Private ruling: Lump sum payment from foreign fund - Applicable fund earnings
Date of advice: 28 November 2018
Published: March 2019
Ruling period: Income year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Is any part of the lump sum paid by The Fund, to your client, assessable income under section 305-70 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: In the mid 1970s Your Client became a member of The Fund, an overseas hybrid pension plan. More than 10 years later Your Client became an Australian resident for income tax purposes. Your Client was able to provide a value of their interest in The Fund on the day before their Australian residency. In the 2017-18 income year Your Client received a lump sum amount from The Fund. The rules of The Fund do not allow members to access or withdraw any of their funds from their account prior to retirement. There were no contributions to The Fund by or in respect of Your Client during the period Your Client was an Australian resident. There were no foreign transfers into The Fund during the period Your Client was an Australian resident. There are no previously exempt fund earnings in relation to the lump sum. The amount received represents Your Client’s total interest in The Fund.

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 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 307-15 | 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 Section 10 | Superannuation Industry (Supervision) Act 1993 Subsection 10(1) | Superannuation Industry (Supervision) Act 1993 Section 62 | Superannuation Industry (Supervision) Act 1993 Paragraph 62(b) All references are to the ITAA 1997 unless otherwise indicated.

Reasons for decision: Summary: A portion of the lump sum payment received by Your Client from The Fund should be included as assessable ‘applicable fund earnings’ in Your Client’s income tax return for the 2017-18 income year. | 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. 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). 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. The overall effect of section 305-75 is that Your Client will be assessed on the sum of: ● the total growth they earned on their benefits in a foreign superannuation fund during the period between the start day and the date when the lump sum is paid; and ● any previously exempt fund earnings. | Detailed Reasoning - Foreign superannuation fund: A foreign superannuation fund is defined in subsection 995-1(1) 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), 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. | Detailed Reasoning - Superannuation fund: ‘Superannuation fund’ is defined in subsection 995-1(1) 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. | Detailed Reasoning - 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’. 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. A similar approach was adopted by Taylor J and Windeyer J who said: It thus becomes necessary to look carefully and critically at the terms of the trust deed, at what is required and what is permitted – that is to say in what ways the trustees might, without any breach of the trusts it imposes, apply the trust property. …In other words, if they could, keeping within the terms of the trust, apply the fund or any portion thereof to purposes foreign to the true purposes of such a fund, then it would not be such a fund. In Baker v FC of T 2015 ATC 10-399; (2015) AATA 469, …for a payment to be a payment from a scheme for the payment of benefits in the nature of superannuation upon retirement the scheme would need to provide for payments that have the essential qualities, character or features of payments of superannuation benefits on retirement. Further, the scheme would need to be such that such payments were more than just possibilities among a range of alternatives such as simple withdrawals available at any time. In section 62 of the SISA, a regulated superannuation fund must be ‘maintained solely’ for one or more of 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). In addition, paragraph 62(b) of the SISA allows for a regulated superannuation fund to be maintained solely for one or more of the core purposes and for one or more of the following ancillary purposes of providing benefits to a member when the events occur: ● on or after the member’s termination of employment with an employer who had, at any time, contributed to the fund in relation to the member; ● the cessation of work and the cessation is due to ill-health (whether physical or mental); ● 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. As reiterated by Justice O’Loughlin in Baker v FC of T 2015 ATC 10-399; (2015) AATA 469 at paragraph 16, … a trust arrangement that is not a provident fund , benefit fund or retirement fund , that allows for payment of superannuation styled benefits and other benefits not permitted by the Supervision Act will not be a superannuation fund. 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), consideration must also turn to 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. In this case, information provided indicates Your Client's benefits in the Fund are locked-in and not accessible prior to retirement. 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 received by Your Client from The Fund, was a payment from a foreign superannuation fund as defined in subsection 995-1(1). | Detailed Reasoning - Calculation of applicable fund earnings: Your Client received a lump sum payment in respect of their foreign entitlements in The Fund in the 2017-18 income year. As this was more than six months after Your Client became an Australian resident, section 305-70 applies to include any ‘applicable fund earnings’ in their assessable income. [In accordance with section 307-15, the date Your Client received the lump sum payment was the date it was paid into their bank account]. As Your Client became an Australian resident after the start of the period to which the lump sum relates, the applicable fund earnings are worked out under subsection 305-75(3). Subsection 305-75(3) 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). | Detailed Reasoning - Foreign currency conversion: Subsection 960-50(1) 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 that when applying section 960-50 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. In ATO Interpretative Decision ATO ID 2015/7 Income tax/Superannuation: Foreign currency translation rules in working out ‘applicable fund earnings’ under section 305-75 of the ITAA 1997 , the Commissioner considered the foreign currency translation rules in relation to lump sum transfers from foreign superannuation funds. The Commissioner in considering Item 11A of the table in subsection 960-50(6) of the ITAA 1997, determined that the exchange rate at which it is reasonable to translate amounts used in the method statements set out in subsection 305-75(3) into Australian currency is the exchange rate applicable at the time of receipt of the relevant superannuation lump sum. Therefore, for the purposes of section 305-70, the ‘applicable fund earnings’ amount in respect of the lump sum received from a fund should be calculated by deducting the Australian dollar equivalent of the amount vested in the fund just before the day the taxpayer first became an Australian resident, from the amount received by the taxpayer from the fund. Both amounts should be translated using the exchange rate applicable on the day of receipt of the lump sum. | Detailed Reasoning - Calculation: The calculation of the applicable fund earnings for the lump sum received by Your Client from The Fund has been calculated with reference to the facts of the case and subsection 305-75(3). The amounts in the foreign currency are translated into Australian dollars using the exchange rate that you advised was applied on the day of receipt. Your Client’s applicable fund earnings in accordance with subsection 305-75(3) in respect of The Fund is $X .