Transferring from the dark side – part one

Bringing pension scheme payments back to Australia from overseas is a multi-faceted process. In part one of this multi-part feature, Jemma Sanderson provides some useful tips and traps to look out for regarding these situations.

With our global workforce, and particularly many people having being trapped in Australia or overseas due to COVID, or perhaps now intentionally, their superannuation position across multiple jurisdictions has become an increased area of practice. It is desirous to transfer their benefits to Australia (once they have settled here for good) for the following reasons:

• control/flexibility over the investments,

• to mitigate the foreign exchange risks,

• to have an asset that can be left to their beneficiaries when they die, and

• to obtain more effective efficient taxation position.

Navigating through the various jurisdictions is challenging and requires a comprehensive understanding of the Australian superannuation and tax provisions. There is much misunderstanding about how such transfers are undertaken in practice, with many individuals receiving advice that only covers one side of the transaction – the ‘dark side’ of the jurisdiction where the money is currently held, which can have substantial adverse implications in Australia. Without proper consideration, the above intentions may not be met, particularly the last one.

Overall, where a member has benefits in a United Kingdom pension account, to transfer that benefit to Australia, several things must be in place:

• the member has to be 55 or older,

• the receiving superannuation fund needs to be a Registered Overseas Pension Scheme (ROPS),

• any rollover needs to take into consideration:

a. the taxation implications in Australia,

b. the contribution limits in Australia, and

c. the taxation implications in the UK (this is dependent on b. above and whether any amount rolled over is refunded back to the member in Australia), and

• if the money is to be taken as a lump sum directly to the individual (from a UK perspective), the Australian and UK taxation implications need to be considered.

There are obviously a substantial number of other foreign jurisdictions where individuals may hold pension benefits. Each jurisdiction will have different rules and different ways that they will interact with the Australian rules. We recommend specialist advice in this regard is always sought to address all the relevant considerations.

Australian taxation of foreign pensions

Where an individual receives pension payments from a foreign pension, generally they are fully taxable at their marginal tax rate in Australia. There is an avenue for an annual deductible amount to apply, depending on the level of personal contributions made to the scheme by the individual, and it can be claimed by completing form NAT 16543.

Where an individual receives lump sum payments from a foreign pension, the taxation treatment depends on whether the foreign pension is a foreign superannuation fund (FSF) under the Australian rules.

As a rule of thumb, a scheme based in the UK would satisfy this requirement, however, schemes in the United States, that is, 401(k) or individual retirement accounts, do not. Other jurisdictions depend on the local legislation regarding pensions, as well as the trust deed for the scheme itself.

Where the scheme is an FSF

Where the FSF provisions are satisfied, the taxation in Australia of a lump sum payment is as follows:

• within six months of the date of residency – not assessable income or exempt income (effectively tax-free), or

• outside six months of the date of residency – tax is payable on the increase in value since the individual became a resident of Australia, taking into consideration any contributions over that time, as well as the proportion of time the individual may have been a resident of Australia since first becoming a resident. This is called the applicable fund earnings (AFE).

The default position is the AFE is taxable at the individual’s marginal tax rate. However, there is an opportunity for this tax to be paid at the superannuation fund level at 15 per cent where:

• the benefits are paid directly from the FSF to an Australian superannuation scheme, and

• there are no benefits remaining in the source scheme subsequent to the transfer. This is of substantial benefit with respect to UK transfers as the schemes in the UK are familiar with and prefer a transfer direct to a fund in Australia that would satisfy the UK ROPS provisions. An SMSF can meet these requirements.

Contribution provisions

In the situation where such a transfer direct to super can occur, there would be two components of a transfer, which are treated differently for Australian superannuation contribution purposes:

• the AFE is not assessed towards the concessional cap or the nonconcessional cap, and

• the balance of the transfer is classified as a non-concessional contribution (NCC).

The second point above can be a concern where the ultimate transfer results in the individual breaching the NCC cap or where they don’t have any NCC cap available as their total superannuation balance (TSB) is over $1.7 million.

In situations where this arises it doesn’t necessarily mean the transfer can’t occur, however, alternative options are required to be considered:

1. The potential to release an excess NCC from any other non-ROPS superannuation benefits in Australia.

2. Structuring the account in the UK before transfer such that any transfer would not give rise to an excess NCC.

Item 2 above can be challenging in terms of navigating the UK provisions and requirements, particularly given the increased regulation in the UK at present.

Avoid – proportionate transfers

It is important to note that to achieve the 15 per cent tax on the AFE, any transfer to superannuation in Australia can’t be proportionate. It must be 100 per cent from the source fund. This is one area where all good intentions to transfer don’t accomplish the objective.

Example

Luke is 56 and has a benefit in the UK worth £450,000. He has been in Australia for 15 years and when he came to Australia, his account was worth £300,000. The components of Luke’s benefit if transferred to Australian super are as in Table 1.

TABLE 1 £ % AUD (1:1.75) $

Applicable fund earnings 150,000 33.33 262,500

Non-concessional component 300,000 66.67 525,000

Pension account balance 450,000 100 787,500

If Luke transferred 100 per cent of his benefit to an Australian ROPS, then he would have an excess NCC. If Luke wanted to manage that position and thought the AFE was proportionate and only transferred A$490,000 equivalent (about £280,000) direct to superannuation in Australia, then the components would be as in Table 2.

TABLE 2 £

Applicable fund earnings 150,000

Non-AFE component 130,000

Pension balance transferred 280,000

AFE is not taken out proportionately – it is the first component that is attributed to a lump sum when one is made. Accordingly, the AFE would be the first component out. A further sting in the tail however is that by doing a proportionate transfer, Luke’s strategy will have substantial other tax and superannuation implications:

• the AFE can’t be included in the assessable income of the fund as there is still a benefit remaining in the source fund,

• Luke will be taxable on that AFE at his marginal tax rate. Again, this isn’t the proportionate AFE of 33.33 per cent of the £290,000, but the full £150,000. That is A$262,500 Luke will have to pay tax on personally at the highest tax rate, resulting in a A$123,375 tax liability.

• as the money was transferred directly into superannuation and Luke is only 56, he can’t access any of the money for at least another four years from superannuation to pay this tax. Therefore, Luke will need to come up with A$123,375 to pay the tax.

• As there is no AFE component of the transfer to the super fund where the fund can elect to pay the tax (ineligible due to the proportionate transfer), the entire transfer amount to super in Australia is treated as an NCC – £290,000/ A$480,000. That would then result in Luke having an excess NCC of at least A$150,000, and

• dealing with an excess NCC where the benefits are sourced from the UK could have additional tax implications of between 47 per cent and 55 per cent on the excess NCC. As is evident, tripping up on one element of the transaction has substantial compounded implications.

In Luke’s situation, it would have been more appropriate to consider splitting an amount from his current account to a completely new scheme in the UK so that any transfer would be eligible for the concessions. This also needs to be undertaken correctly, as if not implemented properly, it can have adverse tax implications.

Avoid – PCLS

Other nasty tax implications can arise where individuals only receive advice on the UK tax implications and not the complementary Australian provisions. For example, advice to take out a pension commencement lump sum (PCLS) from their UK benefits, which is the equivalent of up to 25 per cent of their benefits (up to their lifetime allowance) as a lump sum payment. Such a payment is very tax effective in the UK as it is tax-free. However, that is not the tax position in Australia.

Let’s revisit Luke’s scenario, where he seeks advice in the UK. He is advised not to conduct a transfer to superannuation in Australia as an initial step, but to take a PCLS. He takes out £112,500, or 25 per cent, from his UK account and no tax is payable in the UK.

However, from an Australian tax perspective, the first lump sum payment an individual receives is AFE, so 100 per cent of the £112,500 will be taxable in Australia at Luke’s marginal tax rate, resulting in tax of up to A$92,531. At least in this situation Luke would have received cash in his own name and could pay the tax. However, this is an incredibly nasty tax outcome for him.

Further, the extraction of the remaining £337,500 out of the UK can be a challenge as this account is then classified as being ‘crystallised’ under the UK rules and can then only be transferred either:

• 100 per cent direct to superannuation in Australia, which would give rise to an excess NCC position, or

• to Luke as regular (and flexible) pension payments, which would likely be fully taxable to Luke in Australia.

Therefore, what seems to be a good outcome in terms of enjoying 25 per cent of his benefits tax-free, once again has a terrible consequence for Luke.

A PCLS can be of benefit where the individual is not a resident of Australia at the time of the payment or they manage to request the payment within six months from their date of residency. However, there is then a challenge to extract or transfer the remaining 75 per cent into Australia due to the subsequent nature of the remaining balances (being a crystallised account).

Strategies

Although there are warnings above regarding transfers, there are substantial opportunities in this space for individuals to transfer their entire benefits to Australia in a tax-effective and timely manner. This is also regardless of the amount of the benefit.

Alluded to above is the situation where a benefit is split to another UK scheme before it is transferred to Australia. This is quite commonly undertaken and is one of the options available to achieve an effective transfer. There are nuances in every situation and therefore it is important to obtain specialist advice.

Transferring from the dark side – part one