BAKER v FC of T

Members:
F D O'Loughlin SM

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2015] AATA 469

Decision date: 30 June 2015

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F D O'Loughlin (Senior Member)

1. The outcome in this application turns on whether an Individual Retirement Account or IRA maintained for the benefit of the Applicant in the USA^[1] United States of America. is a foreign superannuation fund for the purposes of s 305-80(1) of the 1997 Assessment Act^[2] The Income Tax Assessment Act 1997 (Cth). or, if not, whether a proposed payment from that account would be a payment from a scheme for the payment of benefits in the nature of superannuation upon retirement or death within the meaning of s 305-55 (2) of the 1997 Assessment Act.

2. The Applicant sought a ruling from the Commissioner that a payment he proposes will be made from his IRA will be either paid from a foreign superannuation fund or will be a payment from a scheme for the payment of benefits in the nature of superannuation upon retirement. The Commissioner declined such a ruling.

3. For present purposes the parties agree that if the Applicant succeeds on either of the propositions he advances, pending further challenge by the Commissioner in respect of these questions, the Applicant would satisfy all remaining requirements for the ruling he seeks.

The legislation

4. Sections 305-80(1) and 305-55(2) of the 1997 Assessment Act are in the following terms:

305-80 Lump sums paid into complying superannuation plans-choice

• (1) This section applies if:
  • (a) section 305-70 applies to a *superannuation lump sum that is paid from a *foreign superannuation fund; and
  • (b) you are taken to receive the lump sum under section 307-15; and
  • (c) all of the lump sum is paid into a *complying superannuation fund; and
  • (d) immediately after the lump sum is paid into the complying superannuation fund, you no longer have a *superannuation interest in the foreign superannuation fund.
• ….

and

305-55 Restriction to lump sums received from certain foreign superannuation funds

• …
• (2) This Subdivision also applies if you receive a payment, 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 never has 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.

5. The defined terms embedded in those sections that are relevant to the present application are in the following terms:

• (a) 1997 Assessment Act, s 995-1(1):

  "Australian superannuation fund" has the meaning given by section 295-95.

  "foreign superannuation fund" :

  • (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.

  "superannuation fund" has the meaning given by section 10 of the Superannuation Industry (Supervision) Act 1993.

• (b) 1997 Assessment Act, s 295-95(2):
  • (2) A * superannuation fund is an Australian superannuation fund at a time, and for the income year in which that time occurs, if:
    • (a) the fund was established in Australia, or any asset of the fund is situated in Australia at that time; and
    • (b) at that time, the central management and control of the fund is ordinarily in Australia; and
    • (c) at that time either the fund had no member covered by subsection (3) (an active member ) or at least 50% of:
      • (i) the total * market value of the fund's assets attributable to * superannuation interests held by active members; or
      • (ii) 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.

• (c) Supervision Act,^[3] Superannuation Industry (Supervision) Act 1993 (Cth). s 10(1):

  "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.

6. The concepts of benefits in the nature of superannuation as used in s 305-55(2), an indefinitely continuing fund, a provident fund, a benefit fund, a superannuation fund, and a retirement fund each as used in the definition of a superannuation fund in s 10(1), are not defined.

The facts

7. The Commissioner has set out the primary facts that define the scheme in his ruling. Expressing those facts in third rather than second person grammar, they are as set out in Annexure A.

8. A critical aspect of the scheme upon which the Commissioner has ruled is the investment in the Merrill Lynch managed IRA. While the Commissioner's articulation of the scheme he ruled upon has not included all of the formal terms and conditions associated with the IRA, nor the associated promotional or explanatory material and statutory context in which it sits, all of the formal terms and conditions associated with the IRA must be taken to be part of the scheme ruled upon. Similarly, the context in which the scheme ruled upon sits can be a permissible factor to which regard might be had in determining how the relevant part/s of the 1997 Assessment Act will affect the scheme ruled upon. Accordingly, a number of further terms and conditions of the IRA and the context in which it needs to be considered are as set out in Annexure B. The references in the contextual material to USA taxation, and the reliance the Applicant places on what he describes as a penalty for early withdrawals from IRAs requires at least the form of expression used in the USA taxation legislation, if not the legal effect of that legislation, to be noted. Accordingly, Annexure C details the terms of § 72 of the USA Internal Revenue Code dealing with Annuities; certain proceeds of endowment and life insurance contracts.

The relevant authorities - what is meant by indefinitely continuing?

9. While expressed with reservation due to a lack of argument, in Cameron Brae^[4] Cameron Brae Pty Ltd v Federal Commissioner of Taxation (2007) 161 FCR 468 . Allsop and Stone JJ said that:

… the ordinary meaning of the word "indefinite" is "without distinct limitation of being or character; indeterminate, vague, undefined; of indetermined extent, amount or number" …^[5] Cameron Brae, at [32].

and Jessup J said:

… I doubt that "indefinitely" could be given a meaning effectively equivalent to "forever", since the rules of every fund would have to contain, one would have thought, reasonable and practical provisions for the fund to be wound up where it had to be^[6] Cameron Brae, at [108]. and … I am disposed to think that the facility for the fund to be wound up at any time by the trustee "for any reason" was inconsistent with the proposition. It may be that the relevant statutory meaning of "indefinitely" is "undefined" rather than "unlimited", but, in the absence of argument on the subject, I am not disposed to extend to the appellant the favour of adopting that meaning.^[7] Cameron Brae, at [109].

10. The sentiment to the effect that indefinite is not meant to be forever has a certain attraction to it as many contemporary superannuation funds, e.g. self-managed superannuation funds, implicitly, have an end date upon exhausting assets from which benefits may be paid but are nevertheless accepted as superannuation funds which entails acceptance that they are indefinitely continuing.

11. In the present circumstances, the conclusions reached on other questions make it unnecessary to decide this question. The occasion for that might be better left until the underlying policy of the concept, in a superannuation and taxation setting, is explored fully in argument and where the answer to the question will determine the outcome.

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ATC 6795

The relevant authorities - what is a superannuation fund?

12. When determining whether a given arrangement is a superannuation fund, courts have focussed on the terms of the constituent arrangements and what the relevant trustee can and cannot do, and is and is not obliged to do, with the trust assets and property.

13. In Mahony^[8] Mahony v Federal Commissioner of Taxation (1967) 10 AITR 463 , at 462–463. Kitto J examined the terms of the relevant deed and considered what could and could not be done pursuant to it. A similar approach was adopted by Taylor J^[9] Mahony , at 468–469. and Windeyer J who said:

It thus becomes necessary to look carefully and critically at the terms of this trust deed, at what it required and what it permitted - that is to say to see in what ways the trustees might, without any breach of the trusts it imposes, apply the trust property. Unless they were confined to applying the fund in ways consonant with it being a provident, benefit or superannuation fund for the benefit of employees, it cannot answer that description. 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.^[10] Mahony , at 472.

14. In Cameron Brae^[11] Cameron Brae Pty Ltd v Federal Commissioner of Taxation (2007) 161 FCR 468 . Allsop and Stone JJ^[12] Cameron Brae, at [33] and [34]. concluded that a trust that could serve no other purpose other than to provide superannuation benefits, albeit that the trustee had some discretions, would be a superannuation fund. Their Honours concluded that the authorities did not preclude such characterisation of trusts that afforded the trustees discretions as to the identity of recipients of superannuation benefits and added that the authorities:

permit the confident conclusion that a trust is only a superannuation fund if its sole purpose is for the payment of superannuation benefits. The circumstances in which it was held that that was not so and where benefits might be seen to be illusory and not real were cases where the deed permitted persons to benefit other than by way of superannuation or where the conduct of the affairs in connection with the fund made it apparent that purposes other than superannuation were engaged.^[13] Cameron Brae, at [34].

15. Jessup J held to similar effect.

In answering the question whether the fund was a "superannuation fund" as the term is ordinarily understood, it is, in my view, critical that payments could not have been made out of the fund (other than by way of administration expenses, taxation, etc) save to members of the relevant discretionary class, and save in circumstances which fell within the ordinary understanding of superannuation. A proper characterisation of the fund should, in my view, depend upon the purposes for which the assets and moneys of the fund might have been used rather than upon the quality of the rights of individual members of the fund. If the fund could have been used only to achieve what might be described as a superannuation purpose, I would describe the fund as a "superannuation fund". That a particular member of a discretionary class might not, ultimately, have received any payment, was not, in my view, disqualifying.^[14] Cameron Brae, at [106]. (Emphasis added).

16. Accordingly 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.

The relevant authorities - what is a scheme for the payment of benefits in the nature of superannuation on retirement?

17. There are no authorities directly addressing s 305-55(2).

18.

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ATC 6796

Similar concepts of in the nature of and in the form of have attracted attention in settings where activities in the nature of, or in the form of, a business have been considered by the courts.^[15] E.g. State Superannuation Board (NSW) v Federal Commissioner of Taxation 88 ATC 4382 , Sheppard J; in State Authorities Superannuation Board v Commissioner of Taxation (1988) 21 FCR 535 , Davies J; Federal Commissioner of Taxation v Swansea Services Pty Ltd 72 ATR 120 at 141 [99], McKerracher J. From those decisions, principles can be deduced that a thing, or state of affairs, in the nature of a nominated thing or state of affairs (e.g. a business) does not require the former to be precisely the same as the latter. The former concept is wider than or extends the reach of the latter.^[16] Swansea Services, at 141 [99], McKerracher J. While the concepts of in the nature of or in the form of widen the range of eligible things or circumstances embraced by the statute,^[17] See State Superannuation Board (NSW) v Federal Commissioner of Taxation 88 ATC 4382 at 4392 Sheppard J. referred to with approval on appeal by Davies J in State Authorities Superannuation Board v Commissioner of Taxation above at 547. and therefore constitute an easier standard to be satisfied,^[18] See State Superannuation Board (NSW) v Federal Commissioner of Taxation 88 ATC 4382 at 4389 Sheppard J. it is still necessary for the things or circumstances to have the essence of the subject matter which is resembled.^[19] State Authorities Superannuation Board v Commissioner of Taxation above Davies J at 547–548. When used as a noun the term form means, among others, the visible shape or configuration of something, the particular way in which a thing exists or appears, or the type or variety of something.^[20] Oxford University Press, Oxford English Dictionary: form http://www.oxforddictionaries.com/definition/english/form , viewed 25 June 2015. Similarly, when used as a noun the term nature means, among others, basic or inherent features, character, or qualities of something or the innate or essential qualities or character of something.^[21] Oxford University Press, Oxford English Dictionary: nature, http://www.oxforddictionaries.com/definition/english/nature, viewed 25 June 2015.

19. Accordingly, 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.

20. Such a construction of s 305-55(2) is consistent with its terms in modifying, by way of enlargement, the operation of s 305-80.

The contentions

21. The Applicant contends that the IRA was a superannuation fund and foreign superannuation fund. He contends that the IRA is sufficiently indefinitely continuing and is a scheme under which it is illegal or unlawful to withdraw funds before what might be described as retirement events or retirement ages are reached attracting a penalty tax if such withdrawals are made. Based on these contentions the Applicant contends that the IRA and the regime in which it sits are more restrictive than what are undoubtedly superannuation fund arrangements in Australia and ought be treated on the same footing. The Applicant's indefinitely continuing contention is based on what was said in Cameron Brae. The Applicant's illegal or unlawful withdrawal contention is explained in terms that it is contrary to the legislative intent of the tax system regulating IRAs and departures from that intent attract a penalty tax.

22. For substantially the same reasons the Applicant contends that the payment from the IRA, as planned by the scheme ruled upon, would be a payment from a scheme for the payment of benefits in the nature of superannuation upon retirement. The reasons in support are substantially the same as those in support of the proposition that the IRA is a superannuation fund.

23. The Commissioner contends that the IRA is not a superannuation fund because it is not indefinitely continuing, because it describes itself as a custodian agreement which it is, and because the Applicant is not restricted in taking money from it at any time.

Analysis of the contentions

24. The Commissioner's reliance on the nomenclature given by the IRA terms and conditions document (Custodian Agreement), without more, does not assist him. The appropriate principles concerning the extent to which nomenclature and labels govern outcomes were summarised in the following terms:^[22] M M Gordon (before her Honour’s appointment), Principles of Deductibility of Interest , Presentation to The Tax Institute, 12 June 2003, <http://www.taxinstitute.com.au/seminar-papers/principles-of-deductibility-of-interest-seminar-paper>.

The law has been and remains clear: it is not what you call something that counts, it is "what it really is" that matters. A mere label is not sufficient and never will be.

In Commissioner of Taxation v BHP, the Full Federal Court said:

"The true position is that the label that a party uses to characterise payment, in the present case the word "interest", will not be determinative, although it may have some relevance: cf NM Superannuation Pty Ltd v Young , referred to by the learned trial Judge in this context. What that relevance may be will depend on the particular circumstances of the case. A licence does not become a lease because the parties chose to call it one, if it is in truth a licence: Radaich v Smith . A person does not cease to be an employee and become an independent contractor because the parties use the latter description: Hannan & Allen v Australian Mutual Provident Society . So, it may be said that an amount payable does not become interest, if the parties chose to adopt that word, if in law it is not".

Really this is no more than a particular example of the law's preference for substance over form. As Hill J said in Commissioner of Taxation v BHP:

"I would wish to say something about the issue of substance and form. While, no doubt, questions such as whether a covenanted payment is an annuity will, having regard to historical matters, depend to some, perhaps a considerable, extent on the form which the parties have adopted: Australia and New Zealand Savings Bank Ltd v Commissioner of Taxation , referred to with approval on this point on appeal: Australia and New Zealand Savings Bank Ltd v Commissioner of Taxation and Commissioner of Taxation v Australia and New Zealand Savings Bank Ltd ; it is not assumed that form must always prevail over substance. The law has moved somewhat from the rather rigid adherence to form to be found in cases such as Inland Revenue Commissioners v Duke of Westminster . This is merely to emphasise that the Courts will always consider the substance of a transaction in characterising the character of the advantage which is sought to be obtained in determining whether an outgoing is on revenue account or whether on capital account and thus excluded from deductibility ". (Citations omitted and emphasis added.)

25. A more substantive approach is required.

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ATC 6797

26. On consideration of the facts and contextual material noted above, a number of conclusions are readily apparent.

27. First, it is readily apparent, and the Commissioner does not disagree, that there are parallels between the USA and Australian regimes designed to encourage the community to plan for and fund their own retirement income needs. Both regimes:

• (a) give tax concessions for accumulations of income;
• (b) direct attention to, and regulate by way of tax imposts or withdrawal of tax concessions, amounts that can be contributed to the concessionally taxed wealth accumulation vehicles;
• (c) either withdraw concessions or impose extra taxes when arrangements transgress particular boundaries; and
• (d) provide for certain types of rollovers.

28. Second, it is readily apparent that any additional impost payable on withdrawal of amounts from an IRA is neither expressed as a penalty or sanction nor is the event of the early withdrawal a prohibited act. Use of the expressions penalty and penalty tax in the Merrill Lynch documentation for the IRA needs to be seen and understood in the non-pejorative sense of a disadvantage suffered as the result of an action or situation.^[23] Oxford University Press, Oxford English Dictionary: penalty , http://www.oxforddictionaries.com/definition/english/penalty viewed 25 June 2015. In fact, the structure and form of expression in § 72 of the USA's Internal Revenue Code suggests that as a primary position there is an additional tax burden on certain amounts from which a taxpayer is relieved in prescribed circumstances.

29. There does appear, however, to be a fundamental difference between the Australian and USA regimes that are directed to incentivise retirement planning and saving. The USA regime does not appear to have prohibitions on activities that can be undertaken within a concessionally taxed structure intended to incentivise retirement saving, or by those who control those structures, to the same degree as in Australia. And beyond what he describes as illegality and the penalty taxes as noted and addressed above, the Applicant does not advance that there are any such limitations. Importantly, under the USA regime, money can be withdrawn at any time prior to any retirement event at the complete discretion of the IRA holder. Any amount can be released or withdrawn at any time. Retirement income, or superannuation payments or payments in the nature of superannuation payments are but possibilities under the IRA structure rather than what is an essential feature of the structure by reason of limitations in or the scope of the formal terms and conditions of the structure.

30. The Australian structure is quite different. Superannuation funds are regulated, by the Supervision Act and by the Supervision Regulations.^[24] Superannuation Industry (Supervision) Regulations 1994 (Cth) . Only unrestricted non-preserved benefits can be withdrawn at any time.^[25] Supervision Regulations, r 6.20. A narrow range of contributions to a superannuation fund are received by such funds as unrestricted non-preserved benefits.^[26] Supervision Regulations, rr 6.10 and 6.13. There is a presumption that contributions and rollovers to superannuation funds are preserved and restricted until the trustee is satisfied they are not,^[27] Supervision Regulations, r 6.15. and amounts not received by a superannuation fund as unrestricted and unpreserved benefits must become unrestricted and unpreserved by the member satisfying a condition of release and the member's cashing restriction becoming nil before they can be paid.^[28] Supervision Regulations, rr 6.10, 6.12 and 6.20. The conditions of release are also quite detailed and specific covering a range of circumstances.^[29] Supervision Regulations, Schedule 1.

31. The Applicant's contention that the IRA is equivalent to or more restricted than an Australian superannuation fund is

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ATC 6798

therefore unsustained and the conclusions that he seeks based on these contentions are therefore not reached.

32. While it can readily be accepted that the USA IRA is a method that might be commonly adopted and used to plan and save for retirement income, that such planning and saving is incentivized by means that have their parallels in Australia, that these vehicles and the concessions that are afforded to them if certain behaviors are observed are part of a strategy designed by the USA government to encourage self-provision for and in retirement, the restrictive features required of trusts so as to be superannuation funds for Australian income tax purposes do not accommodate the flexible structures that appear to be promoted in the USA to achieve equivalent purposes in Australia.

33. It follows that the IRA is not a superannuation fund as defined and therefore is not a foreign superannuation fund within the meaning of s 305-80(1).

34. The flexibility of monetary withdrawals from an IRA is such that payments in the nature of superannuation payments from it are but one of a number of possibilities which means that the scheme does not qualify as one for the payment of benefits in the nature of superannuation upon retirement or death within the meaning of s 305-55(2).

Decision

35. The Tribunal affirms the decision under review

Annexure A

Relevant facts and circumstances.

….

• 1 The Applicant resided and worked in the United States of America (USA).
• 2 In July 1987, the Applicant became an Australian resident for tax purposes.
• 3 In a letter dated 23 June 1988, the Schlumberger Technology Corporation advised that in lieu of the Applicant's pension, the amount of US$3,566.97 would be made to the Applicant as a lump sum. In addition, the Applicant's profit sharing account would be paid out.
• 4 In a settlement statement from the Texas Commerce Bank (as Trustee for Schlumberger Technology Corporation Profit Sharing Plan), it shows a withdrawal amount of US$37,640.31 for the Applicant for the period 1 January 1988 to 30 September 1988.
• 5 On 2 September 1988, the Texas Commerce Bank advised that the amount of US$37,640.31 was to be credited to the Applicant's account number 137-28395 with Merrill Lynch.
• 6 On 24 October 1988, the Applicant commenced membership with a Merrill Lynch Individual Retirement Account Rollover Plan (the IRA Plan). The IRA Plan is a personal tax-deferred retirement plan.
• 7 In a statement from the IRA Plan it shows the Applicant's benefits of US$41,207.28 (US$3,566.97 and US$37,640.31) were transferred to the Plan in 1988 tax year.
• 8 The IRA Plan is not an employer sponsored fund.
• 9 The IRA Plan was started with roll-overs from the Applicant's USA employer's pension fund and other termination payments.
• 10 A copy of the Merrill Lynch IRA Disclosure Statement and the IRA Custodial Agreement have been provided which state amongst other matters that:

  Distributions from Your Merrill Lynch IRA

  4.1 Your rights to distribution

  You can withdraw all or any of the assets in your IRA at any time except to the extent you restrict your liability to do so by assigning assets in your IRA as security, in accordance with an applicable Internal Revenue Service pronouncement, to repay a distribution from a retirement plan restricted under U.S. Treasury Regulation Section 1.401-4(c)(1). Any amount you or your beneficiaries receive from your IRA is called a "distribution".

  …

  Part 7: Other Rules for your IRA:

  …

  Loans from or against your IRA . If you were to borrow all or any portion of the assets of your IRA, the entire value of your account would be treated as though it were distributed to you. If you were to pledge all or part of your IRA as security (collateral) for a loan, the part you pledged will be considered to have been distributed to you for the year it is pledged. In either case, you would then have to report the amount deemed distributed to you in your gross income for the year involved, and the 10% penalty tax on premature distributions would apply if you were under age 59½ and not totally and permanently disabled.

• 11 The Applicant also provided information that stated.

  Currently, if you receive a distribution before you are age 59½, you may not have to pay the 10% additional tax penalty if you are in one of the following situations.

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    ATC 6800

    • You are totally and permanently disabled.
  • • You have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse was born before January 2, 1949) of your adjusted gross income.
  • • The distributions are not more than the cost of your medical insurance due to a period of unemployment.
  • • The distributions are not more than your qualified higher education expenses.
  • • You use the distributions to buy, build, or rebuild a first home.
  • • You are the beneficiary of a deceased IRA owner.
  • • You are receiving distributions in the form of an annuity.
  • • The distribution is due to an IRS levy of the qualified plan.
  • • The distribution is a qualified reservist distribution.

• 12 The information provided further states:

  …Generally, if you are under age 59½, you must pay a 10% additional tax penalty on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59½ are called early distributions. The 10% additional penalty tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.

• 13 In a letter dated 9 July 2014, Merrill Lynch advised the Applicant of the sale of Bank of America Merrill Lynch's International Wealth Management business to Switzerland-based Julius Baer Group. The letter also advised:
  • • the Applicant may transfer his assets to another suitable financial institution that is qualified to service IRA and/or the 529 Plan; or
  • • the Applicant could elect to liquidate all the assets held in his account(s) and have the proceeds distributed directly to him in the form of a cheque.
• 14 No contributions have been made by the Applicant or anyone on behalf of the Applicant to the IRA Plan since he became a resident of Australia.
• 15 No additional amounts were transferred from any source after the IRA Plan was opened and no active investment of the account was taken after the initial investment selection.
• 16 The Applicant's date of birth is 15 April 1958.

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ATC 6807

Annexure B

EXTRACTS:

• • IRA INTRODUCTORY EXPALANTORY MATERIAL
• • IRA DISCLOSURE STATEMENT
• • IRA CUSTODIAL AGREEMENT TERMS & CONDITIONS

1 EXTRACTS FROM THE IRA INTRODUCTORY EXPLANATORY MATERIAL

THE MERRILL LYNCH INDIVIDUAL RETIREMENT ACCOUNT

Reflecting The Tax Reform Act of 1986

Ever since the U.S. Congress expanded the availability of individual retirement accounts (IRAs) in 1981, taxpayers have been able to conveniently use them to help provide for retirement income while enjoying significant tax benefits. And with the Tax Reform Act 1986, IRAs are as strong as ever. The purpose of an IRA is to help you plan your financial security at retirement. Almost all taxpayers who are employed, even those who are covered by an employer-sponsored retirement plan, can establish and contribute up to $2,000 (or $2,250 with a Spousal IRA) each year.

As an IRA owner, you can strengthen your retirement security by investing your IRA funds on a tax-deferred basis. That means your account can grow, and no taxes are payable on that growth until a withdrawal is made from the IRA. You pay no taxes on any dividends, interest or gains in your IRA until you begin making withdrawals from the account, usually after retirement, when your income and your tax bracket may be lower. This feature can

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ATC 6801

produce significant tax savings and can have a dramatic effect on the growth potential of your IRA.

…

Prudent planning now is required for you to maintain your present lifestyle upon retirement. Whatever future income Social Security or your company retirement plan may provide, participation in a Merrill Lynch IRA can provide you with additional retirement dollars. Thus, your contributions to your Merrill Lynch IRA offer a convenient way to help secure your comfortable retirement.

If you receive cash or assets from another retirement plan- such as another IRA or an employer-sponsored retirement plan-you may be able to roll over all or part of those assets to your Merrill Lynch IRA. This permits you to continue the tax advantages for these assets.

2 EXTRACTS FROM THE IRA DISCLOSURE STATEMENT

Part 1: How Your Merrill Lynch IRA Works

A tax-deferred personal retirement plan

Your Merrill Lynch IRA is your own personal tax-deferred retirement plan. You can contribute to this IRA even if you are covered by a tax-qualified plan (such as a pension or profit-sharing plan), a government retirement plan or a 403(b) annuity plan maintained by a qualifying organization, which includes various charitable, religious and educational organizations.

What does "tax-deferred" mean? You can contribute a portion of the income you earn each year to your IRA. The earnings on those contributions will not be subject to federal income tax until you withdraw those earnings from your IRA - they are "tax-deferred."

How significant is the tax deferral? By postponing payment of federal income taxes on your IRA investment earnings, as well as on any deductible contributions to your IRA, you can achieve significant tax savings. …

…

Can my IRA contributions be deducted? IRA contributions for your 1986 tax year (which can be made until the due date, without extensions, of your 1986 federal income tax return- normally April 15,1987), can be deducted in full for federal income tax purposes, up to $2,000 or 100% of your compensation, whichever is less. However, beginning with your 1987 tax year, new limits take effect. The new limits do not affect your ability to contribute up to $2,000 (or $2,250 with a Spousal IRA). You may, however, be restricted in the amount you can deduct depending on your adjusted gross income, and your status as a participant in an employer-sponsored retirement plan. For a complete description of those limits, see Part 2 of this Disclosure Statement The eligible portion, if any, of your contribution may be deducted from your gross income on your federal tax return. The remaining portion, if any, will be considered your nondeductible contribution.

…

Requirements for an IRA

As long as you work and receive compensation (or are divorced and receive alimony) and will not reach age 70½ by the end of the tax year, you can establish and contribute to an IRA for that year. You are also permitted to contribute to an IRA for your nonworking spouse who has not reached age 70½ before the end of the tax year even if you are 70½ or older and are still receiving compensation.

…

Part 2: Contributions to Your Merrill Lynch IRA

Annual IRA contributions

Each tax year, you can contribute up to $2,000 or 100% of your compensation, whichever is less. For your 1986 tax year, you can deduct the full amount of your contribution from your gross income on your federal income tax return. This is true even if you take the standard deduction and do not itemise deductions. For 1987 and later tax years, you may still contribute the same amount to your IRA, but you may not be able to take a tax deduction for some or all of the contribution.

Annual contributions to a Merrill Lynch IRA must be made by check or money order. No annual contributions in the form of securities are permitted.

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ATC 6802

The rules for 1987 and later tax years that determine to what degree you can claim a deduction for your IRA contributions are as follows:

For single taxpayers and married taxpayers filing jointly.

• A. If neither you nor your spouse, if any is an active participant in an employer-sponsored retirement plan*, you can deduct your full IRA contribution of up to $2,000 (or $2,250 with a Spousal IRA).
• B. If either you or your spouse, if any (or both of you) is an active participant in an employer-sponsored retirement plan, and your Adjusted Gross Income (AGI) as defined under current law with certain modifications is less them $25,000, or $40,000 if you are married, you can also deduct your full IRA contribution of up to $2,000, (or $2,250 with a Spousal IRA).
• C. If either you or your spouse, if any, is an active participant in an employer-sponsored retirement plan, and your AGI is between $25,000-$35,000, or $40,000-$50,000 if you are married, your IRA deduction will be proportionately reduced. For example, if you are married and your AGI is $45,000, only up to $1,000 of your IRA contribution will be deductible. With AGI over $50,000, no portion of your IRA contribution will be deductible.

…

If you contribute to another IRA (or retirement plan). The maximum amount you can contribute to your Merrill Lynch IRA for a tax year is reduced by any contributions you make to another IRA for that year (and for pre-1987 tax years, by any voluntary tax-deductible employee contributions you make to your employer's retirement plan for that year). Voluntary nondeductible contributions you may make to your employer's retirement plan do not affect your permissible IRA contributions.

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If your employer contributes to this IRA for you . The maximum amount you can contribute to your Merrill Lynch IRA for a particular tax year is reduced by any IRA contributions your employer makes on your behalf for that year (other than employer contributions to your IRA under a Simplified Employee Pension (SEP) plan).

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Excess contributions: more than your limit

If you contribute more to your ERA for a tax year than you are permitted, the amount that exceeds the permissible limit is considered an "excess contribution " You cannot, under any circumstances, deduct the excess contribution from your income on your tax return, and you may incur a penalty tax on the excess amount. Part 5 explains how to correct an excess contribution and thus avoid or reduce the penalty tax.

Rollovers from other retirement plans

If you receive cash or other assets from another IRA or other retirement plan, such as a qualified pension or profit-sharing plan, you may be able to roll over all or part of those assets to your Merrill Lynch IRA. While you cannot deduct any portion of this type of contribution from your income on your tax return, you can continue to postpone paying income tax on the assets rolled over. The maximum amount rolled over may not exceed the taxable portion of the distribution. …

Part 3: investment of Your Merrill Lynch IRA

You control how your IRA is Invested

A very important feature of your Merrill Lynch IRA is flexibility of investments. That is, you control the investment of all contributions made to your account.

You can choose between two investment plans:

• (A) Flexible Investment Plan. Under this plan, you select the type of investments that best suit your particular needs. For example, younger individuals who would like to build up a sizable account balance by the time of their retirement may choose to invest in aggressive growth-oriented investments. On the other hand, older individuals may prefer more conservative investments with emphasis placed on fixed-income alternatives. Through self-directed IRAs, individuals can achieve their personal investment objectives.
• …
• (B) Limited Investment Plan. Maximum flexibility is not for everyone. With a Limited Investment IRA, you can direct the investment of your retirement assets among a limited number of alternatives. You can choose to invest in products such as certain mutual funds (including the "Merrill Lynch Family of Funds"), certificates of deposit, zero-coupon investments (including TIGRs® and TIGR cubs®), and certain Merrill Lynch-sponsored bond funds. These products span a broad spectrum of opportunities to help you meet your financial objectives, whatever they may be.

If you feel uncomfortable trying to choose from the wide array of investments available, or cannot spare the time to do so, Merrill Lynch offers a "Family of Funds," which provides you with a choice of several different mutual funds to help meet a variety of financial goals, whether they are current income, capital appreciation, capital appreciation with income, or income with preservation of principal.

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Part 4: Distributions from Your Merrill Lynch IRA

You can

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ATC 6803

withdraw all or part of the balance in your Merrill Lynch IRA at any time. Under limited circumstances involving rollover contributions from a qualified defined-benefit pension plan, however, you may elect to limit your ability to make withdrawals by assigning assets in your ERA as security to repay a "restricted distribution" from the pension plan. This restriction will apply in special circumstances prescribed by Treasury Regulations and will affect few employees. …

Distributions are subject to Tax Code rules and to the terms of the Merrill Lynch IRA Custodial Agreement. Under that Agreement, you must complete a special distribution form entitled the "IRA/SEP Distribution and Tax Withholding Form," which can be obtained from your Merrill Lynch Financial Consultant. You must also inform your Financial Consultant as to which investments should be sold to generate cash to make the distribution. Generally, a noncash distribution from your IRA of, for example, stocks, bonds or mutual fund shares can be made only once a year.

Distributions subject to regular income tax

Normally, any distribution to you from your IRA must be included in your gross income on your federal income tax return for the tax year you receive it and is taxable as ordinary income for that year. (There are some exceptions to this rule: for example, if you make a withdrawal to remove an excess contribution or if you withdraw assets from one IRA to consolidate them in another, you may not have to report the withdrawal in your income-see Parts 5 and 6.) However, if, after 1986, you have made a nondeductible contribution to any IRA, a distribution that you receive from any IRA (whether from a regular IRA, a Rollover IRA, a Spousal IRA or a SEP/IRA) will be only partially taxable on a prorated portion, based on all the assets in all of your IRAs combined. In such a situation; you are required to perform a calculation in order to exclude the portion attributable to all nondeductible contributions in computing your federal taxable income.

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Penalty tax on certain distributions before age 59½

The Tax Code encourages the use of IRAs to save for your retirement by imposing a nondeductible 10% penalty tax on the taxable portion of a "premature distribution"-that is, a distribution from your account made before you reach age 59½. This penalty is in addition to ordinary income tax imposed on the taxable portion of the amount withdrawn.

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This penalty tax does not apply, however, to distributions made to you before age 59½ if you are totally and permanently disabled.

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Distributions between ages 59½ and 70½

Between ages 59½ and 70½, you can, whenever you wish, withdraw as little as you wish or as much as you wish from your Merrill Lynch IRA. In this way, you can time withdrawals to meet your financial needs while at the same time take your tax situation into consideration. There is no minimum annual withdrawal required, as there is after reaching age 70½. Amounts withdrawn will be subject to regular income taxes if they are attributable to your deductible contributions or to earnings. The 10% premature distribution penalty tax will not apply to the amount withdrawn. (See Page 7 for a description.)

Distributions must be made upon attaining age 70½

You must start receiving minimum distributions of any amounts remaining in your Merrill Lynch IRA by the April 1^st following the calendar year in which you reach age 70½. The minimum amount you must take is determined by your life expectancy, or the joint life expectancy of you and your designated beneficiary. Life expectancy is calculated according to Tax Code regulation tables.

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Penalty tax for failure to take minimum distributions

Once you reach age 70½, if you fail to take the minimum distribution for any tax year, you may be subject to a nondeductible IRS penalty tax of 50% of the difference between what you were required to withdraw and the amount you actually withdrew.

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ATC 6804

Example: Irene Reilly's minimum distribution for a year is $10,000, but she withdraws only $9,000. Her penalty tax would be $500 ($10,000 - $9,000 = $1,000; $1,000 x 50% = $500)

In certain cases, the Internal Revenue Service may waive application of this penalty. You should see your tax advisor for advice on this subject.

Penalty tax on large distributions

Starting with 1987, the Tax Code imposes a nondeductible penalty tax equal to 15% of the amount of any "excess" retirement plan distributions you receive in a calendar year, regardless of your age. You cannot be considered to have received an "excess" distribution unless you receive taxable retirement plan distributions in a given year in excess of $112,500 (adjusted for inflation beginning in 1988). For this purpose, all distributions you receive from all IRAs, other individual retirement plans and certain employer-sponsored plans are to be added together. This new tax, added by the Tax Reform Act of 1986, is quite complex. It is very important for you to consult your tax advisor if you anticipate receiving large benefits. Your tax advisor should be consulted immediately if your "accrued" retirement plan benefits as of August 1,1986 totalled, $562,500 or more.

Distributions due to your death

You can name one or more beneficiaries to receive any balance remaining in your Merrill Lynch at your death. If no designated beneficiary survives you, or if no beneficiary designation; is in effect at your death, your balance will be paid to your estate in a single payment.

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Part 5: Rules for Avoiding Penalty Tax on Excess Contributions

Penalty tax on excess contributions

An excess contribution is the portion of an annual contribution made by you (or considered to be contributed by you) that exceeds the amount of your permissible contribution.

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If the excess contribution remains in your IRA beyond your federal income tax return filing deadline (including extensions) for the tax year for which the excess contribution was made, you will be liable for a nondeductible penalty tax of 6% of the excess contribution.

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Before your filing deadline - avoid penalty tax completely

You can avoid the 6% penalty tax completely if you withdraw the excess contribution - and any earnings on it - before your deadline (including extensions) for filing your federal income tax return for the tax year for which the excess contribution was made.

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Part 6: Rules for Rollovers from Other Retirement Plans

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Rollovers from another IRA

You can roll over to your Merrill Lynch IRA all or part of the assets you withdraw from another IRA. By following these Tax Code rules, you can continue to postpone paying income taxes on the assets you roll over to the Merrill Lynch IRA.

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ATC 6805

Part 7: Other Rules for Your IRA

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Your right to your IRA balance

Your right to the balance in your IRA cannot be forfeited at any time.

Loss of tax deferral for prohibited uses of your IRA

The Tax Code prohibits you from using your IRA to engage in certain transactions under penalty of losing your IRA's tax-deferred status. For example, you cannot borrow from your account, sell property to it or buy property from it. If your IRA were to lose its tax-deferred status, you would have to include the entire IRA balance in your gross income for the year the deferred status was lost (subject, however, to the normal rules for the exclusion of nondeductible IRA contributions you may have made). And, if you had not yet reached age 59½ and were not totally and permanently disabled, the taxable amount would also be subject to the 10% penalty tax on premature distributions.

Loans from or against your IRA . If you were to borrow all or any portion of the assets of your IRA, the entire value of your account would be treated as though it were distributed to you. If you were to pledge all or part of your IRA as security (collateral) for a loan, the part you pledged will be considered to have been distributed to you for the year it is pledged. In either case, you would then have to report the amount deemed distributed to you in your gross income for the year involved, and the 10% penalty tax on premature distributions would apply if you were under age 59½; and not totally and permanently disabled.

When IRS Form 5329 must be filed

You must file Form 5329-Return for Individual Retirement Arrangement Taxes - with your federal income tax return for any tax year in which you owe:

• ▪ The 6% penalty tax for an excess contribution (see page 10);
• ▪ The 10% penalty tax for a premature distribution (see page 8); or,
• ▪ The 50% penalty tax for failing to take a minimum annual distribution after you reach age 70½ (see page 9).

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3 EXTRACTS FROM THE IRA CUSTODIAL AGREEMENT TERMS AND CONDITIONS

Section 2: Contributions to Your Merrill Lynch IRA

We can accept three types of contributions to your IRA under this agreement:

• ▪ annual IRA contributions of not more than the lesser of $2,000 or 100% of your compensation;
• ▪ rollovers of assets you receive from other retirement plans; and,
• ▪ employer contributions for your benefit under an employer's Simplified Employee Pension (SEP) plan designed to comply with the requirements of Section 408(k) of the Tax Code.

2.1 Annual IRA contributions

We will not knowingly accept more than $2,000 as an annual IRA contribution made by you on your own behalf to your Merrill Lynch IRA for any tax year. …

2.2 Rollovers from other retirement plans

We may accept all or part of the assets you receive from other retirement plans as tax-free transfers to your IRA as described in or treated under Tax Code Sections 402(a)(5), 402(a)(7), 403(a)(4), 403(b)(8) and 408(d)(3). A rollover can be in assets other than cash. However, all noncash assets must be compatible with our administrative and operational requirements and framework

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Section 3: Investment of Your Merrill Lynch IRA

3.1 Investing contributions to your IRA

You will direct us as to how to invest contributions to your IRA and any earnings on the assets purchased with those contributions. You can have us place each contribution in one or more of the investment alternatives we offer for your IRA, subject to any rules we may reasonably establish. The following are permissible categories of investments: securities traded on recognised securities exchanges or "over-the-counter"; government securities; shares or interests in selected money market and other mutual funds; interests in certain limited partnerships and unit investment trusts; the writing of listed covered call options; the buying of put options against long securities positions; and any other investments that are compatible with Merrill Lynch's administrative and operational requirements and framework. Beginning in 1987, certain gold and silver coins issued by the United States are also permissible investments. Assets in your IRA, however, may not be commingled with other property except in a common trust fund or a common investment fund.

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3.4 Legal restrictions on investments

Your IRA cannot be invested in life insurance contracts. In addition, your IRA cannot be invested in "collectibles" such as works of art, antiques, rugs, metals, gems, stamps, coins or alcoholic beverages. Beginning in 1987, however, certain gold and silver coins issued by the United States will not be considered "collectibles" and will be acceptable investment alternatives.

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ATC 6806

Section 4 Distributions from Your Merrill Lynch IRA

4.1 Your right to distribution

You can withdraw all or any of the assets in your IRA at any time except to the extent you restrict your ability to do so by assigning assets in your IRA as security, in accordance with an applicable Internal Revenue Service pronouncement, to repay a distribution from a retirement plan restricted under U.S. Treasury Regulation Section 1.401-4(c)(1). Any amount you or your beneficiaries receive from your IRA is called a "distribution."

4 2 Withholding of federal income taxes

The Tax Code requires that federal income taxes be withheld (subtracted) from all taxable distributions from your IRA -unless you tell us that you don't want any taxes withheld. We will provide you with a special form so that you can make your choice as to whether or not taxes are to be withheld. Note: To qualify for the check-writing privileges, you must elect not to have taxes withheld from all distributions made by check.

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4.4 Distribution must begin by age 70½

Unless already fully distributed, you must begin receiving distributions from your IRA by April 1 following the year in which you reach age 70½. By that time, you must choose either to receive the entire balance in your IRA in one payment, or to begin receiving payments over a prescribed period in minimum amounts each year.

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4.5 Distributions due to death

If you die before distributions to you from your IRA have commenced, the entire balance in your IRA must be distributed within five years after your death. However, if any portion of your IRA balance is payable to an individual designated as your beneficiary, and distributions to that beneficiary begin no later than one year after your death, that portion of your IRA balance may be paid over the life of your beneficiary or over a period not extending beyond your beneficiary's life expectancy. The requirement that distributions must begin within one year after your death does not apply, however, if your designated beneficiary is your surviving spouse. In that case, the date distributions to your spouse are to begin may be postponed to the date when you would have reached age 70½.

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Section 5 Our Rights and Responsibilities

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5.4 Changing custodians

We can resign as custodian of your IRA by giving you written notice. Our resignation will take effect 30 days after mailing of the notice to your last known address in our records. If you do not appoint a qualified successor custodian to replace us, we can distribute the balance in your IRA to you in a single payment.

You can direct us in writing to transfer the assets in your IRA to some other custodian or trustee of another IRA you identify to us. …

Annexure C

USA Internal Revenue Code § 72 - Annuities; certain proceeds of endowment and life insurance contracts

§ 72(t) 10-percent additional tax on early distributions from qualified retirement plans

(1) Imposition of additional tax

If any taxpayer receives any amount from a qualified retirement plan (as defined in section 4974(c)), the taxpayer's tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income.

(2) Subsection not to apply to certain distributions

Except as provided in paragraphs (3) and (4), paragraph (1) shall not apply to any of the following distributions:

(A) In general

Distributions which are-

• (i) made on or after the date on which the employee attains age 59½,
• (ii) made to a beneficiary (or to the estate of the employee) on or after the death of the employee,
• (iii) attributable to the employee's being disabled within the meaning of subsection (m)(7),
• (iv) part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary,
• (v) made to an employee after separation from service after attainment of age 55,
• (vi) dividends paid with respect to stock of a corporation which are described in section 404(k),
• (vii) made on account of a levy under section 6331 on the qualified retirement plan, or
• (viii) payments under a phased retirement annuity under section 8366a(a)(5) ^[3] or 8412a(a)(5) of title 5, United States Code, or a composite retirement annuity under section 8366a(a)(1) ^[3] or 8412a(a)(1) of such title.

(B) Medical expenses

Distributions made to the employee (other than distributions described in subparagraph (A), (C), or (D)) to the extent such distributions do not exceed the amount allowable as a deduction under section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).

(C) Payments to alternate payees pursuant to qualified domestic relations orders

Any distribution to an alternate payee pursuant to a qualified domestic relations order (within the meaning of section 414(p)(1)).

(D) Distributions to unemployed individuals for health insurance premiums

• (i) In general Distributions from an individual retirement plan to an individual after separation from employment-
  • (I) if such individual has received unemployment compensation for 12 consecutive weeks under any Federal or State unemployment compensation law by reason of such separation,
  • (II) if such distributions are made during any taxable year during which such unemployment compensation is paid or the succeeding taxable year, and
  • (III) to the extent such distributions do not exceed the amount paid during the taxable year for insurance described in section 213(d)(1)(D) with respect to the individual and the individual's spouse and dependents (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof).
• (ii) Distributions after reemployment Clause (i) shall not apply to any distribution made after the individual has been employed for at least 60 days after the separation from employment to which clause (i) applies.
• (iii) Self-employed individuals To the extent provided in regulations, a self-employed individual shall be treated as meeting the requirements of clause (i)(I) if, under Federal or State law, the individual would

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  ATC 6808

  have received unemployment compensation but for the fact the individual was self-employed.

(E) Distributions from individual retirement plans for higher education expenses

Distributions to an individual from an individual retirement plan to the extent such distributions do not exceed the qualified higher education expenses (as defined in paragraph (7)) of the taxpayer for the taxable year. Distributions shall not be taken into account under the preceding sentence if such distributions are described in subparagraph (A), (C), or (D) or to the extent paragraph (1) does not apply to such distributions by reason of subparagraph (B).

(F) Distributions from certain plans for first home purchases

Distributions to an individual from an individual retirement plan which are qualified first-time homebuyer distributions (as defined in paragraph (8)). Distributions shall not be taken into account under the preceding sentence if such distributions are described in subparagraph (A), (C), (D), or (E) or to the extent paragraph (1) does not apply to such distributions by reason of subparagraph (B).

(G) Distributions from retirement plans to individuals called to active duty

• (i) In general Any qualified reservist distribution.
• (ii) Amount distributed may be repaid Any individual who receives a qualified reservist distribution may, at any time during the 2-year period beginning on the day after the end of the active duty period, make one or more contributions to an individual retirement plan of such individual in an aggregate amount not to exceed the amount of such distribution. The dollar limitations otherwise applicable to contributions to individual retirement plans shall not apply to any contribution made pursuant to the preceding sentence. No deduction shall be allowed for any contribution pursuant to this clause.
• (iii) Qualified reservist distribution For purposes of this subparagraph, the term "qualified reservist distribution" means any distribution to an individual if-
  • (I) such distribution is from an individual retirement plan, or from amounts attributable to employer contributions made pursuant to elective deferrals described in subparagraph (A) or (C) of section 402(g)(3) or section 501(c)(18)(D)(iii),
  • (II) such individual was (by reason of being a member of a reserve component (as defined in section 101 of title 37, United States Code)) ordered or called to active duty for a period in excess of 179 days or for an indefinite period, and
  • (III) such distribution is made during the period beginning on the date of such order or call and ending at the close of the active duty period.
• (iv) Application of subparagraph This subparagraph applies to individuals ordered or called to active duty after September 11, 2001. In no event shall the 2-year period referred to in clause (ii) end before the date which is 2 years after the date of the enactment of this subparagraph.

(3) Limitations

(A) Certain exceptions not to apply to individual retirement plans

Subparagraphs (A)(v) and (C) of paragraph (2) shall not apply to distributions from an individual retirement plan.

(B) Periodic payments under qualified plans must begin after separation

Paragraph (2)(A)(iv) shall not apply to any amount paid from a trust described in section 401(a) which is exempt from tax under section 501(a) or from a contract described in section 72(e)(5)(D)(ii) unless the series of payments begins after the employee separates from service.

(4) Change in substantially equal payments

(A) In general

If-

• (i) paragraph (1) does not apply to a distribution by reason of paragraph (2)(A)(iv), and
• (ii) the series of payments under such paragraph are subsequently modified (other than by reason of death or disability)-

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    ATC 6809

    (I) before the close of the 5-year period beginning with the date of the first payment and after the employee attains age 591/2, or
  • (II) before the employee attains age 591/2,

  the taxpayer's tax for the 1st taxable year in which such modification occurs shall be increased by an amount, determined under regulations, equal to the tax which (but for paragraph (2)(A)(iv)) would have been imposed, plus interest for the deferral period.

(B) Deferral period

For purposes of this paragraph, the term "deferral period" means the period beginning with the taxable year in which (without regard to paragraph (2)(A)(iv)) the distribution would have been includible in gross income and ending with the taxable year in which the modification described in subparagraph (A) occurs.

(5) Employee

For purposes of this subsection, the term "employee" includes any participant, and in the case of an individual retirement plan, the individual for whose benefit such plan was established.

(6) Special rules for simple retirement accounts

In the case of any amount received from a simple retirement account (within the meaning of section 408(p)) during the 2-year period beginning on the date such individual first participated in any qualified salary reduction arrangement maintained by the individual's employer under section 408(p)(2), paragraph (1) shall be applied by substituting "25 percent" for "10 percent".

(7) Qualified higher education expenses

For purposes of paragraph (2)(E)-

(A) In general

The term "qualified higher education expenses" means qualified higher education expenses (as defined in section 529(e)(3)) for education furnished to-

• (i) the taxpayer,
• (ii) the taxpayer's spouse, or
• (iii) any child (as defined in section 152(f)(1)) or grandchild of the taxpayer or the taxpayer's spouse,

  at an eligible educational institution (as defined in section 529(e)(5)).

(B) Coordination with other benefits

The amount of qualified higher education expenses for any taxable year shall be reduced as provided in section 25A(g)(2).

(8) Qualified first-time homebuyer distributions

For purposes of paragraph (2)(F)-

(A) In general

The term "qualified first-time homebuyer distribution" means any payment or distribution received by an individual to the extent such payment or distribution is used by the individual before the close of the 120th day after the day on which such payment or distribution is received to pay qualified acquisition costs with respect to a principal residence of a first-time homebuyer who is such individual, the spouse of such individual, or any child, grandchild, or ancestor of such individual or the individual's spouse.

(B) Lifetime dollar limitation

The aggregate amount of payments or distributions received by an individual which may be treated as qualified first-time homebuyer distributions for any taxable year shall not exceed the excess (if any) of-

• (i) $10,000, over
• (ii) the aggregate amounts treated as qualified first-time homebuyer distributions with respect to such individual for all prior taxable years.

(C) Qualified acquisition costs

For purposes of this paragraph, the term "qualified acquisition costs" means the costs of acquiring, constructing, or reconstructing a residence. Such term includes any usual or reasonable settlement, financing, or other closing costs.

(D) First-time homebuyer; other definitions

For purposes of this paragraph-

• (i) First-time homebuyer The term "first-time homebuyer" means any individual if-

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    ATC 6810

    (I) such individual (and if married, such individual's spouse) had no present ownership interest in a principal residence during the 2-year period ending on the date of acquisition of the principal residence to which this paragraph applies, and
  • (II) subsection (h) or (k) of section 1034 ^[4] (as in effect on the day before the date of the enactment of this paragraph) did not suspend the running of any period of time specified in section 1034 ^[4] (as so in effect) with respect to such individual on the day before the date the distribution is applied pursuant to subparagraph (A).
• (ii) Principal residence The term "principal residence" has the same meaning as when used in section 121.
• (iii) Date of acquisition The term "date of acquisition" means the date-
  • (I) on which a binding contract to acquire the principal residence to which subparagraph (A) applies is entered into, or
  • (II) on which construction or reconstruction of such a principal residence is commenced.

(E) Special rule where delay in acquisition

If any distribution from any individual retirement plan fails to meet the requirements of subparagraph (A) solely by reason of a delay or cancellation of the purchase or construction of the residence, the amount of the distribution may be contributed to an individual retirement plan as provided in section 408(d)(3)(A)(i) (determined by substituting "120th day" for "60th day" in such section), except that-

• (i) section 408(d)(3)(B) shall not be applied to such contribution, and
• (ii) such amount shall not be taken into account in determining whether section 408(d)(3)(B) applies to any other amount.

(9) Special rule for rollovers to section 457 plans

For purposes of this subsection, a distribution from an eligible deferred compensation plan (as defined in section 457(b)) of an eligible employer described in section 457(e)(1)(A) shall be treated as a distribution from a qualified retirement plan described in 4974(c)(1) to the extent that such distribution is attributable to an amount transferred to an eligible deferred compensation plan from a qualified retirement plan (as defined in section 4974(c)).

(10) Distributions to qualified public safety employees in governmental plans

(A) In general

In the case of a distribution to a qualified public safety employee from a governmental plan (within the meaning of section 414(d)) which is a defined benefit plan, paragraph (2)(A)(v) shall be applied by substituting "age 50" for "age 55".

(B) Qualified public safety employee

For purposes of this paragraph, the term "qualified public safety employee" means any employee of a State or political subdivision of a State who provides police protection, firefighting services, or emergency medical services for any area within the jurisdiction of such State or political subdivision.