Withdrawing from your foreign super fund? Know your tax consequences first!

Expats returning to Australia should check before withdrawing from their foreign super fund.

In many cases, the withdrawal will be treated as a taxable capital distribution from a foreign trust and taxed at the individual’s marginal rates.

What are the risks of withdrawing from a foreign super fund?

The main risk comes from the definition of ‘foreign superannuation fund’ – it is much narrower than it sounds.

Australian residents are taxed concessionally on lump sums they receive from either:

• a ‘foreign superannuation fund’
•  a foreign ‘scheme for the payment of benefits in the nature of superannuation upon retirement or death’.

For example, a resident will not be taxed on a lump sum they receive from a foreign superannuation fund within six months after becoming a resident (subject to certain conditions).

Problems arise when the foreign fund does not qualify as a ‘superannuation fund’ or a relevant ‘scheme’ within the meaning of Australia’s superannuation law.

In practice, we see that many foreign funds that are intended to provide benefits to employees upon their retirement do not qualify because they lack one of the essential characteristics of a superannuation fund. The most common reason is that the member is entitled to withdraw funds before they reach retirement age – for example, when they cease employment with their employer. In that case, the concessional rules for foreign superannuation funds do not apply.

The effect is then that the fund may be treated as a foreign trust and the withdrawal taxed as a capital distribution under section 99B of the Income Tax Assessment Act 1936. For more information on section 99B, please see our previous alert.

This can produce alarming results. For example, an expat may spend 10 years living and working for his employer in the United Arab Emirates (UAE), all the while contributing to his UAE provident fund, which allows him to withdraw funds when his employment ceases. When his employment is terminated as a result of COVID-19, he withdraws $200,000 from his provident fund and returns to live in Australia.

As the provident fund is not a ‘superannuation fund’ or a relevant ‘scheme’, the expat may be taxed on the lump sum (or part of it) at rates up to 47% under section 99B – even though the funds were contributed, and the investment earnings derived, while the expat was a non-resident.

What are the possible solutions?

Section 99B taxes capital of a foreign trust that is ‘paid to’ or ‘applied for the benefit of’ a beneficiary who is an Australian tax resident at any time during that income year.

This means a non-resident may be taxed on a withdrawal they make from a foreign fund if, later in the same income year, they return to Australia and become a resident. Non-residents who do not intend to return to Australia immediately may consider withdrawing from their foreign fund in the income year before the year in which they become an Australian resident. Non-residents whose foreign employment has been terminated may have little choice, particularly where their home overseas was provided by their employer. It is important for non-residents with an Australian domicile to maintain their permanent place of abode in the foreign country in order to remain non-resident. Please see our article on how the ATO will apply the ‘permanent place of abode’ test of residency for further information.

Section 99B is subject to a number of exclusions. Relevantly, the amount that is taxable under section 99B is reduced by ‘corpus’. In some cases, there may be an argument that part of the lump sum withdrawn is original corpus or that the funds were deemed to be ‘applied for the benefit of’ the fund member while the member was a non-resident. This requires a detailed analysis of the terms of the trust deed and governing rules for the fund.

In all cases, it is crucial to identify the potential tax risks before withdrawing from a foreign super fund.

If, however, you have already withdrawn funds from your foreign super fund, then please seek advice on whether any of those amounts are subject to tax in Australia.

Please contact a team member if you would like to discuss.