Edited version of private advice

Authorisation Number: 1012631498832

Ruling

Subject: Payment from foreign superannuation scheme

Questions

1. Are the monthly pension payments from the overseas pension scheme paid into your client's overseas bank account included as assessable income of your client?

2. Will your client be entitled to a deduction under subsection 27H(2) of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the undeducted purchase price of the overseas pension?

3. Will any part of the benefit transferred from your client's overseas pension scheme to an Australian superannuation fund be assessable as applicable fund earnings under section 305-75 of the Income Tax Assessment Act 1997 (ITAA 1997) for the 2013-14 income year?

4. Will your client be entitled to choose under section 305-80 of the ITAA 1997 to include all or part of the applicable fund earnings (if any) in the assessable income of the Australian Superannuation Fund?

Answers

1. Yes.

2. No.

3. Yes.

4. No.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

Your client is over 55 years old.

Your client became a resident of Australia for tax purposes during the relevant income year.

Your client previously worked for a foreign government.

Your client resigned during the relevant income year.

The foreign Government currently operates two statutory, non-contributory pension schemes for civil servants who are serving on pensionable terms.

Your client is a member of a pension scheme (the Pension Scheme).

Your client elected to receive 50% of the retirement benefit as a lump sum and 50% as a monthly pension.

In an official document, the following information was provided:

(a) Unreduced Annual Pension at date of resignation/retirement

(b) Rate of Reduced Annual Pension opted for 50%

(c) Reduced Annual Pension at date of resignation/retirement

(d) Commuted Pension Gratuity at date of

resignation/retirement X

(e) Cumulative Pension Increase Factor

(f) (i) Revised Reduced Annual Pension

(ii) Revised Commuted Pension Gratuity Y

(g) Date from which the Deferred Pension

benefits become payable 2012-13

The benefit is calculated according to a formulae relating to pensionable emoluments and length of service.

The lump sum payment will not be taxable in the foreign country.

The ongoing monthly pension is assessable in the foreign country.

During the 2012-13 income year, Y was transferred into your client's self-managed superannuation fund (SMSF).

You have confirmed that your client did not make personal contributions towards the foreign pension.

Assumptions

A value of the commuted pension gratuity could not be obtained for the day preceding your client's residency date as they were still an employee of the foreign Government and therefore still a member of the scheme. However, the value approximately two months after residency date could be obtained.

The Commissioner considers it reasonable to assume that the value of the pension account on the day before your client became an Australian resident was the same as it was two months later as the pension was subject to annual indexation after this date. Therefore the value of the pension scheme on the day before your client became an Australian resident is taken to be X.

Relevant legislative provisions

Income Tax Assessment Act 1936 Former Paragraph 23(q)

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Subsection 6-5(4)

Income Tax Assessment Act 1997 Subsection 6-10(1)

Income Tax Assessment Act 1997 Subsection 6-10(2)

Income Tax Assessment Act 1997 Subdivision 305-B.

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

Income Tax Assessment Act 1997 Subsection 305-55(2).

Income Tax Assessment Act 1997 Section 305-70.

Income Tax Assessment Act 1997 Subsection 305-70(2).

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

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

Income Tax Assessment Act 1997 Paragraph 305-75(3)(a)

Income Tax Assessment Act 1997 Paragraph 305-75(3)(b)

Income Tax Assessment Act 1997 Paragraph 305-75(3)(c)

Income Tax Assessment Act 1997 Paragraph 305-75(3)(d)

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

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

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

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

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary

The monthly pension benefits that your client receives are assessable and will need to be included in their income tax return.

Your client will not be entitled to a deduction for the undeducted purchase price of their foreign pension has they did not make personal contributions towards the pension.

The 'applicable fund earnings' in respect of the lump sum payment made from your client's foreign pension scheme is Z. This amount will be subject to tax at your client's marginal tax rate as they are not eligible to make the election to have the amount taxed within their self-managed superannuation fund. The remaining portion of the lump sum payment is non-assessable, non-exempt income.

Detailed reasoning

Ordinary income and statutory income

Subsection 6-5(1) of the Income Tax Assessment 1997 (ITAA 1997) provides that assessable income includes 'income according to ordinary concepts', which is called ordinary income.

Subsection 6-5(2) of the ITAA 1997 provides that, if you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Subsection 6-10(1) of the ITAA 1997 provides that assessable income also includes amounts that are not 'ordinary income', but which are included as income by statutory provisions. Subsections 6-10(2) and 6-10(4) of the ITAA 1997 refer to these amounts as statutory income, and if you are an Australian resident, include all amounts (from inside and outside Australia) within assessable income.

Income according to ordinary concepts

'Income according to ordinary concepts' is not defined within the legislation; however case law discussion has provided the following characteristics:

• It is received periodically

• It is earned as a result of work performed

• It is expected

• It is relied upon

• It replaces income or has the characteristics of income

In your client's case, they are an Australian resident taxpayer entitled to foreign Government pension benefits as a result of their previous civil service for that Government. Your client has elected to receive these pension benefits as a 50% lump sum payment and the remaining 50% as monthly pension benefit payments.

The Commissioner considers that your client's pension payments will be ordinary income pursuant to subsection 6-5(1) of the ITAA 1997 as these payments have the characteristics of ordinary income: they have been earned as a result of work performed, are expected, and will be relied upon. Your client's monthly pension benefits will also be received periodically.

The fact that your client's pension income is the result of their public service overseas will not affect its character as ordinary income in Australia (subsection 6-5(2) of the ITAA 1997).

Derivation of income

Income is assessable when it is 'derived'. The case of The Commissioner of Taxes (South Australia v The Executor, Trustee and Agency Company of South Australia Limited (1938) 63 CLR 108 provides some guidance on the meaning of derived. This case noted that payments for services rendered are generally derived when they are received, regardless or whether the payment is for current, future, or past services.

Further, legislative guidance on the meaning of derived is contained within subsection 6-5(4) of the ITAA 1997. This section provides that, in working out whether you have derived an amount of ordinary income, and (if so) when you have derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

Therefore, the Commissioner considers that your client's Government pension benefits will be derived when they receive them. The exemption under former paragraph 23(q) of the ITAA 1936, will not apply to your client has the income is taken to be derived after 1 July 1987. That is, when your client receives the monthly payments.

Assessability of Foreign Pension Benefits

Most foreign pensions and annuities are taxable in Australia, even if tax was withheld from the payment by the country from which the payment came. Foreign funds do not meet the definition of a complying superannuation fund. Therefore, as they are not governed under Australian Superannuation law the fund, and importantly, the benefits paid, are not entitled to the same concessional taxation treatment as most Australian Superannuation funds receive.

Therefore, in determining the assessability of your client's pension benefits from the foreign Government, it is necessary to identify whether the payments are being made from a '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 funds 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.

Thus, 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.

In the present case, however, the entity making the payment is a statutory scheme established under the relevant laws of the foreign country. It is not a superannuation fund as that term is normally understood. Monies are not set aside or pooled together in a separate fund (Mahony v. Commissioner of Taxation (Cth) (1967) 41 ALJR 232; (1967) 14 ATD 519 and Scott, Associated Provident Funds Ltd & Belvidere Investments Pty Ltd v Commissioner of Taxation (Cth) [No 2] (1966) 10 AITR 290; (1966) 14 ATD 333; 40 ALJR 265). Benefits are paid out of the general revenue of the overseas country.

Thus the statutory scheme established under the Pension Scheme is not a superannuation fund and thus, not a foreign superannuation fund as defined in subsection 995-1(1) of the ITAA 1997.

However, subsection 305-55(2) of the ITAA 1997 extends the application of Subdivision 305-B, which deals with the taxation of superannuation benefits from foreign superannuation funds, to payments (other than pension payments) received from a scheme for the payment of benefits in the nature of superannuation upon retirement or death, provided the scheme:

_ is not, and never has been, an Australian superannuation fund or a foreign superannuation fund; and

_ was not established in Australia; and

_ is not centrally managed or controlled in Australia.

As noted above, the Pension Scheme is a statutory scheme established under the relevant laws of the foreign country. The Pension Scheme is set up for the express purpose of providing for the payment of benefits in the nature of superannuation upon retirement or death. Its central management and control is clearly not in Australia and it is neither an Australian superannuation fund nor a foreign superannuation fund.

Therefore, Subdivision 305-B of Part 3-30 of Chapter 3 of the ITAA 1997 will apply to payments from the Pension Scheme made to Australian residents.

Low Rate Cap

The low rate cap does not apply to non-complying superannuation funds. As subdivision 305-B of Part 3-30 of Chapter 3 of the ITAA 1997 applies to the payments from the Pension Scheme made to Australian residents, the low rate cap will not apply.

As the low rate cap does not apply, pension and annuity income will be taxed at marginal rates and they will not contain either taxed or untaxed elements (as these are only for complying superannuation funds).

Foreign Income Tax Offsets

Taxpayers may claim a foreign income tax offset in relation to this income if the country from which the foreign pension or annuity came withheld tax from the payment, they were not entitled to seek a refund of the foreign tax from that country, and the foreign pension or annuity is also taxable in Australia.

Subsection 770-10(1) of the ITAA 1997 provides that a taxpayer is entitled to a foreign income tax offset for an amount of foreign income tax if they paid it in respect of an amount that is all or part of an amount included in their assessable income for the year.

To qualify for the offset, foreign income tax must have been paid on an amount that is included in your assessable income; it is not enough that foreign tax has accrued, or that a liability has arisen.

Double Tax Agreements

Further, a refund may result from the terms of an agreement between Australia and that country to prevent double taxation. If the pension or annuity is paid from a country with which Australia has a tax treaty, taxpayers may be able to make arrangements to not have tax withheld from future payments from that country.

However Australia does not have a tax treaty with the foreign country, therefore these arrangements do not apply.

Assessability of Monthly Pension Benefits

In your client's case, they have elected to receive 50% of the retirement benefit as a lump sum and 50% as a monthly pension. Whilst your client's monthly pension benefit is assessable in the foreign country, it is below the personal allowance. As such, no tax will be paid on your client's pension benefits.

Based on the information provided the Commissioner considers the monthly pension benefits that your client receives to be assessable and will need to be included in your client's income tax return. The reasons for this are as follows:

• The income will be derived when your client receives it

• The income has the characteristics of ordinary income

• The income is not exempted under former paragraph 23(q) of the ITAA 1936

• Your client is not entitled to a foreign income tax offset as Australia does not have a DTA with the foreign country and no tax will be paid on the benefits in that country.

A recent Administrative Appeals Tribunal (AAT) decision in the case of Tong v Federal Commissioner of Taxation [2007] AATA 1234 is of some relevance to you:

• In this case, the taxpayer, a resident of Australia, received a yearly pension from the Hong Kong government for his past services as a civil servant.

• The taxpayer argued that the his pension income was 'derived' during his civil service for the Hong Kong government, and was exempt from tax as he could not 'derive' his pension again when he received it while in Australia. This argument was rejected by the AAT when it held that the taxpayer's pension payments were 'derived' when he received them, or constructively received them, i.e. when they were paid into his account.

• The taxpayer then argued that his pension payments were not statutory income. This argument was rejected by the AAT when it was held that the pension payments could be considered an annuity

• The taxpayer then argued that paragraph 23(q) of ITAA 1936 applied to make the pension payments that he was receiving exempt. This argument was rejected by the AAT when it held that, as the taxpayer's pension payments were 'derived' when he received them; paragraph 23(q) of the ITAA 1936 had no application.

• The AAT held, in this case, that the taxpayer's civil service pension payments were not exempt income, and was therefore assessable income as ordinary and statutory income. The AAT also found that, as there was no double tax agreement between Australia and Hong Kong, issues of taxation could not be considered.

Undeducted Purchase Price

In order to claim a deduction for the Undeducted Purchase Price (UPP) of a pension, an individual must have made personal contributions (not employer fund contributions) towards the pension.

As you have confirmed that your client did not make any personal contributions towards the pension, they will not be entitled to a deduction.

If a UPP deduction cannot be claimed the full amount of the pension is required to be reported in your client's income tax return at Question 20 Label L 'Net Foreign Pension or annuity income WITHOUT an Undeducted Purchase Price'.

The assessability of your client's lump sum payment has been determined below.

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.

As identified above, even though the payments will not be made by a foreign 'superannuation fund' subdivision 305-B of Part 3-30 of Chapter 3 of the ITAA 1997 will apply to payments from the Pension Scheme made to Australian residents.

Applicable fund earnings

Your client became a resident of Australia for tax purposes during the relevant income year and received the lump sum payment in respect of the pension scheme during the 2012-13 income year. As this was more than six months after your client became an Australian resident, section 305-70 applies to include the 'applicable fund earnings' as assessable income.

The 'applicable fund earnings' are worked out under section 305-75. 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:

a. 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;

b. 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;

c. 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 the Pension Scheme less any contributions your client made since they 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 (AU$). 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.

Amounts to be used in calculation

The value of the benefit in the Pension Scheme on the day before your client became a resident of Australia was X This is converted into Australian dollars at the exchange rate that applied on that day. As that day fell on a weekend, the exchange rate on the next business day is used which converts the amount of X to X (cents ignored).

From the facts provided no contributions have been made to the pension scheme since your client migrated to Australia. There have been no transfers into the pension scheme from other foreign pension schemes by your client since becoming a resident of Australia.

During the 2012-13 income year, AU$Y was transferred into your client's self-managed superannuation fund (SMSF).

'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. As your client was a resident for the whole of this period 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.

Applying subsection 305-75(3) of the ITAA 1997 to your client's circumstances, the amounts to be used in calculating the applicable fund earnings for Pension Fund 1 are as follows:

305-75(3)(a)(i) X

305-75(3)(a)(ii) Nil

305-75(3)(a)(iii) Nil

305-75(3)(b) Y

305-75(3)(c) 1

305-75(3)(d) Nil

Calculation of the assessable amount of the payment from Pension Fund 1

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

X + nil + nil = X

This total is then subtracted from the amount determined under paragraph 305-75(3)(b), Y

Y - X = Z

This figure is multiplied by the proportion of the total days determined under paragraph 305-75(3)(c) - '1'

Z x 1 = Z

To this figure we add the amounts determined under paragraph 305-75(3)(d) - nil

Z + nil = Z

The applicable fund earnings of Z will be subject to tax at your client's marginal tax rate as they are not eligible to make an election to have the Australian superannuation fund treat the transferred amount as assessable income of the fund tax it accordingly at 15%. See election eligibility below.

Election eligibility

A taxpayer transferring their overseas superannuation directly to an Australian complying superannuation fund more than six months after becoming a resident may be able to elect under subsection 305-80(2) of the ITAA 1997 to have all or part of the payment treated as assessable income of the Australian superannuation fund.

As a result, any amount the taxpayer specifies in an election notice will be included as assessable income of their Australian superannuation fund and subject to tax at 15% rather than being included in the taxpayer's assessable income and subject to tax at the taxpayer's marginal rate.

To qualify, a taxpayer must, immediately after the relevant payment is made, no longer have an interest in the paying fund under subsection 305-80(1) of the ITAA 1997. Under subsection 305-80(3), the election must be in writing, specify the amount to be covered by the election and comply with any requirements specified in the Income Tax Regulations.

In this case, your client will still have an interest in the Pension Scheme as they will be receiving their monthly pension. Therefore your client will not be eligible to make an election under subsection 305-80(1) of the ITAA 1997.