Edited version of your written advice

Authorisation Number: 1051214676199

Date of advice: 13 April 2017

Ruling

Subject: Assessability of terminal gratuity payments

Question

Is any part of the terminal gratuity payment received by the Taxpayer from the Foreign Armed Forces Pension Scheme assessable as applicable fund earnings?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

The Taxpayer joined the Foreign Armed Forces and became a member of the Foreign Armed Forces Pension Scheme 1975 (AFPS).

The benefits were preserved in the AFPS.

Pension benefits can be accessed in the following instances:

● A pension lump sum upon retiring at age 55 or over;

● A preserved pension upon retiring prior to age 55 paid when pension benefit age is reached;

● Ill health benefits where discharge from service is caused by ill-health or injury; or

● Dependants’ benefits upon death during service or after leaving service.

The Taxpayer has been an Australian resident.

The Foreign Ministry of Defence advised that the payment of the Taxpayer’s deferred service pension would be made.

The payment was for the following benefits:

● annual service pension; and

● terminal gratuity.

The Taxpayer the terminal gratuity payment converted into Australian dollars.

The deferred pension benefits were subject to indexation.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 section 6-10

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

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

Income Tax Assessment Act 1997 Section 305-55

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 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

The ‘applicable fund earnings’ with respect to the terminal gratuity payment is assessable income.

Detailed reasoning

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision. The assessable income of an Australian resident includes statutory income from all sources, whether in or out of Australia (subsection 6-10(4) of the ITAA 1997).

Under section 305-70 of the ITAA 1997 any applicable funds 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, is assessable income.

Therefore, where the requirements of section 305-70 of the ITAA 1997 are met, any applicable fund earnings in relation to the terminal gratuity you received from the AFPS is brought to account as statutory income and is to be included in your assessable income for the relevant financial year.

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 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 was not an Australian resident at all times during the period to which the lump sum relates.

In determining whether an amount is assessable under section 305-70 of the ITAA 1997, it is first necessary to ascertain whether the payment is being made from a foreign superannuation fund.

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 305-55(2) of the ITAA 1997 applies if a payment is received, other than a pension payment, from a scheme for the payment of benefits in the nature of superannuation upon retirement or death that:

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

(b) was not established in Australia; and

(c) is not centrally managed or controlled in Australia.

To determine if the AFPS is a foreign superannuation fund or scheme requires consideration of what constitutes a superannuation or retirement fund or payments of benefits in the nature of superannuation.

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’ 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 Superannuation Industry (Supervision) Act 1993 (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 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) of the ITAA 1997. 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.

Information available indicates that benefits in the AFPS are only payable upon retirement, incapacity and death and the AFPS therefore meets the definition of superannuation fund or scheme. In addition, it is clear the payer of the lump sum payment is established outside of Australia with its central management and control outside of Australia.

Therefore, on the basis of the information provided, the Commissioner considers the lump sum payment from the AFPS was from a foreign superannuation fund or scheme.

Applicable fund earnings

As the Taxpayer became an Australian resident for tax purposes and received a lump sum payment from the AFPS more than six months after the Taxpayer became an Australian resident, section 305-70 applies to include any ‘applicable fund earnings’ in their 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:

(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).

The effect of subsection 305-75(3) of the ITAA 1997 is that the Taxpayer is assessed only on the income they earned on their benefits in the AFPS. Any amounts attributable to contributions made by the Taxpayer and amounts attributable to transfers from other foreign funds 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) of the ITAA 1997 states that when applying section 960-50 of the ITAA 1997 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.

For the purposes of working out 'applicable fund earnings' in relation to a superannuation lump sum under section 305-75 of the ITAA 1997, the correct rule for translating foreign currency into AUD is the rule described in Item 11A of the table in subsection 960-50(6) of the ITAA 1997. In the circumstances of this case, each amount in a foreign currency that is an element in the calculation of 'applicable fund earnings' is to be translated to AUD at the exchange rate applicable at the time of receipt of the relevant superannuation lump sum.

Applicable fund earnings amount – Calculation

The calculation of the applicable fund earnings for the lump sum received from the AFPS is shown in the table below. As discussed above, any amounts in pound sterling are translated into Australian dollars using the exchange rate applicable on the date of receipt.

The Commissioner has used CPI/RPI figures to estimate the value of the Taxpayer’s interest in the AFPS on the day before the Residency Date.

Therefore, the applicable fund earnings of the gratuity transferred from the AFPS to the Taxpayer is assessable income as ‘applicable fund earnings’ of the Taxpayer for the 2015-16 income year.