Edited version of your private ruling

Authorisation Number: 1012500437150

Ruling

Subject: Lump sum payment from foreign superannuation funds

Question

Is any part of the lump sum payments from foreign country retirement annuities included in assessable as applicable fund earnings?

Answer

Yes.

This ruling applies for the following periods:

2009-11 income year

The scheme commences on:

1 July 2009.

Relevant facts and circumstances

You held interests in the following retirement annuities established in a foreign country:

(a) Fund A administered by Provider A;

(b) Fund B administered by Provider B; and

(c) Fund C administered by Provider C.

You became a resident for Australian income tax purposes a number of years ago (the residency date).

You advised the value of the retirement annuities on the day before the residency date.

You further advised that you were granted permission by the tax authority of the foreign country to withdraw the monies from the retirement annuities as you were no longer residing in the foreign country. As a consequence payments were made to your bank account in the foreign country.

No contributions were made to the retirement annuities after the residency date

The retirement annuities cannot be accessed other than at retirement, permanent incapacitation, or death. There was no option to borrow against any of the policies.

The payments received were later transferred from your foreign bank account to your Australian bank account.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 305-70.

Income Tax Assessment Act 1997 Subsection 305-70(1).

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 Subsection 305-75 (5).

Income Tax Assessment Act 1997 Subsection 305-75 (6).

Income Tax Assessment Act 1997 Section 305-80.

Income Tax Assessment Act 1997 Subsection 305-80(1).

Income Tax Assessment Act 1997 Subsection 305-80(2).

Income Tax Assessment Act 1997 Subsection 305-80(3).

Income Tax Assessment Act 1997 Subsection 306-70.

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.

Reasons for decision

Summary

A portion of the lump sum benefits you received from the foreign retirement annuity funds is assessable as 'applicable fund earnings'. The applicable fund earnings represent the increase or growth in the retirement annuity funds during the period you were a resident of Australia for tax purposes.

In this case, the applicable fund earnings in relation to the lump sum payments will be included in your respective tax returns for the 2009-10 and 2010-11 income years.

Detailed reasoning

Lump sum payments transferred 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 remainder of the lump sum payment is not assessable income and is not exempt income.

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 was not an Australian resident at all times during 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.

Under the definition of 'Australian superannuation fund' in subsection 295-95(2) of the ITAA 1997 a superannuation fund that is established outside of Australia and has its central management and control outside of Australia would qualify as a foreign superannuation fund. The fact that some of its members may be Australian residents would not necessarily alter this.

Subsection 995-1(1) of the ITAA 1997 defines a superannuation fund as having the same meaning given by section 10 of the Superannuation Industry (Supervision) Act 1993 (SIS Act), which requires that the fund is a provident, benefit, superannuation or retirement fund.

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)¹ (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)² (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 SIS Act, 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 that the SIS Act applies only to 'regulated superannuation funds' (as defined in section 19 of the SIS Act), and foreign superannuation funds do not qualify as regulated superannuation funds as they are established and operate outside Australia, the Commissioner views the SIS Act (and the SIS 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 SIS Act.

Therefore, in order for the lump sum payment from the overseas fund 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.

From the facts provided, benefits were only paid from the retirement annuities on retirement, permanent incapacitation, or death. Therefore, the schemes would each meet the definition of superannuation fund. In addition, it is clear that each payer of their respective lump sum payment was established outside of Australia with its central management and control outside of Australia.

Accordingly, on the basis of the information provided, the Commissioner considers that the lump sum payments you received are from a foreign superannuation funds as defined in subsection 995-1(1) of the ITAA 1997.

Applicable fund earnings

You became a resident of Australia for tax purposes on the residency date and received the lump sum payments on separate dates in the relevant calendar year. As the receipt dates were more than six months after you became an Australian resident, section 305-70 of the ITAA 1997 applies to include the 'applicable fund earnings' (if any) 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 retirement annuities less any contributions you 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 (A$). The applicable fund earnings is the result of a calculation from two other amounts and subsection 960-50(4) states that 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.

The table in subsection 960-50(6) of the ITAA 1997 sets out the translation rules. Only the following items are relevant to determining the issue in your case:

· item 11 which deals with a receipt or payment to which none of the other items apply, and

· item 11A which applies to amounts that are neither receipts nor payments and to which none of the other items apply.

Amounts to be used in calculation

In relation to the lump sum payments made from the foreign retirement annuity funds it is noted that:

· you made no contributions to the relevant retirement annuity after the residency date; and

· no transfers were made to the relevant retirement annuity from other foreign superannuation funds.

For the purposes of paragraph 305-75(3)(c) of the ITAA 1997 'the period' 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 that period is from the residency date to the date of payment into the foreign bank account for each retirement annuity.

You were a resident for the whole of those periods. Therefore, the Australian resident days and the total days are the same, and so the proportion to be used in the following calculations is 1.

Further, there are no previously exempt fund earnings for the purposes of paragraph 305-75(3)(d) of the ITAA 1997 in relation to each lump sum.

Foreign income tax offset

It is noted that foreign tax amounts were withheld from the lump sum payments credited to your foreign bank account.

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 in the case Workers' Compensation Board of Queensland v. Technical Products Pty Ltd. 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 relevant lump sum will be calculated as follows:

Foreign x amount of lump sum in Australian assessable income

tax paid amount of lump sum

¹ (1966) 10 AITR 290; (1966) 40 ALJR 265; (1966) 14 ATD 333

² (1967) 41 ALJR 232; (1967) 14 ATD 519