Edited version of your written advice

Authorisation Number: 1012728396567

Ruling

Subject: Lump sum foreign pension payment

Questions

1. Is any part of the foreign pension lump sum payment to the taxpayer assessable as applicable fund earnings under section 305-70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Is the foreign pension lump sum payment assessable to the taxpayer as income from an annuity under section 27H of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answers

1. No

2. Yes

This ruling applies for the following period:

Income year ended 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

Some years ago, the taxpayer (the Taxpayer) arrived in Australia from the foreign country and has been an Australian resident for tax purposes since the date of arrival.

During the 200X income year, the Taxpayer became eligible to receive the foreign pension.

The foreign pension is paid from the fund which was established under the relevant Insurance Scheme to provide unemployment benefits, sickness benefit, retirement pensions and other benefits in cases where individuals meet the contribution and other qualifying conditions.

The Taxpayer elected to defer claiming their foreign pension until the relevant income year and chose instead to receive a lump sum payment in arrears.

During the subsequent income year, the Taxpayer received a lump sum payment in arrears for the deferred pension payments.

The Taxpayer currently receives a regular foreign pension payment.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 27H

Income Tax Assessment Act 1936 section 159ZRA

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 subsection 6-10(4)

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 subsection 295-95(2)

Income Tax Assessment Act 1997 section 305-70

Income Tax Assessment Act 1997 subsection 305-75(2)

Income Tax Assessment Act 1997 subsection 305-75(3)

Income Tax Assessment Act 1997 subsection 995-1(1)

International Tax Agreements Act 1953 section 4

International Tax Agreements Act 1953 section 5

Superannuation Industry (Supervision) Act 1993 section 10

Superannuation Industry (Supervision) Act 1993 subsection 10(1)

Superannuation Industry (Supervision) Act 1993 section 19

Superannuation Industry (Supervision) Act 1993 section 62

Australian Tax Treaties United Kingdom Convention Article 17(1)

Reasons for decision

Summary

No part of the lump sum payment received by the taxpayer is assessable as applicable fund earnings under section 305-70 of the ITAA 1997 because the entity making the payment is not a foreign superannuation fund.

The lump sum pension payment is assessable to the taxpayer as income from an annuity under section 27H of the ITAA 1936.

Detailed reasoning

Applicable fund earnings

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 ITAA 1997.

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

The applicable fund earnings is worked out under either subsection 305-75(2) or 305-75(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.

An amount is only assessable under section 305-70 of the ITAA 1997 if the entity making the payment is a foreign superannuation fund.

Meaning of '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 (SISA).

In accordance with subsection 10(1) of the SISA, 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.

Meaning of 'provident, benefit, superannuation or retirement fund'

The High Court examined both the terms 'superannuation fund' and 'fund' in Scott v. Federal Commissioner of Taxation (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. Federal Commissioner of Taxation (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'.

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 that 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 the Superannuation Industry (Supervision) Regulations 1994 (SISR)) 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 and the SISR.

In this case, the lump sum payment received by the Taxpayer is not received from a foreign superannuation fund. While it is true that the relevant Insurance Scheme, under which the foreign pension is paid, is similar to a superannuation fund in some respects, the relevant Insurance Scheme does not ultimately provide the narrow range of benefits required by the definition of a superannuation fund. Even though the majority of payments from the scheme are for the purpose of providing benefits upon retirement, the contributors to the scheme are also eligible to receive payments for other purposes before retirement. Examples include the Christmas bonus payment, unemployment benefits, maternity allowances and bereavement benefits.

It is considered that the foreign pension is a government social security pension similar to the Australian Age Pension. The lump sum payment received by the Taxpayer was thus not received from a foreign superannuation fund. As such, section 305-70 of ITAA 1997 does not apply to the lump sum payment.

Is the lump sum pension payment assessable as income from an annuity?

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts which are not ordinary income but are included in assessable income by another provision.

Subsection 6-10(4) of the ITAA 1997 states that the assessable income of an Australian resident taxpayer includes the statutory income from all sources, whether in or out of Australia, during the income year.

Particular types of assessable income are listed in section 10-5 of the ITAA 1997. Included in this list is section 27H of the ITAA 1936, which provides that, subject to Division 54 of the ITAA 1997, the amount of any annuity derived by a taxpayer during the income year is to be included in the taxpayer's assessable income. An annuity, at common law, is a series of payments payable for the remainder of the life of the recipient or for a fixed term.

Division 54 of the ITAA 1997 exempts from income tax certain personal injury annuities and certain payments to reversionary beneficiaries.

As the foreign pension is a series of payments payable for the remainder of the recipient's life, it will be considered to be an annuity for the purposes of section 27H of the ITAA 1936.

In the Taxpayer's case, they received a lump sum from the Department for Work and Pensions during the subsequent income year. This figure represents the amount of annuity which had accrued over the period where the Taxpayer had elected not to take the pension. The payment is thus considered to be a lump sum payment of an annuity in arrears.

As the foreign pension is not an annuity covered under Division 54 of the ITAA 1997, the lump sum payment is assessable to the Taxpayer in the subsequent income year.

Double tax agreement

In determining the Taxpayer's liability to pay tax in Australia it is necessary to consider not only the domestic income tax laws but also any applicable international tax agreements.

Section 4 of the International Tax Agreements Act 1953 (Agreements Act) incorporates that Act with the ITAA 1936 and the ITAA 1997 so that all three Acts are read as one. The Agreements Act overrides both the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Section 5 of the Agreements Act states that, subject to the provisions of the Agreements Act, any provision in a Convention listed in section 5 has the force of law. The Convention between the Government of Australia and the relevant overseas government for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital gains is listed in section 5 of the Agreements Act.

Article 17(1) of the overseas Convention advises that pensions (including government pensions) and annuities paid to a resident of Australia shall only be assessable in Australia.

Therefore, the lump sum payment received by the Taxpayer is taxable only in Australia.

If the Department of Work and Pensions has withheld tax from the lump sum payment, the Taxpayer will need to inform the department that they are a resident of Australia for taxation purposes in order to claim the tax back and to ensure that no further tax will be withheld from any future pension payments.

Undeducted purchase price

The part of the Taxpayer's pension payment which represents a return to the Taxpayer of their personal contributions is free from tax and is known as the deductible amount.

The deductible amount represents the undeducted purchase price (UPP) of the pension apportioned over the term that the pension is paid, or expected to be paid. The UPP of a pension is the total amount of the personal contributions made by the member to secure entitlement to the pension. It does not, however, include contributions made by an employer.

Basically, the deductible amount is calculated as the UPP divided by the life expectancy of the recipient (or, where appropriate, the reversionary pensioner, if greater), or the term of the pension if it is payable for a fixed term. The resultant figure represents the amount that a taxpayer may claim each year as a deduction against their pension. The figure is determined in the foreign currency and then converted to Australian dollars each year using the average exchange rate for that particular year.

Taxation Ruling TR 93/13 entitled 'Income tax: undeducted purchase price of pensions from the British National Insurance Scheme' explains how to calculate the UPP of UK State Pension payments using either the 'exact method' or the 'alternative 8% method'. Generally, the alternative 8% method is used where the taxpayer cannot, or elects not to, perform the calculations using the exact method. To calculate the deductible amount using the 8% method, simply multiply the total amount of the pension derived during the income year (in Australian dollars) by 8%.

Lump sum in arrears tax offset

A lump sum amount received by a taxpayer with regards to a payment of an annuity in arrears is fully assessable when received. This is the case even though parts of the payment relate to earlier income years. However, individual taxpayers who have received lump sum payments containing an amount that accrued in earlier income years may be entitled to a lump sum offset under section 159ZRA of the ITAA 1936. The offset is intended to overcome the problem of the lump sum attracting more tax in the year of receipt than would have been payable if the payment had been taxed in each of the years in which it accrued.

When the Taxpayer lodges their income tax return for the subsequent income year, they may claim the tax offset by providing the following information in the Schedule of Additional Information at Item 24:

• the full amount of the lump sum payment in arrears that the Taxpayer was credited with;

• the tax years to which the payment related and the amount attributable to each tax year (in Australian dollars); and

• the deductible amount of the undeducted purchase price of the annuity.

The Australian Taxation Office will use the information provided to calculate the applicable lump sum in arrears tax offset for the taxpayer.