Transferring from the dark side – part three

There are several options available to individuals wanting to repatriate overseas pension scheme payments back to Australia. In part three of this multiple-part feature, Jemma Sanderson details some of the strategies available to make this happen.

Following on from part one regarding some of the issues when transferring United Kingdom pensions and part two regarding pension transfer mythbusting, parts three and four will outline some of the potential strategies available to transfer UK benefits to Australia, depending on the relevant circumstances.

As outlined in part one, where any benefits are transferred from the UK, or even where they were previous UK benefits and now in another offshore jurisdiction, to superannuation in Australia, the domestic fund must be a recognised overseas pension scheme (ROPS). There are two options available in this regard, being an SMSF that obtains ROPS status with His Majesty’s Revenue and Customs (HMRC) or using the currently only public offer ROPS available, which is the Australian Expatriate Superannuation Fund (AESF).

As per part one, the overall outcome/intention is that the increase in value since the individual first became a resident, that is, the applicable fund earnings (AFE), is taxed in the superannuation fund at 15 per cent, rather than at marginal tax rates. Thus, a transfer to a ROPS is often the strategy implemented. In order for the 15 per cent tax rate to apply, there needs to be a nil balance in the source scheme from where the funds have been transferred.

AFE doesn’t count towards either the concessional contributions cap or the nonconcessional contributions (NCC) cap. The challenge arises as the non-AFE component is treated as NCC, and therefore the standard NCC cap provisions for the individual and how they interact with the UK rules need to be considered.

Strategies are dependent on the individual’s circumstances with reference to:

1. the AFE in the account and the subsequent nonAFE amount,

2. whether the non-AFE amount is greater than the individual’s NCC cap,

3. the value of non-ROPS superannuation in Australia, including whether it is greater than the relevant total super balance (TSB) thresholds for NCCs,

4. whether the individual is over their UK lifetime allowance (LTA),

5. whether the benefits have already been crystallised in the UK, and

6. whether the benefits are in a UK pension scheme in the UK, or were previously in a UK scheme but were transferred to another offshore jurisdiction, and therefore the transfer is occurring from that jurisdiction.

The strategies below are the same for an SMSF or an AESF – the decision regarding which fund to use is up to the individual.

Strategy one – full transfer to super, under NCC

Where the non-AFE component is less than the NCC cap, the direct transfer of the amount to the ROPS can be achieved with a single transfer as shown in Table 1.

Luke, 56, has a UK benefit worth £375,000. When he came to Australia 18 years ago his account was worth £175,000. He has $755,000 of superannuation in Australia. His UK benefit components are outlined in Table 1.

Table 1

Applicable fund earnings

£200,000 ---- 53.33% ---- A$ (1:1.75) 350,000

Non-concessional component

£175,000 ---- 46.67% ---- A$ (1:1.75) 306,250

Pension account balance

£375,000 ---- 100% ---- A$ (1:1.75) 656,250

With a 100 per cent transfer to a ROPS in Australia, Luke will be eligible to elect to have up to the AFE amount of $350,000 included in the assessable income of the fund, taxed at 15 per cent, rather than at his marginal rate. The amount that isn’t included in the assessable income is treated as NCC, and is within Luke’s NCC cap, and therefore there are no excess implications where he elects for the full $350,000 to be included in the fund’s income.

Strategy two – full transfer to super, over NCC

What if Luke has only been in Australia for eight years, and the value of his UK benefit at that time was £250,000. If this was the case, then the breakdown would be per Table 2.

Table 2

Applicable fund earnings

£125,000 ---- 33.33% ---- A$ (1:1.75) 218,750

Non-concessional component

£250,000 ---- 66.67% ---- A$ (1:1.75) 437,500

Pension account balance

£375,000 ---- 100% ---- A$ (1:1.75) 656,250

With a 100 per cent transfer to enable a 15 per cent tax rate on the AFE, there would be an NCC of $437,500, which is obviously in excess of Luke’s NCC cap by $107,500. His other superannuation balance in Australia is $475,000 in this scenario.

Given this situation, what are Luke’s options?

In Australia when an excess NCC arises:

1. The amount is retained in superannuation and is subject to excess NCC tax at 47 per cent. This is very rarely the option undertaken. Further, where the tax is paid by the super fund, this is reportable to HMRC as an unauthorised payment and subject to tax in the UK at between 40 per cent and 55 per cent.

2. The amount is refunded from superannuation in Australia via the ATO to the individual once the regulator has issued the election and release authority – usually six to nine months after the end of the financial year of the contribution.

This excess is then subject to associated earnings (AE), with the ATO general interest charge rate applicable, for the period from 1 July of the year of the contribution until the tax commissioner issues the excess determination. `

The AE is included in the individual’s assessable income and taxed at their marginal tax rate, less a 15 per cent tax offset. As this is usually more than a year, if not closer to 18 months, this AE amount is 10 per cent to 12 per cent of the excess amount. That would be about $12,000 for Luke.

The excess amount ($107,500) plus 85 per cent of the AE ($10,200), being a total of $117,700 for Luke, would need to be refunded from superannuation in Australia via the ATO upon issuance of a release authority.

If Luke refunds this amount from the ROPS, it may be a reportable unauthorised payment and subject to tax in the UK at between 40 per cent and 55 per cent. If Luke refunds this amount from his non-ROPS Australian superannuation, then such an issue won’t arise.

Accordingly, where Luke is comfortable with the incurrence of the tax on the AE, at worst tax of $3840 at the highest marginal rate less a 15 per cent offset, then this strategy could be implemented. The net amount refunded from superannuation to Luke’s name would be $113,860.

Outcome: Luke’s UK account is transferred to Australia in one transfer, with a refund from other superannuation 12 and 18 months later depending on the time of the year the UK transfer occurred.

Important elements:

1. The excess refund must only occur once the ATO has issued the release authority to the relevant fund.

2. The excess notice will only be issued after the end of the relevant financial year once the individual’s TSB and contributions for the year have been reported to the ATO by their relevant funds, plus potentially once they have lodged their personal income tax return.

3. The individual will need to monitor their personal tax profile with the ATO closely after year end for the issuance of the election form. This is issued either via their personal tax agent and/or will be on myGov.

The individual has 60 days from the date on the election form to make the election regarding the refunding option and the super fund they wish to receive the refund amount from. If they do not respond within the 60 days by lodging the election form to the ATO, an automatic election occurs, with the refund from the superannuation fund with the highest balance.

In Luke’s case, his other Australian super account is $475,000, and post the UK transfer the net amount in his ROPS is around $623,440. If he doesn’t actively elect that his non-ROPS super fund refunds the account, the release authority will automatically be issued to the ROPS, which is obligated to refund the amount pursuant to the release authority. As above, if this occurs, such a refund from the ROPS could be a reportable unauthorised payment to HMRC and taxed at between 40 per cent and 55 per cent, which is not ideal.

This strategy is feasible for Luke, given the total tax of $36,652.50 ($32,812.50 on the AFE, and the tax of $3840 on the AE), or 5.6 per cent on the gross transfer. However, it will be imperative all the steps are followed/ implemented correctly to ensure no inadvertent issues arise.

Strategy three – multiple tranche transfer to super

What if Luke had been in Australia for only two years, and the breakdown of his benefits are as per Table 3. As Luke has only been in Australia for two years, his Australian super balance is $65,000.

Table 3

Applicable fund earnings

£75,000 ---- 20% ---- A$ (1:1.75) 131,250

Non-concessional component

£300,000 ---- 80% ---- A$ (1:1.75) 525,000

Pension account balance

£375,000 ---- 100% ---- A$ (1:1.75) 656,250

Where he wanted to undertake a 100 per cent transfer of the above, he would have an excess NCC of $195,000, and insufficient non-ROPS super to refund the excess. Therefore, strategy two is not appropriate.

One alternative is a multi-tranche transfer, where the UK benefit is split in the UK and transferred to Australia either across multiple years or a combination of a transfer to super in Australia and payment to him directly.

As the AFE is the first component of any transfer that is made, this amount, £75,000, plus an amount up to Luke’s NCC, say £175,000 to provide for a foreign exchange buffer, could be transferred in the UK to a separate, new UK pension account. This amount of £250,000 would then be transferred to the ROPS in Australia, where there would be a nil balance remaining in the UK scheme and the AFE would be eligible for the 15 per cent tax rate in the fund.

There would be £125,000, about $218,750, remaining in the UK.

To transfer the balance, Luke would need to wait until the three-year NCC bringforward period had reset, then seek to transfer that balance across, subject to the NCC rules at that time. There may be some further AFE over that period, which may not be an issue if the transfer is 100 per cent to the ROPS. It would be taxed at 15 per cent and the balance of the £125,000 would be NCC and within his cap. This would occur in year four.

Luke could undertake the first transfer as £75,000 AFE plus say £60,000 NCC to fall within his single-year NCC, where this is transferred to the second UK scheme to transfer to the ROPS in Australia. In the following financial year, £175,000 could be transferred to the ROPS to use his bringforward NCC. That would still leave £65,000 remaining in the UK, which would need to stay there until year five when the bring forward would reset.

The main consideration with this strategy is the timing of the transfers as it could be up to five years before all the monies are in Australia. Further, it is the author’s experience that setting up the second UK pension account can take between three and six months, given the compliance requirements in the UK. However, this strategy, or strategy four to be outlined in part four, is generally the only option available where the individual will be in excess of their NCC cap with a transfer and they don’t have the non-ROPS superannuation in Australia to refund the excess.

More strategies in part four

The above strategies are available where an individual is within their UK LTA, or where they haven’t already crystallised their benefits in the UK. Part four will explore an alternative to strategy three where benefits have an excess NCC and where the individual is over their LTA or has crystallised components.

What is most important in any of these strategies is that they are implemented correctly. If this does not occur, there will be some potentially adverse tax implications both in Australia and the UK.