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Ruling

Subject: Lump sum payment from a foreign fund

Question

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

Answer/Advice

Yes.

This ruling applies for the following period

For the year ended 30 June 2012

The scheme commenced on

1 July 20011

Relevant facts and circumstances

Several years ago you became a member of an overseas pension preservation fund product (the Product) through an overseas wealth management group. The Product had an exit date in the relevant Australian income year.

A number of years ago, you arrived in Australia on a temporary visa (residency date) and a short time later received permanent residency.

You have advised the value of your benefits in the Product as at a specified date earlier than your residency date.

From the information provided, benefits can only be withdrawn from the Product for retirement purposes.

Several years ago, as a result of legislative changes in the overseas country, the rules of the Product were amended such that if a person has formally emigrated from the overseas country the full value of the policy less tax, could be remitted overseas.

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

Late in the relevant Australian income year, you declared formal emigration from the overseas country for tax purposes and this enabled you to make an exit and receive the benefits from the Product.

A submission of an Income Tax Return for the 20XX overseas income year to the overseas country's taxation authority was required with the assessment issuing to you.

You have provided a copy of a document entitled Employee Income Tax Certificate for the 20XX overseas income year which shows a retirement lump sum withdrawal benefit with an amount of tax withheld. In addition your agent in the overseas country arranging the withdrawal and transfer, withheld fees from this amount.

Late in the relevant Australian income year, a lump sum payment was made from the overseas bank account to your Australian bank account.

You are under the age of 55 years.

Assumptions

You could not provide the value of your total benefits in the Product as at the day before you became an Australian resident. However, you have provided a transfer value of your total benefits as at a specified date.

Therefore, in order to determine the lump sum amount as at the day before you became an Australian resident, you have been advised that the following assumption is being made in issuing the Notice of Private Ruling:

· by using the total transfer value as at a specified date; and

· the total lump sum payment as at a specified date during relevant Australian income year;

· the estimated annual compound rate of growth of transfer value has been calculated to be a particular percentage. By using this specific rate, your transfer value as at the day before you became a resident is calculated to be a specified amount.

Relevant legislative provisions

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 Section 960-50.

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 Subsection 10(1).

Superannuation Industry (Supervision) Act 1993 Section 19.

Superannuation Industry (Supervision) Act 1993 Section 62.

Reasons for decision

Summary

A portion of the benefits you received from the Product, is assessable as 'applicable fund earnings'.

The amount calculated as the applicable fund earnings is to be included in your assessable income for the relevant income year.

You may be entitled to a foreign income tax offset in respect of part, or all of the applicable fund earnings amount that is included in your assessable income for the relevant income year.

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 the Product is not a 'superannuation fund', it will not be an Australian superannuation fund or a foreign superannuation fund. Nor can the amount paid to you be a 'superannuation lump sum' and subdivision 305-B of the ITAA 1997 will not apply.

Therefore, we are first required to determine if the Product 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 the product 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 Product

It is evident that the payer of the lump sum payment in respect of the Product is established outside of Australia. Similarly, the central management and control is outside of Australia. Therefore the Product established in an overseas country is not an Australian superannuation fund as defined in subsection 295-95(2) of the ITAA 1997.

You have advised that no benefits can be withdrawn from the Product prior to retirement age. However, as a result of legislative changes made in the overseas country several years ago, if a person has formally emigrated from the overseas country, the full value of the policy less tax, could be remitted overseas.

Therefore, on the basis of the information provided, the Commissioner considers the lump sum payment you received from the product (from this point onwards referred to as the Fund) is from a foreign superannuation fund as defined in subsection 995-1(1) of the ITAA 1997.

Applicable fund earnings

You became a resident of Australia for tax purposes a number of years ago and received, that is, became entitled to, the lump sum payment in respect of the Fund in the relevant income year. As this was more than six months after you became an Australian resident, section 305-70 of the ITAA 1997 applies to include the 'applicable fund earnings' in your 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, you are assessed only on the income earned (the accretion) in respect of the Fund less any contributions made since you 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:

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

(b) then, calculate the other amounts.

Amounts to be used in calculation

You could not provide the value of your total benefits in the Fund as at the day before you became a resident of Australia. In order to determine the vested amount as at the day before you became an Australian resident, it is proposed to use information shown in the documentation you have provided as follows:

· the total transfer value as at a specified date, and

· the total lump sum payment as at a specified date during 2011-12 income year.

Based on the above information we have estimated the annual compound rate of growth of transfer value to be a specified percentage. By using this specific rate, your total vested amount in the Fund as at the day before you became a resident is calculated to be a specified amount.

You have agreed to the estimated value calculated as the amount of your benefits on the day before you became a resident of Australia and 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.

Consequently, the daily exchange rate will be used in the absence of a valid daily exchange rate.

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

The amount you received in the relevant income year is converted into AUD at the exchange rate that applied on that day.

The Commissioner's view is that '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 case you were a resident for the whole of that period. Therefore, the Australian resident days and the total days are the same.

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 subparagraph 305-75(3)(a)((i), (ii) and (iii) are added.

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

This figure is multiplied by the proportion of the total days determined under paragraph 305-75(3)(c) of the ITAA 1997.

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

The amount calculated in accordance with subsection 305-75(3) of the ITAA 1997 is the assessable applicable fund earnings relating to your benefits in the Fund. This amount is to be included in your assessable income for the 2011-12 income year.

Foreign income tax offset

Subsection 770-10(1) of the ITAA 1997 provides the basic entitlement rule for a foreign income tax offset (FITO) and states:

You are entitled to a tax offset for an income year for foreign income tax. An amount of foreign income tax counts towards the tax offset for the year if you paid it in respect of an amount that is all or part of an amount included in your assessable income for the year.

Subsection 770-10(1) of the ITAA 1997 uses the phrase 'in respect of' to link the foreign income tax with an amount included in the taxpayer's assessable income. The phrase 'in respect of' was considered by the High Court in Workers' Compensation Board of Queensland v. Technical Products Pty Ltd (1988) 165 CLR 642; (1988) 62 ALJR 561; (1988) 81 ALR 260; [1988] HCA 49. In a joint judgement Justices Deane, Dawson and Toohey said the following about this phrase:

The phrase gathers meaning from the context in which it appears and it is that context which will determine the matters to which it extends.

Subsection 770-5(1) of the ITAA 1997 provides relevant context by explaining the object of Division 770 as follows:

The object of this Division is to relieve double taxation where:

(a) you have paid foreign tax on amounts included in your assessable income; and

(b) you would, apart from this Division, pay Australian tax on the same amounts.

The references in the objects provision to relieving 'double taxation' and 'amounts included in your assessable income' demonstrate that, where a taxpayer pays foreign tax on the whole of a lump sum but only a portion of that lump sum is assessable in Australia, the purpose of Division 770 of the ITAA 1997 is to only provide a FITO for the portion of the gain that is included in assessable income and thus subject to taxation in both Australia and the foreign country (that is, double taxation). This can be described as an 'apportionment approach' to the allowance of a FITO.

Such an approach is also consistent with the approach explained in Note 2 to subsection 770-10(1) of the ITAA 1997 which states:

If the foreign income tax has been paid on an amount that is part non-assessable non-exempt income and part assessable income for you for the income year, only a proportionate share of the foreign income tax (the share that corresponds to the part that is assessable income) will count towards the tax offset (excluding the operation of subsection (2)).

While Note 2 is non-operative material, it is relevant context as it is provided to help understand provisions (see sections 2-35 and 2-45 of the ITAA 1997). Accordingly, Note 2 is further contextual support for the view that the words used in subsection 770-10(1) were intended to require apportionment of the foreign income tax paid when only part of an amount that is subject to foreign income tax is included in Australian assessable income.

The FITO provisions in the ITAA 1997 were introduced by the Tax Laws Amendment (2007 Measures No. 4) Bill 2007. Paragraph 1.18 of the Explanatory Memorandum (EM) accompanying the Bill summarises the new law, in part, as follows:

Taxpayers will be entitled to a non-refundable tax offset for foreign income tax paid on an amount included in assessable income (a 'double-taxed amount'). This offset effectively reduces the potential Australian tax that would be payable on double-taxed amounts.

This statement also confirms that a foreign income tax offset will only be allowed on an amount that is included in assessable income in Australia and subject to double taxation. The EM also makes many other references to a foreign income tax offset being limited to amounts included in assessable income and subject to double taxation.

The portion of foreign tax available for credit for each policy will be calculated as follows:

Foreign tax paid ×

Note

Further information regarding calculating a FITO can be obtained from the booklet entitled Guide to foreign income tax offset rules 2011-12 (NAT 72923) which can be obtained from the ATO website www.ato.gov.au.