioned over the term that the pension or annuity is paid, or expected to be paid.

In the case of a pension or annuity that is payable over the life of the pensioner or annuitant this will be the life expectation factor of the pensioner or annuitant (or, where applicable, the reversionary pensioner or annuitant, if greater) as at the commencement of the income stream. The life expectation factor to be used is set out in the relevant Australian Life Tables published by the Australian Government Actuary (regulation 9 of the Income Tax Regulations 1936).

The UPP of a pension or annuity payable from a foreign superannuation fund is the total amount of the personal contributions made by the member to secure entitlement to the pension or annuity. It does not, however, include contributions made by an employer (subsection 27H(5) of the ITAA 1936).

The deductible amount is calculated in accordance with the formula set out under subsection 27(2) of the ITAA 1936 which is as follows:

,

where:

A is the relevant share in relation to the annuity in relation to the taxpayer in relation to the year of income.

B is the amount of the undeducted purchase price of the annuity.

C is:

(a) if there is a residual capital value in relation to the annuity and that residual capital value is specified in the agreement by virtue of which the annuity is payable or is capable of being ascertained from the terms of that agreement at the time when the annuity is first derived - that residual capital value; or

(b) in any other case - nil; and

D is the relevant number in relation to the annuity.

The 'relevant number', in the case of pension or annuity payable for life, is, as noted earlier, the life expectation factor of the pensioner or annuitant (or, where applicable, the reversionary pensioner or annuitant, if greater) as at the commencement of the income stream.

The 'relevant share' will usually be '1', unless the pension or annuity is being paid at the same time to more than one person. In that case it will be a fraction representing the number of persons to whom the pension or annuity is currently being paid.

The result of the formula under subsection 27H(2) of the ITAA 1936 represents the amount that a taxpayer may claim each year as a deduction against his or her pension or annuity. The figure is determined in the foreign currency and then converted to AUD each year using the average exchange rate for that particular year.

It should also be noted that, in cases where both a tax free lump sum and a pension or annuity is paid from a fund, the amount of the personal contributions is pro rated between the lump sum and the pension or annuity in accordance with the method set out in Taxation Ruling IT 2272. The amount attributable to the lump sum payment does not form part of the UPP of the pension or annuity.

Undeducted contributions applicable to the annuity

In this case your client made overseas contributed amounts in the period before becoming an Australian resident and residency contributed amounts since becoming an Australian resident to Overseas Fund 1.

As noted in the facts, one third of your client's total retirement benefit was paid as a lump sum to your client. The remaining balance was paid into Overseas Fund 2 in the second quarter of then 2009-10 income year. An initial charge was applied against this transaction. On the same date, a further amount was paid into Overseas Fund 2 and a further initial charge was applied.

In the second quarter of the 2009-10 income year, the balance of your client's retirement benefit in Overseas Fund 2 was transferred into Overseas Fund 3. An annual annuity then commenced to be payable to your client from this account.

IT 2272 states that where both a pension (or annuity) and a lump sum is payable, undeducted contributions should be apportioned between those two payments. The ruling states at paragraph 8:

Where there is no immediately apparent basis for allocating the contributions made by a person to obtain both a pension and a lump sum, the contributions should be allocated by applying the relevant proportion ascertained in accordance with the following formulae -

• Purchase of pension - ; and

• Purchase of lump sum - ,

where -

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.

Therefore, following this formula, your client will be entitled to apply a portion of their undeducted contributions to reduce the amount payable on the annuity in accordance with section 27H of the ITAA 1936.

The deductible amount

As mentioned earlier, to calculate the deductible amount applicable to your client's annuity payments, the formula in subsection 27H(2) of the ITAA 1936 must be applied. The relevant number to be used in the formula will be your client's life expectancy factor at the date the annuity commenced.

The Australian Life Tables prescribed under regulation 9 of the Income Tax Regulations 1936 for pensions or annuities that commenced to be on or after 1 January 2005 and before 1 January 2010 are the Australian Life Tables 2000-02.

Accordingly, where the annuity has been received by your client for a full year, the annual deductible amount will be determined as per the formula under subsection 27H(2) of the ITAA 1936.

For the 2009-10 income year, however, your client was in receipt of the annuity for part of the year. Accordingly, for that year only the pro rata amount will apply for this year.

A similar pro rata amount will apply in the final year the annuity is payable to your client.

Exchange Rates

According to paragraph (a) of Item 7 in subsection 960-50(6) of the ITAA 1997, an amount in a foreign currency is to be translated into Australian currency at the exchange rate at the time of receipt of the payment.

In the present case, the records you have provided show that the annuity payments are made annually and that your client received payments in the second quarter of the 2009-10 income year and the second quarter of the 2010-11 income year.

The Australian Taxation Office (ATO) website provides a historical list of daily, monthly and average yearly exchange rates in respect of various foreign currencies, at www.ato.gov.au. Alternatively, they may be obtained by calling our information helpline on 13 10 20.

Other relevant comments

Foreign tax credit offset

It is noted that foreign tax was withheld from the lump sum payment paid to your client in the second quarter of the 2009-10 income year.

Subsection 770-10(1) of the ITAA 1997 provides that a person is entitled to a foreign income tax offset (FITO) for foreign tax paid in respect of an amount that is included in the person's assessable income in a year of income. It is not necessary that the payment of foreign income tax actually occurs in the claim year.

To determine the amount of FITO in any particular year, a person must first calculate the total foreign income tax paid on amounts included in their assessable income for the year.

The tax offset has the effect of reducing the Australian tax that would otherwise be payable on the double-taxed amount. A FITO is a non-refundable tax offset.

The FITO rules do not allow for the carry forward of excess foreign tax. This means that all available FITOs will need to be utilised in the year in which they arise. There will be no opportunity to carry them forward for use against future Australian tax on foreign income.

Furthermore, there is a FITO limit. Where the total foreign income tax paid by a person is less than or equal to AU$1,000, the person is not required to calculate the FITO, that is, the person's FITO will equal the foreign income tax paid on amounts included in the their assessable income.

Where the total foreign income tax paid is more than AU$1,000, the person can choose to offset only AU$1,000 of foreign tax (and not formally calculate the FITO entitlement) or calculate the offset limit to determine the maximum FITO entitlement under section 770-75 of the ITAA 1997.