Australian superannuation fund exemption

Sections CW 23B and EX 33E of the Income Tax Act 2004, section CG 15 2(cb) of the Income Tax Act 1994, section 245RA (2)(cb) of the Income Tax Act 1976

A new exemption has been added to the foreign investment fund (FIF) rules. The exemption applies to interests in specified Australian superannuation schemes held by an individual.

The exemption applies from the 1993-94 income year.

Background

Individuals working in Australia generally have compulsory contributions into a superannuation scheme made on their behalf by their employers. This scheme is treated as an employment-related foreign superannuation scheme for New Zealand tax purposes.

In general, Australian and New Zealand citizens cannot access these superannuation interests until they reach retirement age. If these individuals migrate or return to New Zealand they could be subject to tax on these interests under the FIF rules if they make contributions to the scheme after being resident in New Zealand for five years.

Consultation with the private sector has suggested that individuals with Australian superannuation interests may not be complying correctly with their tax obligations under the FIF rules or may not be aware that they have to account for tax. For those people who are aware of their tax responsibilities, determining whether they have a FIF obligation can involve high compliance costs. Although the current exemptions provide some relief from these rules, there may be difficulty in determining which exemption applies and the need to meet the ongoing requirements of the exemption.

In addition, the potential tax consequences under the FIF rules could be a disincentive for individuals with interests in particular superannuation schemes to take up long-term or permanent employment in New Zealand. For example, members of defined benefit schemes¹ must continue to contribute to such schemes to preserve the expected value of their future entitlements. If they cease making contributions, the ultimate benefit payout could be significantly reduced from the level expected had contributions continued. While it is in their interests to continue to contribute they would eventually face tax consequences under the FIF rules. If a member transferred his or her entitlements in a defined benefit scheme to another scheme such as a defined contribution scheme this transfer could also give rise to a FIF liability.

The scope of the new exemption will have wide coverage because most superannuation schemes in Australia (including schemes that receive compulsory employment superannuation contributions under Australia's guarantee scheme) will fall within one of the listed schemes. These schemes are all subject to strict prudential standards and rules relating to the preservation and early release of superannuation benefits. Therefore, the exemption should achieve the desired policy outcome of addressing the trans-Tasman migration and compliance issues arising under the FIF rules.

Key features

New section EX 33E of the Income Tax Act 2004 exempts from the FIF rules interests in the following Australian superannuation schemes:

• approved deposit funds;
• exempt public sector superannuation schemes;
• regulated superannuation funds; and
• retirement savings accounts.

These schemes are subject to strict preservation rules whereby benefits are generally locked-in until a person reaches retirement age. Individual schemes may have some capacity to pay benefits to people experiencing severe financial hardship and on compassionate grounds, but these payments are strictly limited. For example, payments may be made to treat life-threatening illnesses, to prevent foreclosure by a mortgagee or the exercise of an express or statutory power of sale over the family home. When a person dies the scheme will pay benefits in cash to the person's dependents or the person's estate. It is also possible to transfer benefits between superannuation schemes, but only to Australian schemes that meet certain regulatory standards, including the preservation of benefits.

Consequential amendments have also been made to the corresponding provisions in the Income Tax Act 1994 and the Income Tax Act 1976.

New section CW 23B provides roll-over relief in situations when an individual has withdrawn an amount from one of the listed schemes and invests the entire amount in another listed scheme. The amount withdrawn and reinvested will be exempt from income tax. This roll-over relief applies on a prospective basis from the 2006-07 income year.

Application date

The new exemption applies from the 1993-94 income year for taxpayers whose corresponding non-standard accounting year ends after 30 November 1993, or the 1994-95 income year for all other taxpayers.

Detailed analysis

Description of Australian superannuation schemes

The superannuation schemes subject to the new exemption are all constituted under Australian law and are described below. The principal legislation governing the regulation of superannuation in Australia is the Superannuation Industry (Supervision) Act 1993 (SISA) and the Superannuation Industry (Supervision) Regulations 1994 (SISR).

Approved deposit funds

An "approved deposit fund" is defined in section 10 of SISA. Approved deposit funds receive, hold and invest certain types of roll-over funds until the funds are withdrawn in accordance with the preservation rules in SISA. They were created as roll-over vehicles into which a member could transfer superannuation benefits so as to retain them in the superannuation system.

Exempt public sector superannuation schemes

An "exempt public sector superannuation scheme" is defined in section 10 of SISA. Exempt public sector superannuation schemes provide for payments of superannuation, retirement or death benefits, and are established under:

• a Commonwealth, state or territory law; or
• the authority of the Commonwealth, state or territory government, or a municipal corporation, another local governing body or a public authority that is constituted by or under a Commonwealth, state or territory law.

These schemes are specifically listed in Schedule 1AA of SISR. Although these schemes are not regulated under SISA they conform to the principles of that Act.

Regulated superannuation funds

A "regulated superannuation fund" is defined in section 19 of SISA. These funds have made an irrevocable election for the regulatory provisions of SISA to apply to them. Most entities involved in the provision of superannuation in Australia will be regulated superannuation funds. They include:

• corporate/employer funds, which are established and run by an employer (usually large) for its own employees;
• industry funds, which are for employees of different employers in the same industry, for example - hospitality industry or building industry;
• retail or public offer funds, which are open to anyone to join, and are usually run by large banks or life insurance companies; and
• small funds approved by the Australian Prudential Regulation Authority² and self-managed superannuation funds³. These funds have five or fewer members and are predominantly used by the self-employed.

Retirement savings accounts

A "retirement savings account" is defined in section 8 of the Retirement Savings Account Act 1991. These accounts are typically offered by banks or similar financial institutions and operate in a similar way to a bank account - accumulating small amounts deposited regularly by their members and by the member's employer and paying interest on those deposits. The money is invested in assets that are low risk. The Retirement Savings Accounts Regulations 1997 contain preservation rules including restrictions on the early release of benefits from retirement savings accounts, which are identical to the preservation rules in the SISR.

Preservation rules and restrictions on early release

In general, superannuation benefits may be paid out only on the occurrence of one of the following events:

• retirement on or after reaching preservation age. A person's preservation age depends on his or her date of birth - if a person's date of birth is before 1 July 1960, his or her preservation age would be 55⁴ years. In addition, if a member is under 60 years of age the scheme must be satisfied that the member never intends to work again;
• reaching age 65 years;
• permanent incapacity;
• termination, at any age, of gainful employment with an employer who had contributed to the scheme, as long as the benefits are paid in the form of a noncommutable lifetime pension.

The early release of superannuation benefits is not permitted on any grounds other than those specified by the relevant legislation. The final decision on whether a release is permitted on any grounds rests with the trustees of the applicant's superannuation schemes, subject to the governing rules of the scheme.

There are two principal ways by which an individual can access his or her superannuation benefits before reaching retirement age. An individual can apply to his or her superannuation scheme's trustee on the grounds of severe financial hardship; or alternatively, apply to the Australian Prudential Regulation Authority for release on compassionate grounds.

Benefits may be released on compassionate grounds in very limited circumstances. These circumstances are defined in relevant legislation or in the trust deed of the scheme and cover expenses for medical treatment, medical transport, modifications to the family home or motor vehicle because of severe disability, palliative care, and funeral expenses. Funds may also be released on compassionate grounds to prevent foreclosure of a mortgage or exercise of a power of sale over the member's principal place of residence. Benefits can also be released to meet expenses in other cases where the release is consistent with one of these grounds.

The regulatory arrangements attempt to balance the need for superannuation benefits to be protected for retirement purposes against the need for access when superannuation fund members experience a personal emergency.

Non-preserved or unrestricted interests

The exemption applies to interests in superannuation schemes that are subject to preservation arrangements. However, some interests that were acquired before certain dates might not be preserved or restricted. This is because over the years the rules relating to accessing Australian superannuation benefits have been gradually tightened to encourage or enforce the preservation of member interests, but the general practice has been to "grandparent" any interests that members have had at the time of each change.

Even so, these unpreserved or unrestricted interests should still qualify for exemption from the FIF rules as long as the scheme is listed in the new exemption provision. Excluding these interests from the exemption relief would have led to both compliance costs for taxpayers and administrative costs for Inland Revenue, thereby negating any benefit from the exemption.

¹ Defined benefit schemes provide superannuation benefits that are based on the member's salary at a particular time (or averaged over a particular period) or some other amount specified in the trust deed of the scheme.
² The Australian Prudential Regulation Authority is responsible for prudential regulation of all superannuation funds, except selfmanaged funds, and for ensuring that those funds comply with the relevant regulatory standards.
³ Self-managed superannuation funds are administered by the Australian Tax Office.
⁴ The preservation age is increasing from 55 to 60 on a phased basis between the years 2015 and 2025. This will mean that for an individual born before 1 July 1960, the preservation age will remain at 55 years, whereas an individual born after 30 June 1964, the preservation age will rise to 60.