Geographical borders are becoming less of a hurdle in regard to employment and travel. Grant Abbott looks at some of the rules dictating the treatment of superannuation while an individual is situated overseas.
Want to boost overseas investment into Australia and increase tax revenue at the same time? Then why not let non-residents invest in SMSFs, provided a certain proportion of their investments are situated in Australia?
There is no doubt superannuation is taxed at low concessional rates in Australia; 15 per cent for those in the accumulation phase and tax-free for those in the pension stage. More importantly, for those members who are over 60 and able to access their benefits, any pension or lump sum payments are tax-free. Is there any wonder why United Kingdom residents are moving to Australia and transferring their pension plans to a qualifying SMSF? Live in Australia, enjoy all Australia has to offer and pay no tax on income in the fund or when withdrawn after the age of 60 as opposed to living in the UK and paying tax on pension income at marginal tax rates.
It’s certainly not strange to think of Australia being the world’s best retiree tax haven provided you have a visa or permanent residency to stay here. In fact, many countries welcome retirees who have financial cash to splash around with special purpose retiree visas. Why not Australia? I think it would be a great idea to let any non-resident invest in Australia through an SMSF and not make the fund non-complying. After all, wouldn’t we be getting investment and tax that we would otherwise miss out on?
But this is not the case, so we are left with a system that makes a non-Australian super fund a non-complying fund. Let’s look at a case study on how the laws currently work.
Case study: going overseas
John Jones is going overseas for a short-term holiday, but has inquired about a retirement visa in Thailand with the potential loss of Australian residency for taxation purposes. What happens to his SMSF and what are the conditions needed for it to remain a complying SMSF?
Review of the law
This question is paramount for income tax purposes. The consequence of being an Australian superannuation fund is that the fund includes in its assessable income the ordinary and statutory income the fund derives from all sources, whether in or outside Australia, during the income year. If the fund is a complying superannuation fund in relation to the year of income, this income will be taxed concessionally at 15 per cent and entitled to a tax exemption for pension income. However, if the fund is non-complying, the income will be taxed at the highest tax rate, that is, 45 per cent.
According to section 42A of the Superannuation Industry (Supervision) (SIS) Act 1993, a complying SMSF is a resident regulated superannuation fund, defined as an Australian super fund as stipulated by the Income Tax Assessment Act (ITAA)1997.
Section 295-95(2) of the ITAA provides three tests a fund must satisfy to be treated as an Australian super fund:
- the fund is established in Australia or any asset of the fund is situated in Australia,
- the central management and control (CM&C) of the fund is ordinarily in Australia at a particular time, and
- the active member test.
ATO Taxation Ruling (TR) 2009/5 provides explanations on these three tests. We are going to consider only the CM&C and the active member test as they are the most important when members or trustees go overseas.
The location of the CM&C of the fund is determined by where the high-level and strategic decisions of the fund are made and high-level duties and activities are performed. It includes the performance of the following duties and activities:
- formulating the investment strategy for the fund,
- reviewing and updating or varying the fund’s investment strategy, as well as monitoring and reviewing the performance of the fund’s investments,
- if the fund has reserves, the formulation of a strategy for their prudential management, and
- determining how the assets of the fund are to be used to fund member benefits.
In the majority of cases, the other principal areas of operation of a superannuation fund, such as the acceptance of contributions, the actual investment of the fund’s assets, the fulfilment of administrative duties and the preservation, payment and portability of benefits, are not of a strategic or high-level nature to constitute CM&C. Rather, these activities form part of the day-to-day or productive side of the fund’s operations.
To be ordinarily in Australia, the CM&C must be regularly, usually and customarily exercised in Australia. If the CM&C of the fund is being temporarily exercised outside Australia, this will not prevent the CM&C of the fund being ordinarily in Australia at a particular time.
Moreover, subsection 295-95(4) of the ITAA states the CM&C is “ordinarily in Australia at a time even if that CM&C is temporarily outside Australia for a period of not more than two years”.
Furthermore, the ruling says where there are an equal number of trustees, both in Australia and overseas, who equally participate in the exercise of the CM&C of the fund, the CM&C will ordinarily be in Australia.
In some situations a person other than the trustee is exercising the CM&C of the fund. Where the trustee of a fund delegates their duties to another person, the delegate will be exercising the CM&C of the fund if they independently and without influence from the trustee perform those duties and activities that constitute CM&C of the fund.
However, if the trustee continues to participate in the high-level decision-making and activities of the fund by reviewing or considering the decision and actions of the delegate before deciding whether any further or different action is required, then it cannot be said the delegate is exercising the CM&C of the fund.
A trustee of an SMSF can bring in a person holding the member’s enduring power of attorney to act as trustee on behalf of the member while overseas, provided the governing rules of the SMSF allow it and the person has been validly appointed.
Ruling example: person other than trustee exercising CM&C while trustees are overseas
Henry and Eleanor are the trustees and only members of their SMSF, which was established in Australia. On 29 September 2009, Henry and Eleanor travel to France to take up management of Eleanor’s family business interests in Europe. They do not have an expected return date, although they do intend to return to Australia at some point in the future. They return to Australia permanently on 22 September 2011.
Prior to moving overseas, Henry and Eleanor arrange for Richard to perform the duties and activities that constitute the CM&C of the fund. During their absence from Australia, Richard undertakes these activities without reference to Henry and Eleanor. Furthermore, Henry and Eleanor did not participate in any of the high-level decision-making activities while overseas.
In these circumstances, the CM&C of the fund continues to be ordinarily in Australia, by virtue of Richard exercising the CM&C in Australia within the meaning of paragraph 295-95(2)(b) of the ITAA at all times during Henry and Eleanor’s absence.
The other test that needs to be satisfied in order for the fund to be treated as an Australian superannuation fund is the active member test.
The active member test is satisfied if at the relevant time:
- the fund has an active member, or
- at least 50 per cent of the total market value of the fund’s assets attributable to superannuation interests held by active members is attributable to superannuation interests held by active members who are Australian residents (sub-paragraph 295-95(2)(c)(i) of the ITAA), or
- at least 50 per cent of 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 (sub-paragraph 295-95(2)(c)(ii) of the ITAA).
An active member is:
- a contributor to the fund at that time, or
- an individual on whose behalf contributions have been made.
A non-active member is:
- a foreign resident, and
- is not a contributor at that time, and
- the only contributions made to the fund on their behalf since they became a foreign resident were made in respect of a time when they were an Australian resident.
Example: not an active member
Ally is the single member of her SMSF and goes overseas on a holiday in July 2009 for an indefinite period of time. She ceases being an Australian resident in July 2011. Before travelling overseas, she worked as a fitness instructor at the local gym. Her employer failed to make any superannuation contributions in respect of the period of work performed by Ally in the quarter prior to her departure (April to June 2009). In August 2012, her former employer pays the superannuation guarantee charge to the ATO, which then distributes the shortfall component of the charge to Ally’s SMSF in September 2012. Ally makes no personal contributions to her SMSF during her absence from Australia.
As Ally is not a resident of Australia from July 2011 and the contribution, that is, the shortfall component of the superannuation guarantee charge was made to the SMSF on her behalf in respect of the April-June 2009 period when she was a resident, she does not become an active member because of the contribution.
Transferring from foreign super funds to Australia
As noted earlier, foreign superannuation funds are an important factor for expatriates migrating to Australia. Each year there are literally thousands of former United States, European, UK and Asian residents now living in Australia who can access their superannuation benefits from a foreign superannuation fund. Some may have only just packed up and moved here, while others may have been here for decades. The taxation issue is obviously an important one.
Adviser question to NowInfinity Legal
I have a question concerning the tax treatment of lump sums and pensions paid to a 54-year-old engineer who has become an Australian resident from a foreign super fund. The client received advice from an accounting firm stating the contribution caps applied.
We are not so sure and would welcome your thoughts.
There are four possible outcomes.
1. Lump sum within six months of residency
If the client receives a lump sum from a foreign super fund in respect of foreign employment while a non-resident and that lump sum is paid within six months of becoming an Australian resident, then there is no tax.
In that regard under section 305-55 of the ITAA a foreign superannuation fund is a superannuation fund that is not an Australian superannuation fund. The laws relating to lump sums from a foreign superannuation fund are found in sections 305-60 and 305-65 of the ITAA.
In short, the payment of a lump sum within a six-month period is neither assessable nor exempt income (nor tax-free), provided it meets the conditions of these sub-sections. It cannot be rolled over as it is not a rollover superannuation benefit pursuant to section 306-10 of the ITAA as it comes from a non-complying superannuation fund.
As the amount is not taxable, the option of contributing the amount into super exists. The caps on contributions, $35,000 concessional contributions a year and $180,000 non-concessional contributions a year or $540,000 for three years, will apply to the amount if the choice is made to contribute it into super. He can keep it tax-free, of course.
2. Lump sums after six months
If he receives a lump sum from a foreign fund more than six months after becoming an Australian resident, he is taxed on the accrued earnings that arose after becoming a resident, unless he chooses to roll over the benefit.
For many migrants to Australia this is the most common practice as many overseas superannuation funds do not necessarily allow the withdrawal of benefits pre-retirement. A person cannot simply go to the fund when they leave their country and get their superannuation benefits (in Australia you still have to meet a condition of release under the preservation rules).
As such, members of foreign super funds generally have to wait until a specific time or event, such as retirement or turning 50, to claim their offshore superannuation money. It is only recently that some foreign jurisdictions have allowed the transfer of superannuation benefits from a local fund to an Australian superannuation fund.
In terms of lump sum payments after six months, section 305-70 of the ITAA provides that lump sums received from a foreign superannuation fund will be assessable. The method is complex, however, in short it is the applicable fund earnings relative to the time the member is a resident that will become assessable income and taxed at marginal tax rates with no tax offsets. Applicable fund earnings exclude concessional and non-concessional contributions. As it is not an Australian superannuation benefit, they cannot access tax-free super benefits after the age of 60.
One of the reasons for taxing the growth accrued in the foreign superannuation fund since residency is that the lump sum has been accumulating in a foreign superannuation fund that is probably tax-free in its own jurisdiction, such as in the UK and US, which tax end benefits, not contributions or fund income.
Of course, after paying any tax on the foreign superannuation fund benefits, the member may contribute the net proceeds into an SMSF. The contribution will consist of a concessional (if a tax deduction is claimed) or a non-concessional component. One of the problems may be the contribution caps noted above if a large sum is involved.
3. Rolling over benefits
If the client receives a foreign superannuation fund lump sum payment after six months, then the member can choose to roll the amount into a complying fund and the super fund is taxed on the earnings that arose after the member became a resident. This will depend on the jurisdiction where the payment is coming from as many do not allow the transfer of pension money to offshore pension funds.
The UK, with its Qualifying Recognised Overseas Pension Scheme, allows transfers provided the governing rules of the fund meet certain criteria. These criteria became stricter after April 2015 and deeds will need to be reviewed by HM Revenue & Customs.
Sections 295-200(2) and 305-80 of the ITAA say a member can transfer the tax liability, that is, the assessable income amount determined, to the trustee of the superannuation fund. It can be part or the whole of the applicable fund earnings.
Rolling over amounts into super does not appear to be the same as making a direct contribution to the fund and a different set of rules applies. It is clear section 305-80 of the ITAA states if there is a rollover, then section 295-200 applies. ITAA subsection 295-200(2) provides where the member has chosen to transfer their tax liability to the trustee of the fund, then this amount is assessable income of the fund.
The concessional contribution limit prescribed in ITAA section 292-20 is $35,000 for a person over 50. The excess above the concessional contribution limit is taxed as income in the hands of the individual at their marginal tax rate. Concessional contributions are defined in ITAA section 292-25 as any contribution to the super fund that is included in the super fund’s assessable income, but does not include an amount mentioned in section 295-200(2) that is the rollover of foreign super (see sub-paragraph 292-25(2)(c)(i)).
As far as the non-concessional contributions are concerned, the limit to non-concessional contributions is set at three times the concessional contribution limit (see ITAA subsection 292-85(2)). A non-concessional contribution is defined in ITAA section 292-90 as a contribution that is made into a super fund and is not included in the assessable income of the superannuation fund. ITAA section 295-200 clearly states the foreign super transferred is included in the assessable income of the super fund, but remember it is only the assessable component.
Note: you can only transfer the amount that is the ‘applicable fund earnings’ (the assessable amount), hence any other amount transferred (that relates to pre-residency) would be a non-concessional contribution and caught by ITAA section 292-80.
As such, the $35,000 and $180,000 limits do not apply to the assessable amount transferred to the super fund. Instead it forms part of the fund’s taxable income and is taxed according to ITAA section 295-10 and would be taxed at the low rate (15 per cent). It is only non-arm’s-length income and non-tax-file-number contributions that are taxed at higher rates.
When the superannuation benefits are paid from the SMSF, they will consist of taxable or tax-free components. A tax-free component is defined under ITAA section 307-210 and includes the contributions segment and the crystallised segment.
The contributions segment is found in ITAA section 307-220 and is so much of any contributions made into the fund that are not assessable income. In the foreign superannuation fund case, this would include amounts where the lump has been contributed to the SMSF and no deduction is claimed on the contribution or where the tax liability of the foreign superannuation fund payment has not been transferred under section 305-80 of the ITAA.
Those amounts where the contribution has been included in assessable income form part of the taxable components. The proportional approach applies in respect of growth for any lump sum drawdown or pension payment until the age of 60, after which lump sums and pensions are tax-free (see ITAA section 307-125).
4. Taking a pension
If he draws a pension from the foreign fund while an Australian resident, it is taxable as income under subdivision 301-B of the ITAA.