Edited version of private ruling

Authorisation Number: 1011554382238

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Ruling

Subject: foreign income

Question 1

Is income from your US managed funds assessable income?

Answer:

Yes.

Question 2

Is the increase in value of your interest in the Roth IRA included in your assessable income if the exemption provisions don't apply? 

Answer:

Yes.

Question 3

Is your pension income from the US assessable in Australia?

Answer:

No.

Question 4

Can you include your managed fund income from the foreign country for year X in your relevant Australian return?

Answer:

Yes.

Question 5

Can you claim a foreign income tax offset (FITO) for tax paid in the foreign country?

Answer:

Yes.

This ruling applies for the following period

1 July 2008 to 30 June 2009

The scheme commenced on

1 July 2008

Relevant facts

You are a United States citizen.

Your spouse is an Australian citizen.

You arrived in Australia in the relevant income year on an interim visa.

After A months you filled in documentation to obtain permanent resident status, which was granted in the later income year.

Your primary source of income is from your US Military pension.

You are a resident of Australia.

You are not a temporary resident.

You have been living in a home and paying rent with your spouse since arriving in Australia.

You have no children.

You have three managed funds from which no withdrawals have been made and an insurance policy all taken out in the 1980's with a US bank.

The managed funds are:

· Roth IRA

· B wealth building, similar to a public unit trust in Australia and not a superannuation fund

· B high growth model, similar to a public unit trust in Australia and not a superannuation fund.

You receive distributions from your managed funds which comprise dividends and capital gains.

The insurance policy is payable on death only.

Your total investment in managed funds exceeds A$50,000.

Tax is payable on the Roth IRA on withdrawal.

You have no other assets in the USA.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 Subsection 481(1).

Income Tax Assessment Act 1936 Section 482

Income Tax Assessment Act 1936 Subsection 483(2).

Income Tax Assessment Act 1936 Subsection 485(3).

Income Tax Assessment Act 1936 Section 486.

Income Tax Assessment Act 1936 Subsection 515(1).

Income Tax Assessment Act 1936 Section 519.

Income Tax Assessment Act 1936 Subsection 513(2).

Income Tax Assessment Act 1936 subsection 605(2)

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Subsection 6-5(2).

Income Tax Assessment Act 1997 Subsection 6-5(1).

Income Tax Assessment Act 1997 Subsection 6-10(4).

Income Tax Assessment Act 1997 Subsection 6-10(2).

Income Tax Assessment Act 1997 section 6-15

Income Tax Assessment Act 1997 Section 10-5.

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 995-1(1)

Income Tax Assessment Act 1936 Section 529.

Section 4 International Tax Agreements Act 1953

Article 19 of Schedule 2 International Tax Agreements Act 1953

Section 18 Income Tax Rates Act 1986

Section 20 Income Tax Rates Act 1986

Section 388-55 Schedule 1 Taxation Administration Act 1953

Reasons for decision

The assessable income of a resident taxpayer includes ordinary income and statutory income derived directly or indirectly from all sources, in or out of Australia, during the income year (subsections 6-5(2) and 6-10(4) of the Income Tax Assessment Act 1997 [ITAA 1997]).

Ordinary income is defined to mean income according to ordinary concepts (subsection 6-5(1) of the ITAA 1997).

Statutory income is not ordinary income but is included in assessable income by a specific provision in the tax legislation (subsection 6-10(2) of the ITAA 1997). 

Section 10-5 of the ITAA 1997 lists those provisions. Included in that list is foreign investment fund (FIF) income under section 529 of the Income Tax Assessment Act 1936 (ITAA 1936), capital gains in terms of section 102-5 of the ITAA 1997 and dividend income under subsection 44(1) of the ITAA 1936.

Capital gains and dividend income derived by the trustee of a trust estate retain their character as those types of income when a beneficiary becomes entitled to a distribution of income from the trust estate (Taxation Ruling IT 2680).

Application of the FIF measures

Australian resident taxpayers who have interests in certain foreign investment funds (FIF's), which includes foreign life policies (FLP's) may be subject to tax on an accruals basis on the growth in the value of their FIF assets under the FIF measures contained in Part XI of the ITAA 1936.

A FLP is defined in section 482 of the ITAA 1936 as a life assurance policy issued by a non resident entity, exclusions are policies:

· providing payment on death or permanent disability only or

· issued before 1 July 1992 which cannot after that date be cancelled, surrendered or redeemed and for which the terms have not after that date been altered in a material way.

Your life policy only provides for payment of money on death or permanent disability only. Accordingly your policy is not an FLP.

Foreign trusts are defined as FIF's (subsection 481(1) of the ITAA 1936).

The Internal Revenue Service (IRS), in its Publication 590 Individual Retirement Arrangements, discusses Roth IRAs and defines them as a trust or custodial account set up in the US for the exclusive benefit of you or your beneficiaries.

The funds in these accounts are invested in stocks, bonds, and/or mutual funds. Any interest, dividends and capital gains generated from investments are retained in the accounts.

Accordingly, your Roth IRA will be considered a foreign trust for FIF purposes.

The FIF provisions then look to whether an Australian resident has an interest in such a FIF. An interest in a FIF of a foreign trust means the entitlement to the income or corpus of the trust (subsection 483(2) of the ITAA 1936).

A Roth IRA represents an agreement by an authorised trustee to hold certain funds in trust for an individual. The trustee holds the income and capital of the account in trust for you. Therefore, you have an interest in a foreign trust that satisfies the requirements of an interest in a FIF under subsection 483(2) of the ITAA 1936.

Interest in FIF subject to the FIF measures

Section 529 of the ITAA 1936 is the operative provision of the FIF measures. It includes FIF income in a taxpayer's assessable income, in relation to a notional accounting period of a FIF, for the year of income in which that notional accounting period ended.

The FIF measures apply to your interest in a FIF for the notional accounting period of the FIF that ended in your income year if:

· you had an interest in that FIF at the end of the income year, and

· you were a resident of Australia at any time in that income year (subsection 485(3) of the ITAA 1936).

The notional accounting period of a FIF will generally be 1 July to 30 June unless you elect to use another notional accounting period (section 486 of the ITAA 1936).

The measures do not apply to an interest in a FIF if you dispose of that interest on or before 30 June. However, other provisions of the ITAA 1997 and ITAA 1936 may apply to the interest.

In your case, you held an interest in a Roth IRA at the end of the income year, your interest will be assessable under the FIF measures unless one of the exemption provisions applies.

Exemption from FIF taxation

The main exemptions that could apply to exclude attributable income in relation to your FIF investments are the small investor exemption, the exemption for foreign employer sponsored superannuation funds and the exemption for interests in certain FIF's resident in the US.

Does the small investor exemption apply?

An exemption is available under subsection 515(1) of the ITAA 1936 when your interests, combined with the interests of associates, in a FLP or other FIF interests do not exceed $50,000 in value at the end of the income year.

The small investor exemption does not apply to you as the total value of your interests exceeds $50,000.

Employer-sponsored superannuation funds

This exemption is available under section 519 of the ITAA 1936, if you are a natural person with an interest in a FIF that is an employer-sponsor superannuation fund. The FIF must be a superannuation fund maintained by your employer, or an associate of your employer, for the benefit of their employees. Also you must be an employee or former employee of the employer.

The exemption would not apply to your Roth IRA as it is not a superannuation fund in terms of Subsection 6(1) of the ITAA 1936 or section 995-1(1) of the ITAA 1997, neither is it employer sponsored.

Exemption for interests in certain FIF resident in the US

Division 8 of the ITAA 1936 provides an exemption from the FIF measures for interests in certain FIF's taxed on a worldwide basis in the US and a limited exemption for interests in certain FIF taxed as conduit entities or a common trust fund in the US. The exemption is intended to encourage Australian investment funds to be more efficient by exposing them to competition from the US funds.

The exemption is available for FIF interests in:

· entities that are treated as corporations and are subject to tax on their worldwide income under the US Internal Revenue Code 1986, or

· regulated investment companies and, or real estate investment trusts for the purposes of the US Internal Revenue Code 1986.

A more limited exemption is available under subsection 513(2) of the ITAA 1936 for FIF interests in an entity that is treated as a common trust fund under the US Internal Revenue Code 1986. However, for this exemption to apply, certain conditions must be satisfied. Conditions are satisfied where the interests are held for the sole purpose of investing directly, or indirectly through other entities, in a business conducted in the US or a real property located in the US where the entity does not:

· have an interest in income or gains from non-US sources

· hold an interest in a FIF not resident in the US, or

· hold real property outside the US.

The sole purpose test may still apply where the non-qualifying interest of the entity from non-US sources and the income and gains of the entity from outside the US, do not exceed five per cent of the value of all the interests of the entity or the total value of the assets held by the entity.

In your case, the information provided is not sufficient to determine whether your interest in the Roth IRA qualifies for the FIF exemption under Division 8 of the ITAA 1936. You must obtain the arrangement details in relation to your investments in the Roth IRA. Your fund manager should be able to assist you to obtain this information.

If your investment in the Roth IRA is exempt from the FIF rules, you will not be assessable on an accruals basis on your share of the accumulated income from these investments under the FIF measures.

However, an amount distributed to you from the Roth IRA that has not previously taxed in Australia, would be assessable to you in Australia under other provisions of the ITAA 1936 or ITAA 1997.

Methods of FIF taxation

There are three methods that can be used to determine the FIF income that has accrued to you in a particular income year. These are:

· the market value method

· the deemed rate of return method, and

· the calculation method.

The market value method basically works out the movement in market value of the FIF interest between two annual reporting dates. We expected that most people will use the market value method.

The deemed rate of return method basically works out the movement in value of the FIF by applying the deemed rate of return to the opening value of the FIF at the beginning of the notional accounting period.

You would use the deemed rate of return method only when you are unable to establish a market value for your FIF interest and you have not elected to use the calculation method.

You may use the calculation method if you have access to the financial accounts of the FIF and are able to determine your share of the FIF calculated profit or calculated loss.

More information on the methods of FIF taxation is available in chapter 4 of the Foreign investment funds guide 2009-10 which is available on our website.

Attribution accounts

FIF Attribution accounts operate on the basis of credits and debits. A credit is referred to as a FIF attribution credit and a debit is referred to as a FIF attribution debit.

Your FIF or FLP will have a FIF attribution credit recorded in its attribution account if an amount of FIF or FLP income is included in your assessable income under the FIF measures (section 529 of the ITAA 1936).

The amount of FIF attribution credit is equal to the amount included in your assessable income or the amount of the FIF attribution debit, which arises for the FIF attribution account entity making the distribution (subsection 605(2) of the ITAA 1936).

You will record a FIF attribution debit when the FIF or FLP in which you have an interest makes a distribution to you. Debits trace the movements of profits included in your assessable income under the FIF and FLP measures and prevent that income, where it has been attributed to you, from being taxed again.

A FIF attribution debit also arises where the whole or part of a FIF or FLP unapplied loss for a notional accounting period is an allowable deduction from your assessable income.

Foreign income tax offset

You can claim a tax offset for the foreign tax you have paid on income, profits or gains (including gains of a capital nature), that are included in your Australian assessable income. In some circumstances, the offset is subject to a limit. To be entitled to a foreign income tax offset:

you must have actually paid an amount of foreign income tax; and

the income or gain on which you paid foreign income tax must be included in your assessable income for Australian income tax purposes.

You claim the foreign income tax offset in your income tax return:

If claiming an offset of $1,000 or less, you only need to record the actual amount of foreign income tax paid on your assessable income (up to $1,000).

If claiming a foreign income tax offset of more than $1,000, you will need to perform calculations see the Guide to foreign income tax offset rules 2009-10 which is available on our website.

United States military pension

Exempt income it is not included in the assessable income of a taxpayer (section 6-15 of the ITAA 1997).

Agreements that Australia has with various countries under the International Tax Agreements Act 1953 (the Agreements Act) operates to prevent the double taxation of income. Section 4 of the Agreements Act incorporates that Act with the ITAA 1997 so that both Acts are read as one. The Agreements Act effectively overrides the ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

Article 19 of Schedule 2 (the United States Convention) to the Agreements Act provides that wages, salaries and similar remuneration, including pensions, paid from the funds of the United States of America for labour or personal services performed as an employee in the discharge of governmental functions of the United States of America shall be exempt from tax in Australia.

The United States military pension received by you is exempt income and therefore not assessable in Australia under section 6-5 of the ITAA 1997.

Individuals in receipt of foreign income subject to foreign tax on an annual assessment basis (IT 2498)

You will be required to disclose in your Australian income tax return the amount of foreign income derived during the Australian financial year. As a US tax assessment is raised on a calendar year basis, the US income to be included in your return of income for the 2008-09 Australian year of income would be ascertained by analysing the income of the US years of income ended 31 December 2008 and 31 December 2009 and calculating the US income which was derived by you between 1 July 2008 and 30 June 2009. The US income would in the case of a managed fund, be translated into Australian dollars at the rate of exchange on the date you receive the distribution.

As you have difficulties in dissecting the income for the purposes of returning on a strict Australian income year basis you can return the US source income in your Australian return for that year of income on the relevant US income year basis. The US income derived during the US income year, and the US tax assessed and paid in respect of that income, would be treated as substituting for the US income derived by you, and the foreign tax paid in respect thereof, during the relevant Australian year of income.

You would include the entire US income for the foreign income year ended 31 December 2008 in your 2008-09 Australian income tax return.

NOTE

Extension of time and late lodgement

Your relevant tax return of income was due on the relevant date. Full reasons should be given in an attachment to the return for late lodgement.

The Commissioner has a discretion to grant an extension of time for lodging a return (Section 388-55 Schedule 1 Taxation Administration Act 1953). A request for an extension of time will usually be in writing and must state the reasons for the delay, propose a deferred date for lodgment and give an assurance that future obligations will be met on time once the circumstances giving rise to the delay are resolved (paragraph 55.12 of the ATO Receivables Policy).

Generally, an extension of time will only be granted where the taxpayer has demonstrated that:

· lodgment cannot be made, or has not been made, by the due date because of circumstances beyond the taxpayer's control and reasonable steps have been taken to mitigate the effects of those circumstances;

· lodgment can be made by the deferred due date; and

· future obligations will be met on time unless the circumstances continue to be beyond the taxpayer's control (paragraph 55.13).

Tax-free threshold

The tax-free threshold under the Income Tax Rates Act 1986 (ITRA 1986) refers to that portion of an individual taxpayer's income that is subject to a zero rate of tax under the ordinary rates scale. For the 2008-09 income year, the general tax-free threshold available to most taxpayers is $6,000.

However, the full general tax-free threshold may not be available to a taxpayer where that taxpayer:

· became a resident of Australia during the income year; or

· ceased to be a resident of Australia during the income year (section 18 of the ITRA 1986).

Where the full general tax-free threshold does not apply, the tax-free threshold is pro-rated so that only a portion of the first $6,000 of income is free of tax (section 20 of the ITRA 1986). The remainder of the first $6,000 is subject to tax at the next lowest marginal rate of tax, namely 15% for the 2008-09 year of income.

You became a resident of Australia on 18 September 2008. You will be entitled to a tax free threshold of 9/12 X $6,000 = $4,500.

Your resident tax rates

These rates do not include the Medicare levy.

2008-09

You may also be entitled to a low income offset of $1,200.

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