The United States Income Tax Treatment of Australian Superannuation Funds Owned by U.s. Persons (part 2 of 2)

JurisdictionUnited States,Federal
AuthorBy Roy A. Berg & Marsha-laine Dungog
CitationVol. 25 No. 4
Publication year2016
The United States Income Tax Treatment of Australian Superannuation Funds Owned by U.S. Persons1 (Part 2 of 2)

By Roy A. Berg2 & Marsha-laine Dungog3

A. Section 61 Should Govern Taxation of Supers and Not Section 402(b)

The pressing U.S. tax issue with respect to the Super is whether the SG Contributions and VEC paid to the Super should constitute part of the USP employee-beneficiary's worldwide taxable income. From a high-level overview of the Super, it would appear that all concessional employer and employee contributions to the Super (and income accretions therefrom) are portable, fully funded and fully preserved ("Funded and Secured") from the moment contribution for the benefit ofthe USP employee-beneficiary. Tax practitioners appear to have fixated on this one aspect of the Super, i.e., the employer-employee relationship, as the dispositive basis for applying Section 402(b) to a Super notwithstanding that Supers are: (a) not established exclusively by private contract between an employer and its employee; and, (b) not a foreign tax-deferred retirement plan.4 Most importantly, the Australian courts and tax practitioners have themselves acknowledged the folly of analyzing a member's interests in a Super within the context of contractual rights arising from an employer-employee relationship.5 A reputable Australian jurist, Hon. Justice Graham Hill, has pointed out that a member's interest in a Super is blurred by the existence of two distinct legal relationships that simultaneously overlap in the Super - the first relationship governed by a deed of trust between the trustee, the trust property and beneficiary; and the second relationship arising from a plan between employer and employees that evidence the terms of their contractual relationship.6 We believe that Section 61 provides a more comprehensive framework for determining the taxability of the Super to its USP employee-beneficiary for United States ("U.S.") tax purposes. After all, both employer and employee contributions to the Super, at first blush, reflect a "clear accession to wealth,"7 notwithstanding that such contributions are deposited into a fund or trust. To make this determination, the Super contributions and income accretions must be examined in light of the constructive receipt doctrine and economic benefit doctrine.

1. Constructive Receipt

The issue that arises under Section 61 is whether a USP employee-beneficiary recognizes income when concessional contributions from employer and employees are made to the Super and income accumulations accrue to such accounts (the "accruals") even where the USP employee-beneficiary has not actually received such monies or have any access to such amounts. Treasury Regulation ("Treas. Reg.") Section 1.451-2(a) states that income is constructively received by a taxpayer when it is,

"credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given." 8

Emphasis added.

For decades, U.S. courts and the Internal Revenue Service, ("IRS") have applied the doctrine of constructive receipt to cases where the taxpayer has an unqualified, vested right to receive immediate payment of income9 and has not delayed a payment that would otherwise be due to him.10 Application of the constructive receipt doctrine to Super contributions and income would not result in any gross income attribution to the USP employee-beneficiary. This is because the Super has satisfactory title to all assets11 appearing on the Super's Annual Statement of Financial Position, and such assets are held separately from assets of its members, employers and trustees.

The Super's future obligation to fund a member's benefits upon reaching preservation age is reported on its financial statements as a liability for accrued benefits.12 Indeed, a USP employee-beneficiary does not have any immediate right to payment of amounts accumulated in the Super until the preservation age is reached. Once preservation age is attained, assets in the Super are liquidated and allocated to the member's account for distribution. The member then has an immediate right to payment of benefits from the Super, which he may opt to receive in lump-sum or periodically, but must at a minimum withdraw at least five percent of the account balance yearly. Consequently, the member's right to payment of his Super benefits and control over the manner in which benefits are received at preservation age would support the assertion that the USP employee-beneficiary has actual and constructive receipt gross income subject to U.S. taxation at preservation age but not prior to such period. We would argue that contributions and income accretions in the Super do not constitute gross income to the USP employee-beneficiary until such time when these amounts constitute preserved benefits. Until that time, there are several cashing restrictions that prevent the USP employee-beneficiary from obtaining unfettered access to and control over amounts contributed to and income accretions accumulated in a Super. We would like to note, however, that we are far from conceding the issue of the taxability of the Super at the pension phase. As more fully explained in the next section on Economic Benefits, even a USP employee-beneficiary's access to the Super at the pension phase is not absolute, as there are also limits to the amount and type of benefits that can be distributed at that stage.

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2. Economic Benefit

The economic benefit doctrine has been called "a limited technical device, created and advanced by the government in order to collect taxes from cash-basis taxpayers as soon as possible."13 Under this doctrine, a cash basis taxpayer recognizes income when he has acquired the economic benefit of monies that are unconditionally and irrevocably transferred to him or her, although not necessarily accessible. The Economic Benefit doctrine is frequently applied to attribute income to a taxpayer-employee in deferred compensation arrangements where the employer has irrevocably set aside monies in a trust, away from the employer's creditors, to benefit the employee.14 In the seminal case of Sproull, E.T. v. Commissioner,15 the board of directors of a domestic company irrevocably transferred $10,500 to a trust to be paid out in two installments to a U.S. taxpayer who was the CEO of the company. The amount transferred constituted additional compensation to the CEO for work performed in prior years but underpaid by the Company due to financial conditions. The IRS held that the expenditure of the $10,500 to set up the trust conferred an economic or financial benefit to the Taxpayer CEO in the year of transfer. The right to the trust was not contingent on any further action by the CEO, nor were there any restrictions his right to assign or dispose of his beneficial interest in the trust. Moreover, no one else had an interest in or control over the monies, save for the Trustee whose only duties were to hold, invest, accumulate and payout the fund and its increase to the CEO or his estate.

In determining whether an employer's SG contributions to a Super are taxable to a USP employee-beneficiary under the economic benefit doctrine, three elements must be present: (1) there must be some fund in which money or property has been placed; (2) the fund must be irrevocable and beyond the reach of creditors of the payor; and, (3) the beneficiary must have vested rights in the money, with receipt conditioned only on the passage of time.16 This means that only ministerial duties, not substantial restrictions or conditions, remain until the funds are released.17 Of these three elements, the most controversial one in the context of superannuation is the third element, i.e., determining the nature of the beneficiary's interest in the monies contributed and accrued in the Super. The main contention is whether the USP employee-beneficiary has any vested18 rights in the money, receipt of which is conditioned only with the passage of time as opposed to substantial restrictions or conditions.

Determining the true nature of a member's interest in the Super, i.e., whether vested, contingent or merely a right to be considered for benefits by the trustee, has perplexed Australian courts and practitioners for decades.19 One reputable jurist has posited that the kind of superannuation scheme impacts this determination.20 For example, a member's interest in an accumulated benefits fund21 upon formation is an equitable property interest with no immediate right to payment.22 This equitable interest is a conditional interest in the member's Super account balance where the member does not have a right to the Super benefits until the conditions are met.23 When the conditions are met, the member's interest is altered into two sub-interests, i.e., one that has a right to immediate payment of the member's account balance that is not preserved, and one that remains conditional with respect to that portion of the member's account balance that is required to be preserved.24 The preserved portion of the Super at pension phase pertains to certain benefits which may not be paid to the member until the member retires from the workforce and attains a certain age or the benefits become payable in the event one of the enumerated circumstances set out in the SISR (for example, early retirement on grounds of incapacity, emigration from Australia, early death before retirement, and such other circumstances).25

Compared to accumulated benefit funds, a member's interest in an end benefit scheme26 does not exist until the occurrence of the event which gives rise to the Super benefit.27 Thus, each member's interest in the fund (with respect to preserved...

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