1 Is your 401(k) fund in the US considered a foreign superannuation fund for Australian tax purposes?
No. Question 2 Will you be assessed on the distribution from the 401(k) fund? Answer Yes. Section 99B of the Income Tax Assessment Act 1936 (ITAA 1936) will apply to distributions from the fund. Section 102AAM of the ITAA 1936 will also apply and impose an additional interest charge. Question 3 Are you entitled to a foreign income tax offset for the tax paid in the US on the withdrawal of the shares from your 401(k) fund? Answer Yes. Question 4 Are you entitled to a foreign income tax offset against US tax paid on the eventual disposal of the shares in the US? Answer Yes. Upon disposing of the shares, you will be entitled to a foreign income tax offset for the portion of the gain representing the difference between contributions, reinvested earnings, and market value at time of withdrawal (US Gain 2). This ruling applies for the following period : Year ending 30 June 20XX The scheme commenced on: 1 July 20XX
You are a citizen of the United States of America. You became an Australian resident for tax purposes during the 20XX income year. Until 20XX, you were employed by Company A in the US. While you were employed by Company A, both you and Company A made contributions to your 401(k) retirement fund in the form of Company A shares. Your 401(k) fund allowed for the withdrawal of benefits before retirement age for purposes other than retirement. The total value of the employee and employer contributions to the 401(k) fund was USD $XX. During the 20XX income year, you withdrew the Company A shares (the withdrawal) from the 401(k) fund. You are now the legal owner of these shares. This was an in specie distribution. The value of the shares at the time of the withdrawal was USD $XX. For US tax purposes, the withdrawal is a taxable event. You will be assessed in the US on the initial employee and employer contributions as well as any reinvested earnings until the date of the withdrawal (US Gain 1). This gain is estimated to be USD $XX.
For US tax purposes, you will also be assessed when you dispose of the shares. The amount on which you will be assessed will be the consolidation of two distinct gains. The first is the difference between the initial contributions, reinvested earnings, and market value of the shares at the time of the withdrawal (US Gain 2). The second is the growth in value of the shares after the withdrawal (US Gain 3). In Australia, you have carried forward capital losses of approximately AUD $XX.
Income Tax Assessment Act 1936 subsection 99B(1) Income Tax Assessment Act 1936 paragraph 99B(2)(a) Income Tax Assessment Act 1936 s ection 102AAM Income Tax Assessment (1936) Act Regulations 2015 regulation 19 Income Tax Assessment Act 1997 section 305-70 Income Tax Assessment Act 1997 subs ection 770-10(1) Income Tax Assessment Act 1997 subs ection 770-15(1) Income Tax Assessment Act 1997 s ection 770-130 Income Tax Assessment Act 1997 s ection 770-190 Income Tax Assessment Act 1997 subsection 995-1(1) Superannuation Industry (Supervision) Act 1993 section 10
Issue 1 - foreign superannuation funds Question 1 Is your 401(k) fund in the US considered a foreign superannuation fund for Australian tax purposes? Summary Your 401(k) fund is not considered a foreign superannuation fund for Australia tax purposes. Detailed reasoning Foreign superannuation fund Section 305-70 of the ITAA 1997 provides that where the Taxpayer receives a lump sum from a foreign superannuation fund more than six months after becoming an Australian resident, they include the 'applicable fund earnings' of the lump sum (if any) in their assessable income. Applicable fund earnings are worked out under section 305-75 of the ITAA 1997. If the entity making the lump sum payment is not a foreign superannuation fund, then section 305-70 of the ITAA 1997 will not have any application. A foreign superannuation fund is defined in subsection 995-1(1) of the ITAA 1997 as being a fund that is not an Australian superannuation fund. A superannuation fund has the meaning given by subsection 10(1) of the Superannuation Industry (Supervision) Act 1993 (SISA), which requires that the fund is a 'provident, benefit, superannuation or retirement fund'.
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 judgment indicated that a fund is not a 'provident, benefit or superannuation fund' if there are provisions for the payment of benefits 'for any other reason whatsoever'. Although a fund may contain provisions for retirement purposes, it cannot be accepted as a superannuation fund if it contained provisions that benefits could be paid in circumstances other than to the member's retirement. In section 62 of the SISA, a regulated superannuation fund must be 'maintained solely' for the 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 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 your 401(k) fund allowed for the withdrawal of benefits before retirement age for purposes other than retirement, this fund does not meet the 'sole purpose test' and therefore cannot be considered a 'superannuation fund' for Australian income tax purposes. Issue 2 - section 99B Question 2 Will you be assessed on the distribution from the 401(k) fund? Summary Yes. Section 99B of the Income Tax Assessment Act 1936 (ITAA 1936) will apply to distributions from the fund. Section 102AAM of the ITAA 1936 will also apply and impose an additional interest charge. Detailed reasoning Taxation of trust distributions A distribution from the 401(k) fund may also be subject to assessment under section 99B of the ITAA 1936.
Broadly, section 99B of the ITAA 1936 deals with the receipt of trust amounts that have not previously been subject to tax in Australia. It applies where an Australian resident for tax purposes receives a lump sum payment from a foreign trust. Subsection 99B(1) of the ITAA 1936 provides that where a beneficiary who was an Australian resident at any time during an income year is paid an amount from a trust or has an amount of trust property applied for their benefit, that amount is to be included in the assessable income of the beneficiary in the income year it is paid. However, subsection 99B(2) of the ITAA 1936 reduces the amount to be included in assessable income under subsection 99B(1) by so much of that amount, relevantly for present purposes, as represents the corpus of the trust, but not to the extent that it is attributable to income derived by the trust which would have been subject to tax had it been derived by a resident taxpayer. The term 'corpus' is not defined in the legislation; therefore, it takes the ordinary meaning of the term. The Macquarie Dictionary (Online edition 2019) defines 'corpus' to mean a 'principal or capital sum, as opposed to interest or income'.
If section 99B of the ITAA 1936 includes a distribution of accumulated income from a non-resident trust estate in your assessable income, you may be liable to pay additional tax in the nature of an interest charge on the distribution, under section 102AAM of the ITAA 1936. The interest charge may apply to a distribution of profits from a non-resident trust estate to the extent the distribution was made from profits that: • are referable to eligible designated concession income derived in an income year when the trust was a resident of a listed country, or • were not subject to tax in a listed country and were derived in an income year when the trust was a resident of an unlisted country. The United States is a listed country under regulation 19 of the Income Tax Assessment (1936) Act Regulations 2015 . The amount on which interest is payable is worked out using the following formula: (Distributed amount × applicable rate of tax) - FITO The distributed amount is the amount of the distribution that is included in your assessable income under section 99B of the ITAA 1936. This amount is grossed up for any foreign tax you can claim on that share.
The applicable rate of tax is the maximum marginal rate that applies for the income year of the taxpayer in which the trust distribution is received. The foreign income tax offset is the amount you can claim for foreign income tax paid on an amount included in your assessable income for the distribution made by the non-resident trust. For amounts paid out of income or profits accumulated earlier than the 1990-91 income year, the interest period begins at the start of the 1990-91 income year. For later income years it begins from the start of the income year following the income year it was accumulated. The interest varies depending on the period but from 14 September 2006 it is the base interest rate. For the current quarter (Jan-March 2024) it is 4.38%. You are required to complete the section 102AAM calculation and include the amount on an additional information schedule when lodging the relevant income tax return.
For further information about how to do this calculation see Chapter 2 "Transferor trust and related measures" (Part 2, Section 2) of the 'Foreign income return form guide' available at www.ato.gov.au by searching for QC 66597. Alternatively, search for ATO QC 66597 via Google or another search engine. After you lodge, the ATO will confirm that calculation and the amount payable. Application to your circumstances The amount that represents the corpus of your 401(k) fund includes any amounts previously deposited into the fund by you and your employer. The distribution may also include amounts that represent earnings of the fund. Earnings are not taken to represent corpus, as the earnings are attributable to income derived by the fund which would have been subject to tax had the earnings been derived by a resident taxpayer. Therefore, paragraph 99B(2)(a) of the ITAA 1936 applies to you so that: a) the proportion of any distribution that represents amounts previously deposited to the 401(k) fund by you and your employer is excluded from your assessable income, and
b) the proportion of any lump sum that represents earnings of the 401(k) fund (from the commencement date of the fund) is included in your assessable income. In addition to the amount assessable under section 99B of the ITAA 1936, you are also liable for an interest payment as calculated under section 102AAM of the ITAA 1936. Issue - foreign income tax offsets Question 3 Are you entitled to a foreign income tax offset (FITO) for the tax paid in the US on the withdrawal of the shares from your 401(k) fund? Summary Yes, to the extent that the tax relates to amounts included in your assessable income in Australia. Detailed reasoning Availability of foreign income tax offsets Subsection 770-10(1) ITAA 1997 states that a taxpayer is entitled to a tax offset for foreign income tax paid in respect of an amount that is included in their assessable income. This offset is for the income year in which an amount in respect of which the taxpayer paid foreign income tax is included in their assessable income-even if the taxpayer paid the foreign income tax in another income year. 'Foreign income tax' is defined in subsection 770-15(1).
Section 770-130 of the ITAA 1997 provides that in some circumstances you may be entitled to a FITO where the foreign income tax has been paid by another entity. However, for a taxpayer to entitled to tax relief, there must be a 'material connection' between the foreign income tax paid and the amount included in the taxpayer's assessable income. [1] This connection is limited in cases where the foreign income tax is paid by entities which are not regarded as flow-through entities under Australian law and are liable to tax in their own right, such as foreign superannuation funds. [2] Section 770-190 allows taxpayers to amend an assessment within 4 years of paying an amount of foreign income tax to claim a foreign income tax credit. Application to your circumstances The US will impose income tax on the withdrawal of the shares from your 401(k) in the 20XX income year. This tax will be on the employer and employee contributions as well as reinvested earnings (US Gain 1).
As outlined above, subsection 99B(1) will apply to the withdrawal of the shares from your 401(k). The quantity of this gain (Aus Gains 1&2) is the market value of the shares at the time of the withdrawal. The amount included in your assessable income will be reduced by the value of the employer and employee contributions (paragraph 99B(2)(a)). Your 401(k) fund is considered a flow through entity for Australian tax purposes and is not taxed in its own right in the US. In addition, you are solely liable for any tax associated with your 401(k) fund. There is a sufficient connection between your US and Australian tax liabilities on the withdrawal of the shares for you to claim a foreign tax offset. Since foreign income tax offsets are only available for amounts that are included in the taxpayer's assessable income, the foreign income tax paid which is associated with the employer and employee contributions will not give rise to a foreign income tax offset as this amount is not paid in relation to amounts included in your assessable income.
You will be required to apportion the US tax paid between the tax paid on the employer and employee contributions, and the reinvested earnings. You will be eligible to claim a foreign income tax offset in relation to the US paid on the reinvested earnings. The foreign tax credit will be subject to the offset limit outlined in subdivision 770-B of the ITAA 1997. Question 4 Are you entitled to a foreign income tax offset against US tax paid on the eventual disposal of the shares in the US? Summary Yes. Upon disposing of the shares, you will be entitled to a foreign income tax offset for the portion of the gain representing the difference between contributions, reinvested earnings, and market value at time of withdrawal (US Gain 2). Detailed reasoning Upon the sale of the shares, you will pay income tax in the US. The cost base equivalent for US tax purposes will be the sum of the employer and employee contributions, and the reinvested earnings. The US income tax will therefore be on the difference between this cost base and the market value of the shares at the time of the sale (US Gains 2&3).
For Australian tax purposes, the sale of the shares will be CGT event A1. The cost base will be the value of the shares at the time of the withdrawal. The capital proceeds will be the market value of the shares at the time of the sale (Aus Gain 3). You will be able to amend your 2023 income tax assessment to claim an additional foreign income tax offset for the US tax paid on the difference between the contributions and reinvested earnings, and the market value at the time of the withdrawal (US Gain 2). This gain has already been taxed in Australia under section 99B of the ITAA 1936. Section 770-190 of the ITAA 1997 allows you four years from the time of paying the tax to make an amendment to claim the FITO. To the extent that the capital gain from the sale of the shares (Aus Gain 3) is offset by your carried forward capital losses, you will not be entitled to a FITO for the US tax paid on the remainder of the capital gain (US Gain 3). If your carried forward capital losses are greater than the gain, you will not be entitled to any FITO as there will be no assessable income to which it relates. Appendix: Comparison of US and Australian tax
Table 1: Comparison of US and Australian tax US Gain 1 US Gain 2 US Gain 3 Time of assessment in US At the time of Withdrawal At a later sale of the shares Quantification in US Employer and employee contributions, and reinvested earnings Difference between contributions, reinvested earnings, and market value at time of Withdrawal Growth in shares after Withdrawal Aus Gain 1 Aus Gain 2 Aus Gain 3 Time of assessment in Aus At time of Withdrawal At a later sale of the shares Quantification in Aus Market value at time of Withdrawal Growth in shares after Withdrawal > [1] Explanatory Memorandum, Tax Laws Amendment (2007 Measures No. 4) Bill 2007, paragraph [1.101]. [2] Paragraph 1.106.