This article was first published on 8 February 2021 by Tax Notes International.
This article was co-authored by Marsha Laine Dungong, Tax Partner in the Withers San Francisco office.
No other movie but Star Wars comes close to explaining the tragic duality and complexity of international tax. It demands more than just a pedantic understanding of civil and common laws, tax regimes and treaties. It requires a certain mental agility and appetite for the unknown to understand foreign structures and transactions, unravel its complexity and identify its “closest of kin” in the United States (U.S.) tax regime. For the most part, the foreign entity classification regulations1 promulgated by the Treasury Department and U.S. Internal Revenue Service (IRS) over 24 years ago has provided a framework for analyzing these foreign structures and a route for international taxpayers to obtain, by-election or default classification, some symmetry in how these structures and transactions are classified, reported and taxed in their home countries and the U.S. The framework is relatively simple to follow: a foreign organization that is recognized as a separate entity for federal tax purposes is either a trust or a business entity2. A business entity that is not listed as a per se corporation under the regulations3 may elect its classification for U.S. federal tax purposes, if eligible to do so4, or be subject to default classification either as a disregarded entity separate from its owner, an association taxable as a corporation, or a partnership5. The per se corporation treatment would apply unless the foreign entity filed an election with the IRS for an alternative classification6.
When it comes to the classification of foreign organizations for federal tax law purposes under the foreign entity classification regulations, Australia appears to have drawn the short end of the proverbial stick. This predicament is brought into sharper focus by the pending Tax Court case, Alan C. Dixon v. Commissioner7 (Dixon), which presents the trifecta of cross-border tax issues between the U.S. and Australia: classification of dividends from an Australian private limited company, use of franking credits, and treatment of earnings accrued in Australian superannuation (aka super) funds, which are retirement accounts8. Dixon presents a cautionary tale of cross-border tax compliance complexities experienced every year by Americans and Australians on both sides of the Pacific who file and pay taxes in two countries with different tax regimes.
Classification of Australian entities
The foreign entity classification regulations list just one form of Australian entity, a public company, as subject to treatment as a per se corporation for U.S. tax purposes9. It would therefore appear that a privately owned company such as an Australian proprietary limited company (AusPty) would have some flexibility to elect its treatment for U.S. tax purposes or be subject to default treatment as a disregarded entity, association, or partnership based on the number of its members10. However, because shareholders of an AusPty have limited liability under Australian corporate law,11 it would be unlikely that an AusPty with one member would be able to elect disregarded entity classification under the U.S. check-the-box regulations12.
An AusPty’s classification as a corporation for U.S. tax purposes has important consequences for both U.S. individuals living in Australia and Australian individuals living in the U.S (collectively, U.S. taxpayers) who are shareholders of that company. If the company is classified as a foreign corporation, any Australian franked dividends13 received by a U.S. taxpayer would be included as part of his taxable income for U.S. tax purposes. However, the U.S. taxpayer would be unable to claim foreign tax credits (FTC) for Australian taxes paid on those dividends (franking credits or imputation credits)14 on his U.S. tax returns. From a U.S. tax perspective, an individual shareholder can claim FTCs for foreign taxes he paid. However, for franked dividends, the AusPty is liable for the payment of taxes on those dividends. A U.S. taxpayer who is an individual shareholder cannot claim FTCs on taxes paid by the AusPty on his U.S. tax returns unless he elects to be treated as a corporate taxpayer15.
To claim the Australian franking credits on the U.S. taxpayer’s federal return (and consequently, reduce U.S. taxes on the franked dividends),16 the AusPty must be classified as a partnership for U.S. tax reporting purposes to achieve passthrough treatment for Australian income, gains deductions, and credits paid or accrued by the AusPty to its U.S. owner (or as the case may be, the Australian partnership to its U.S. partner).
Dixon: A trifecta of Lawsuits gone wrong
In 2019 an Australian citizen filed multimillion-dollar lawsuits against the IRS in the U.S. Federal Court of Claims and the Tax Court to dispute specific adjustments proposed by the IRS regarding dividends received from an Australian private company17. The petitioner, Alan Dixon, a U.S. resident since 2014, was the managing director and Cheif Executive Officer (CEO) of Dixon Advisory Group U.S. (DAG-US), an urban luxury home rental business based in New York City and New Jersey18. He was also a shareholder, managing director, and CEO19 of DAG-US’s Australian parent company, Dixon Advisory Group Proprietary Ltd. (DAG- Australia)20.
DAG-Australia, known as “Australia’s most high-profile promoter of self-managed super funds”21 was a Canberra-based asset management and financial advisory firm that in 2017 merged with Evans & Partners,22 a high-end stockbroking firm based in Melbourne. The merger produced Evans Dixon,23 an AUD 18 billion24 financial services firm that listed on the Australia Securities Exchange (ASX) in May 201825 as a public company26. It was the fourth-largest self-managed superannuation fund (SMSF) provider in the country27. Both Alan Dixon and his father, Daryl Dixon, were on its investment committee. It was reported by the Australian news media that the investment committee recommended that its 4,700 SMSF clients invest in the U.S. Masters Residential Property Fund (URF), the biggest in-house Dixon investment28 that was listed as a closed-end fund on the ASX in 2012. At that time, a strong Australian dollar made investing in U.S. assets attractive, with the U.S. dollar and U.S. property market weak29. The URF manages more than 600 homes in New York and New Jersey30 that constitute distressed and not-so-distressed residential properties in those states31. It was reported that URF “loaded up on debt to amass a billion-dollar portfolio of New York and New Jersey real estate, charging hundreds of millions of dollars in fees and renovation costs along the way.”32 By the time the U.S. lawsuits were filed, the URF had fallen 90 percent in value over five years33. And along with it were the superannuation investments of middle-class Australians with reasonable wealth accumulated over decades in white-collar professions34.
Dixon’s U.S. Tax woes
Dixon appeared to be waging war on both sides of the Pacific Ocean. His company, Evans Dixon, was subject to Australian regulatory scrutiny concerning its dealings with the URF and the Australian clients who invested their superannuation monies in it. In the United States, he was subject to an IRS examination of his amended U.S. tax returns that claimed, among other things, entitlement to FTCs on Australian taxes paid by DAG-Australia on franked dividends issued to him35.
His first tax problem was that he received dividends from DAG-Australia that were subject to U.S. tax without any FTC entitlement for franking credits attached to those dividends. His original U.S. returns for tax years 2013, 2014, and 2015 as initially prepared and filed by Ruhel Dalvi36 at PwC-Sydney did not claim franking credits attached to the franked dividends he received37. As a result, he paid approximately $658,985 in federal income taxes for 2013, and $2,131,553 for 201438 His original U.S. tax returns for 2015 reported $6,527,412 in franked dividends received as a shareholder39 of DAG-Australia for tax year 2015 with approximately $2,388,627 of attached franking credits that he could not claim40. Instead, the franked dividends were classified as qualified dividends and subject to U.S. income tax at a rate of 20 percent41. As a U.S. individual taxpayer, he could claim only foreign taxes that he directly paid or accrued as FTCs against his U.S. tax liability.
Next, Dixon was the beneficial owner of four SMSFs in Australia that were accruing earnings that were already subject to tax in Australia at a preferential rate of 15 percent. This tax was paid by the SMSFs directly and not by Dixon. Neither was he subject to Australian income tax on the earnings accrued in these funds. There is nothing equivalent to a superannuation fund in the U.S. However, it is a widely held view among tax practitioners that an SMSF, which is a type of super, would be treated as a foreign grantor trust under the foreign entity classification regulations. By implication, the SMSF itself would be subject to reporting on Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner,” and earnings accrued within the fund would constitute taxable income to the U.S. taxpayer who is a beneficial owner, and therefore subject to U.S. tax at ordinary rates. Moreover, investments by the SMSFs in foreign corporations that constituted passive foreign investment companies for U.S. tax purposes would be subject to reporting on Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.”
PwC-Sydney reported Dixon’s proportional share in the earnings accrued in his SMSFs as part of his U.S. taxable income. This filing position combined with the unclaimed franking credits resulted in quite a substantial U.S. tax bill for Dixon (or anyone for that matter) to pay.
Drumroll please: Enter John Anthony Castro, an international tax attorney42 and founder of Castro & Co. LLC43. For years, Castro has issued legal opinions44 and filed tax returns for U.S. citizens living in Australia who excluded their supers’ earnings from U.S. taxable income45. Castro was no stranger to Dixon, DAG-US, or Evans Dixon because Castro had a contract with Alan Dixon and DAG-Australia for various tax-related services and ongoing tax advice46. Indeed, Castro provides many employees of DAG- Australia with individual tax planning or tax compliance work47. It probably should have come as no surprise that sometime in early 2016 Castro replaced PwC-Sydney as Dixon’s U.S. tax return preparer and representative48.
Castro’s first move was to file an application with the IRS to obtain a U.S. employer identification number for DAG-Australia49. Although DAG-Australia filed corporate tax returns in Australia and was classified as a corporation under Australian law, Castro classified DAG-Australia as a foreign partnership with 50 partners when he filed the Form SS-4, “Application for Employer Identification Number (EIN),” with the IRS. Doing so would solve the FTC issue for Dixon. Interestingly, Castro appears to have taken the position that the EIN filing, by itself, somehow effectuated an election under the foreign entity classification regulations for DAG- Australia to be classified as a partnership50. A partnership classification would cause the dividends to be reclassified as business income to Dixon, and he would be able to claim FTCs for Australian franking credits attached to the franked dividends that were paid by DAG- Australia51. Indeed, Castro claimed that when the IRS approved the EIN application to be classified as a foreign partnership on February 9, 2019, it also approved Castro’s classification of DAG- Australia as a foreign partnership retroactive to DAG-Australia’s date of formation on May 30, 198652. The IRS denies this allegation53. In this regard, we note that entity classifications require the filing of a Form 8832, “Entity Classification Election,” rather than a Form SS-454. Further, the preamble to the foreign entity classification regulations states that, “No election, whenever filed, will be effective before January 1, 1997.”55
Castro amended Dixon’s U.S. tax returns for 201356, 201457, and 201558 to claim the FTCs on Australian franking credits attached to the franked dividends received by Dixon. His multimillion-dollar U.S. tax liability was now a multimillion-dollar tax refund of approximately
The Court of Federal Claims refund actions.
Rather than approving Dixon’s amended returns, the IRS issued a notice of deficiency assessing additional taxes, interest, and penalties on his amended 2013 tax return60 and commenced an examination of his 2014 amended return61. The IRS also seized the tax refund claimed on his 2017 federal return to cover his additional tax liabilities for 201362. Castro, acting for Dixon, sued the IRS in the U.S. Court of Federal Claims to recover the 2013 and 2014 tax refunds63. He sought a refund of $326,985.96 for the 2013 tax year and $1,588,653 for the 2014 tax year on grounds that Dixon is entitled to take FTCs on taxes paid by DAG-Australia on the franked dividends he received64. In doing so, Castro was trying to get a dollar-for- dollar credit for franking credits attached to the dividends that Dixon never paid for.
The Tax Court protest.
Three days after Dixon filed his lawsuit, the IRS commenced an examination of the 2015 amended tax return and requested his consent to extend the tax assessment period pending the examination65. Dixon refused, so the IRS issued an examination report proposing adjustments to his 2015 amended tax returns and advised Dixon and Castro that a notice of deficiency would be issued for additional tax, interest, and penalties due of $1,490,948,66 for a total corrected tax liability of $2,091,91667. The notice of deficiency was dated April 30, 201968. Castro protested the assessment and filed a petition for Dixon with the Tax Court on July 25, 2019.
On February 21, 2020, almost a year since the filing of the lawsuits, Judge Richard A. Hertling of the Court of Federal Claims granted the IRS’s motion to dismiss on a technicality Dixon’s lawsuit to recover his 2013 and 2014 tax refunds. The court held that Dixon did not personally sign nor submit a valid power of attorney for Castro to sign his 2013 and 2014 amended returns69.
Consequently, the court did not have jurisdiction over the lawsuit and dismissed Dixon’s complaint. Incredibly, Australian newspapers erroneously reported the dismissal of the lawsuits as a substantive win by Castro, proving that Australian super funds were foreign social security70.
IRS pot twist
Unlike with the refund lawsuits filed in the Court of Federal Claims, the IRS did not file any motion to dismiss the Tax Court petition contesting the notice of deficiency issued for Dixon’s amended 2015 tax returns. In a plot twist of epic magnitude, the IRS sought to amend its answer to the original petition and seek an increased tax deficiency for SMSF earnings that were excluded from Dixon’s U.S. taxable income as privatized foreign social security71. The IRS reasoned that Dixon had neither identified nor substantiated any social security or other public pension payments that he received from Australia during 2015, and therefore was not eligible to claim a benefit under the Australia-U.S. tax treaty72. In its amended answer, the IRS identified Dixon’s interests in three SMSFs that had generated taxable income in 2015 that he failed to report as taxable income on his returns73.
The case was set for trial on September 28, 201974. However, pending resolution of the motion to stay proceedings, the case was sent to the IRS Independent Office of Appeals sometime in early February 2020. Because of the pandemic’s effect on the operations of Appeals, an Appeals officer had not been assigned as of July 27 when both the IRS and Dixon filed a joint motion for continuance,75 which was granted two days later.
Sometime around August 27, 2020, Dixon disposed of all his shares in Evans Dixon that were held through his Australian private company for approximately AUD 18.6 million76. A week later, on September 4, the Australian Securities and Investment Commission (ASIC), one of several government agencies with oversight over super funds, filed a multimillion-dollar Australian Federal Court claim action77 against Dixon Advisory & Superannuation Services, a wholly-owned subsidiary of Evans Dixon, alleging Dixon Advisory failed to act in its clients’ interests or provide appropriate advice in recommending investments as it purportedly steered its clients to invest in its largest fund, URF78. Later that month, Dixon left the U.S. and resumed residence in New South Wales, Australia79. In November 2020 the shareholders of Evans Dixon voted to approve the rebranding of the company from Evans Dixon to E&P Financial Group80.
Classifying Superannuation Funds
Even if the worst-case scenario were to play out in the U.S. Tax Court for Dixon, it would still not come close to the massive financial losses suffered by DAG-Australia’s clients, a majority of whom are middle-class Australians in white-collar professions with reasonable wealth accumulated over decades in superannuation investments. The super industry is a significant player in the Australian retirement scheme, with superannuation assets totalling AUD 2.9 trillion at the end of the June 2020 quarter81. Approximately 50 percent of the total assets are allocated between Australian listed and international shares, and the rest among property, cash, and Australian and international fixed interests82. At the core of this superannuation industry are six types of super funds available to Australians: industry funds,83 corporate funds,8484 retail funds,85 public sector funds,86 SMSFs,87 and small Australian Prudential Regulation Authority (APRA) funds88. Of these, the SMSF category has the largest number of funds, comprising AUD 735 billion of total assets89 It comes as no surprise therefore that the clients of DAG-Australia opted to invest their SMSF monies in an international fund such as the URF.
And this is where the rubber meets the road for many U.S. expats and Australian nationals in the U.S., such as Dixon. Because superannuation funds do not exist in the United States, they must run the gamut of the foreign entity classification regime. SMSFs in particular are susceptible to adverse U.S. tax treatment, resulting in double taxation in the United States and Australia.
U.S. Tax classification regime
Foreign entities that are foreign trusts are subject to a different entity classification framework. Under reg. section 301.7701-4, a foreign trust is either an ordinary trust or a business trust for U.S. tax purposes. An ordinary trust exists to preserve assets, whereas a business trust is used to engage in a trade or business. If the latter, it would be treated as either a partnership or corporation based on specified characteristics.
Foreign trusts like the Australian super funds continue to evade definitive U.S. tax classification and treatment90. In Australia, the government encourages investment in a super to increase the level of savings for retirement by providing tax concessions, which also act as an offset to the fact that a super cannot be accessed until retirement. Therefore, owners of a super fund are given incentives to contribute to the super and engage in active investments that will grow the assets with those tax-favoured rates. Those investments range from bonds and equities to partnership interests in business operations. Because U.S. tax laws are applied to determine the treatment of the super fund and as a corollary, income and gains generated by its underlying assets, the results are often incongruent and adverse to the preferential treatment applied in Australia. Thus, an Australian’s investment in his or her super, which is the third pillar in Australia’s retirement system,91 could be at risk in the U.S. depending on its classification.
From an Australian perspective, super funds are trusts created under superannuation laws92 to provide for an employee’s retirement and they, therefore, receive tax-favoured treatment to encourage savings and asset growth. Unlike traditional retirement funds, contributions and earnings generated by investments held by a super fund are taxed at a low flat rate of 15 percent93. Broadly, when a super fund has derived a capital gain from the disposal of an asset held in the fund, any net capital gain, after deducting any capital losses, will be included in the fund’s taxable income and will attract tax of 15 percent, which may be further reduced to 10 percent94. Contributions and earnings cannot be accessed by its beneficial owner (the employee) until retirement age. On retirement, distributions from the super fund are generally tax-free.
When superannuation reforms were enacted in 2017,95 Australia’s Parliament made clear its intent to continue providing tax-favoured treatment for the super so that it would eventually replace money paid out of the old age pension funded by the government. In short, one could say it is almost Australian social security. This explains why Australians are perplexed and astounded at how the U.S. could tax contributions, earnings, and distributions from a super simply because the beneficiary of that super is also an American. More importantly, a super fund’s investment in U.S.-based assets (such as real estate, U.S. start-up companies, or businesses) could be taxed by the U.S. not as a foreign pension fund, subject to preferential rates, but just like any other foreign investor, subject to full U.S. tax rates and withholding taxes.
To be fair, super funds do not exist nor resemble any entity or structure in the U.S. tax world. This explains in large part why, until the IRS issues definitive guidance on this issue, there is not one U.S. tax perspective on what a super fund is for U.S. tax purposes. One on hand, it is a foreign pension that would not be subject to any tax-deferred treatment extended to a U.S. 401(k) account or IRA. It could also be a foreign grantor trust if it has a U.S. taxpayer contributor and a U.S. individual beneficiary designated to receive tax-free distributions from the super upon satisfaction of statutory conditions of release (that is, it upon reaching retirement age). Either classification leads to some degree of U.S. taxation on contributions, earnings, and distributions received by a U.S. taxpayer from the super. And because a super is a foreign asset, it also adds to the complexity of a U.S. taxpayer’s international reporting obligations.
Superannuation funds up close
The super fund most susceptible to adverse U.S. tax treatment as a foreign grantor trust is the same type of super that is at issue in Dixon; that is, an SMSF that has a U.S. grantor and a U.S. beneficial owner96. When it does, it is most prone to treatment as a foreign grantor trust, which would mean that all contributions and earnings in the SMSF, including its assets, are attributed directly as owned by its U.S. beneficial owner. Assets that are foreign equities would be further subject to burdensome treatment as PFICs, which would require annual tax filings and at worse, payment of PFIC taxes. Preparing a U.S. tax return to disclose income, gains, and assets held by the SMSF as if the SMSF did not exist poses a substantial financial burden to the U.S. taxpayer. The SMSF’s unique structure lends itself to this diabolical outcome.
A SMSF structure
The regime for SMSFs was introduced under the Superannuation Legislation Amendment Act (No. 3) 199997. An SMSF is essentially a trust structure that provides benefits to its members, the beneficiaries, upon their retirement. An SMSF is established broadly by creating the trust fund and drafting a trust deed that sufficiently describes the purposes of the fund and specifies the regulations to be followed by the trustee.
A trust is established when the settlor settles property on trust for the benefit of the beneficiaries. The trustee must then administer the trust in accordance with the terms of the trust deed. The settlor is generally a person unrelated to the beneficiaries and has no further involvement in the trust following the initial settlement of property on trust. For SMSFs, the trustee effectively assumes the role of settlor.
In Australia, a settlor is prohibited from receiving trust distributions and is usually excluded from the class of beneficiaries because of legislative restrictions on revocable trusts. An SMSF is essentially a revocable trust, given that members (that is, the beneficiaries) are also trustees; however, it is unique in that the SMSF member structure is accepted.
Members can contribute to their SMSFs in several different ways, and trustees must follow regulations in this regard. Contributions may be concessional or non-concessional. Broadly, concessional contributions made to an SMSF are included in the SMSF’s assessable income and taxed at the concessional rate of 15 percent. Non- concessional contributions are after-tax amounts that members contribute to their SMSFs that are not taxed in the superannuation fund. A non-concessional contributions cap of AUD 100,000 annually applies to members 65 or over but under 75. In some circumstances, members may make noncash contributions into their funds. Generally, such contributions are restricted to the transfer of listed securities or business real property.
For an SMSF to qualify for concessional tax treatment, it must be a complying fund under sections 42A and 45 of the Superannuation Industry (Supervision) Act 1993 (SISA), section 10(1). Broadly, an SMSF will be a complying resident fund if the Australian Taxation Office has not issued the fund with a notice of noncompliance. Such notice may be issued when there is a serious contravention of the SISA.
SMSFs as Foreign Grantor Trusts
SMSFs are unique in Australia’s superannuation system and differ from other funds, because members are in control and have sole responsibility for their retirement savings and, therefore, all investment decisions. At the same time, trustees must abide by all regulatory requirements and responsibilities. An SMSF from an Australian perspective is essentially a revocable trust, given that its members (that is, the beneficiaries) are also trustees.
From a U.S. tax perspective, an SMSF could be treated as a foreign grantor trust that would be disregarded for U.S. tax purposes if there is a U.S. person who contributes and a U.S. person who benefits from the trust. Some SMSFs fall squarely within these guidelines when a U.S. person makes voluntary concessional and non-concessional contributions to the fund, and another U.S. person (or the same one) is entitled to receive retirement distributions from the same fund. Treatment as a foreign grantor trust means that all the income, gains, deductions, and credits accrued in the SMSF are immediately attributed to the U.S. person who made contributions to the fund.
However, the U.S. person would also be able to claim FTCs for Australian taxes paid by the SMSF on its Australian tax returns. Theoretically, because contributions and earnings accrued in the SMSF would have already been subject to U.S. tax, any distributions received from the fund would constitute post-tax money and be tax-free.
Many issues arise if the SMSF is treated as a foreign grantor trust for U.S. tax purposes. For one, Australian employers who are non-U.S. persons must make mandatory contributions to the fund as superannuation guarantee payments. Therefore, only that portion of the fund that directly correlates to the U.S. person’s contributions (and arguable earnings on those amounts) should be subject to U.S. tax. The other portion, which is paid by the Australian employer for the benefit of its U.S. person-employee, would be likely treated as a foreign non-grantor trust for
U.S. tax purposes. That treatment would not be in the best interests of the U.S. person who is the member-beneficiary of that trust. This is because U.S. beneficiaries of a foreign trust may incur additional tax liabilities for distributable net income that is allocable to them98. Because an SMSF must accumulate investment earnings and gains in the fund until the member reaches retirement age (or otherwise satisfies a condition of release), it is very likely that those amounts would constitute undistributed net income for U.S. tax purposes, which would be subject to U.S. throwback taxes. to the U.S. person as the beneficiary of the foreign trust. This outcome is indeed unfavourable to that U.S. person. On one hand, the SMSF is subject to preferential treatment in Australia, and yet in the United States, it seems as if the SMSF is treated adversely to the detriment of its U.S. owner.
Are SMSFs foreign Social Security?
It is not surprising that some tax practitioners have taken the position that a super should be treated as an exempt foreign social security plan, because legislative reforms to the superannuation laws effective July 1, 2017, provide a formal legislative intent for the superannuation regime to “provide to Australians retirement income that would substitute or supplement the Age Pension.”99 However, Australian legislative intent does not control U.S. tax classification of super funds. As previously discussed, a super fund is subject to the U.S. foreign tax classification rules for trusts, and an SMSF, in particular, would be likely treated as a foreign grantor trust in the United States. However, we must pause to consider whether the superannuation guarantee component, which would not fall under the foreign grantor trust treatment because it is contributed by an Australian employer (rather than the U.S. person), could be classified as foreign social security. To do so, one must understand first how Australia views the superannuation guarantee, and how the United States would likely treat it under its prevailing tax regime.
A Superannuation guarantee
Under Australia’s superannuation guarantee scheme, employers must provide to their employees the minimum prescribed level of superannuation support, subject to limited exceptions100. Employers are now required to contribute a minimum amount of 9.5 percent of an employee’s ordinary time earnings (broadly, salary and wages) to the employee’s chosen super fund, which includes SMSFs101. From July 1, 2021, the rate will increase to 10 percent and steadily increase to 12 percent from July 1, 2025, onward.
Employers must make these superannuation guarantee payments, which are tax-deductible, by the quarterly due dates. If an employer has not paid the minimum amount within these due dates, it will be liable to pay the superannuation guarantee charge to the ATO. The charge is nondeductible and comprises the unpaid superannuation contribution, an administrative component (AUD 20 per employee per quarter), and interest. Failure to pay the superannuation guarantee charge could give rise to penalties of up to 200 percent of the unpaid superannuation in some circumstances in which employers fail to provide information to the ATO,102 such as a quarterly superannuation guarantee statement, and it is not uncommon for these penalties to be imposed.
Dixon claimed that his super funds were exclusively taxable in Australia under article 18, paragraph 2, of the Australia-U.S. tax treaty103. The IRS challenged this position in its responsive pleadings filed with the Tax Court, on grounds that Dixon had neither identified nor substantiated any social security or other public pension payments that may be eligible for a benefit under the treaty104. The IRS did not elaborate further on this aspect of the case, although it did file an amendment to its pleadings to assess additional deficiencies on Dixon’s amended U.S. tax returns for 2015 attributable to interests in SMSFs that generated taxable income and should have been subject to U.S. tax accordingly105.
Tax treaty article 18(1): Pensions and similar remuneration
Article 18 of the tax treaty concerns pensions, annuities, alimony, and child support. Under this article, pensions and annuities (other than government pensions referred to in article 19) are to be taxed only in the country of residence of the recipient. It is interesting that Dixon did not claim treaty benefits for his SMSFs under article 18(1), which provides that pensions and other similar remuneration paid to a resident of Australia in consideration for past employment shall be taxable only in Australia. The SMSFs would arguably fit within the definition of “pension and other similar remuneration,” which is defined under article 18(4) as periodic payments made by reason of retirement or death, in consideration for services rendered in connection with past employment. The Australian and U.S. governments did not address, through the negotiation process for the protocol, the issue regarding the double taxation of retirement saving plans of many individuals moving between the U.S. and Australia. Had the Australia-U.S. tax treaty been amended in more recent years, it would be able to address the taxation of cross-border retirement plans, as other newer treaties have done106. Specifically, if the Australia-U.S. tax treaty were amended to incorporate article 18 of the 2006 and 2016 U.S. model income tax conventions, then neither the SMSF itself, employee or employer contributions, nor earnings accrued thereafter, would be subject to U.S. taxes107.
Tax treaty article 18(2): Social security payment and other public pensions
Dixon instead claimed treaty benefits under article 18(2) to exempt his super as privatized social security108. Under paragraph (2), social security payments and other public pensions paid by one country to a resident of the other or to a citizen of the United States shall be taxable only in the country from which the payments are made109. The IRS challenged this position, pointing out that Dixon has “neither identified nor substantiated any Social Security or other public pension payments that [he] received from Australia during the tax year 2015. Accordingly, [Dixon] did not receive any payments that may be eligible for a benefit under Article 18 of the Treaty.”110
To some extent, a position could be taken that the superannuation guarantee portion of the Australian regime is equivalent to or should be taken in lieu of what the United States knows as Social Security. As previously noted, the superannuation guarantee is one of the three main pillars of Australia’s retirement system111. Indeed, Australia’s intent to replace the age pension with the superannuation regime is reflected in the Social Security (International Agreements) Act of 1999 (SSIA),112 which was enacted in March 2000 shortly before the implementation of the superannuation scheme in the same year. The SSIA’s scope explicitly references Australia’s existing social security laws and the Superannuation Guarantee Administrative Act (SGAA) as the two primary regimes in Australia that would be subject to an international agreement on social security with another country (aka totalization agreement)113 that would override Australia’s domestic social security law114.
The issue of what would constitute social security for purposes of article 18(2) was sought to be dealt with under a social security agreement between the two countries. In 2002 the Australia-U.S. totalization agreement came into force on the heels of the 2001 protocol to the tax treaty. The totalization agreement referenced the SGAA as falling within the scope of the agreement (along with contributions made under the Old Age, Survivors, and Disability Insurance (OASDI) program of the U.S. and social security law of Australia), which could be interpreted as support for the position that the superannuation guarantee paid by employers as mandatory contributions to the super fund constitutes or is treated as equivalent to Social Security contributions in the United States115. Moreover, the addition of the SGAA to the scope of the Australia-U.S. totalization agreement falls squarely within the guidelines of the U.S. Social Security Act section 233, which allows additional provisions to be made to social security agreements that are consistent with Title II (that is, OASDI).
Closer scrutiny of the superannuation guarantee contribution amounts payable by an Australian employer under the SGAA scheme shows substantial similarities between it and the U.S. Social Security taxes payable by an employer under FICA or self-employed individual the Self- Employed Contributions Act (SECA)116. The similarity between the superannuation guarantee, FICA and SECA has been acknowledged and placed within the scope of coverage of the Australia-U.S. totalization agreement117. Indeed, FICA and SECA explicitly do not apply during a period when employee wages are subject to the social security system of a foreign country under a totalization agreement between the United States and that other foreign country118. In particular, FICA and SECA do not apply when a U.S. person is subject to Australia’s superannuation guarantee scheme. This means, by inference, that Australia’s superannuation guarantee is likely equivalent to the U.S. FICA and SECA taxes119.
If based on the above authorities, the superannuation guarantee amounts paid to Dixon’s SMSF accounts as employer contributions, if any, were to be treated as equivalent to foreign social security, then those employer contributions would be excluded from Dixon’s taxable income and exempt from U.S. taxation under article 18(2) of the Australia-U.S. tax treaty120. However, it appears that Dixon’s claim for tax treaty benefits fell short of providing adequate disclosure regarding specific amounts received or deemed received from his SMSF that were excluded from his U.S. taxable income as foreign social security. The IRS noted that Dixon failed to provide granular detail in Form 8833, “Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b),” submitted along with his tax returns to identify specific amounts received from the SMSF that would be treated as social security121.
Since the Dixon Tax Court case has been placed on continuance pending resolution of IRS Appeals proceedings with Dixon, it remains to be seen whether the issue of Dixon’s SMSFs as foreign social security will ever get its proverbial day in court. Australians are passionate about their super funds, and if the DAG-Australia fallout is any indication, would likely loathe to see any portion of their super funds subject to U.S. taxation. While Dixon and DAG-Australia’s reputation in Australia will probably never be redeemed in light of the misery it has bestowed on those who trusted their super fund monies to him, his firm, and his U.S. real estate fund, perhaps his remaining Tax Court case will garner some sympathy from dual citizens and residents of Australia and the United States who have suffered the punitive taxation of their Australian investments and retirement under the U.S. tax regime.
For further advice on Australian or international tax please do not hesitate to contact our Tax team.
This article was co-authored by Marsha Laine Dungong, Tax Partner in the Withers San Francisco office.
1. More commonly referenced as check-the-box regulations, the final version of these regulations was issued December 18, 1996, as T.D.8697 and promulgated as reg. section 301.7701-1.
2. See T.D. 8697, section A. Trusts generally do not have associates or do business for prot as an objective. Classification of trusts are under reg. section 301.7701-4. Classification of business entities are under reg. section 301.7701-2 and -3.
3. Reg. section 301.7701-2.
4. Reg. section 301.7701-3.
5. See generally reg. section 301.7701-3(b).
6. Reg. section 301.7701-3©(1) provides details on how the election is made. It is generally made by attaching a Form 8832, “Entity Classification Election,” to the federal income tax or information return of any direct or indirect owner of the entity for the tax year of the owner that includes the date on which it was effective.
7. Dixon v. Commissioner, No. 13874-19 (T.C. filed July 25, 2019) (Dixon II)
8. The U.S. tax treatment of Alan Dixon’s Australian self-managed superannuation funds (SMSFs) was raised by the IRS in Respondent’s Answer at para. 4(t), Dixon II, No. 13874-19 (T.C. Sept. 17, 2019).
9. See reg. section 301.7701-2(b)(8)(i).
10. An AusPty with a single member that has unlimited liability under
Australian laws would be treated as a disregarded entity for U.S. tax purposes unless it timely filed an election to be treated as an association taxable as a corporation. As a corollary, an AusPty with more than one member would be treated as a de facto partnership for U.S. tax purposes unless it filed an election to be treated as corporation.
11. See section 1.5.2 of the Australian Corporations Act 2001.
12. To be able to elect disregarded entity classification, the foreign
entity must show that it has one owner with unlimited liability under the check-the-box regulations. However, it is not uncommon for shareholders of an AusPty to also be its directors. In fact, shareholders of an AusPty that is a corporate trustee of an SMSF must also be its directors under Australian superannuation laws. Because directors do not have limited liability under Australian corporate laws, it would appear that a shareholder who is also a director of an AusPty that is a corporate trustee of a SMSF may assert that the AusPty has one member with unlimited liability and request disregarded entity classification anyway. See section 1.5.3 of the Australian Corporations Act 2001.
13. Franked dividends are dividends that have been paid from profits
that have been subject to tax at the relevant corporate rate. The individual shareholder who receives a franked dividend also gets a franking credit (aka imputation credits) attached to the dividend, which represents the tax paid by the company. If the individual’s top tax rate is less than the company’s tax rate, then the ATO refunds the difference.
14. Franking credits were introduced in Australia in 1987 to remove the incidence for double taxation on Australian taxpayers.
15. See, e.g., section 962, which was used by many U.S. taxpayers to elect as a corporate shareholder for U.S. tax purposes.
16. It would be difficult to achieve a complete 100 percent match because Answer at para. 4(t), Dixon II, No. 13874-19 (T.C. Sept. 17, 2019). Australia has a fiscal-year regime while the United States has a calendar-year regime. Also, U.S. FTC rules limit the amount of Australian taxes that can be claimed by a U.S. taxpayer to offset U.S. taxes in any given year.
17. See Dixon v. United States, 2:19-cv-14101 (D.N.J. filed June 21, 2019) (Dixon I); Dixon II, No. 13874-19; and Dixon v. United States, No. 19-270T (Fed. Cl. 2020) (Dixon III).
18. Dixon had been living in the United States since 2014 on an E-2 visa.
19. Dixon left his position as CEO in 2019 and sold his entire 16.7 percent stake in the company to Pitt Capital in August 2020 for AUD 18.6 million. He also left the company’s board in July 2020. See Jonathan Shapiro and Carrie LaFrenz, “Dixon Name to Go, Heartache Remains,” Australian Financial Review, Oct. 17, 2020; and Shapiro and LaFrenz, “ASIC Action May Cost Dixon Advisory Tens of Millions,” Australian Financial Review, Sept. 4, 2020.
20. Dixon Advisory was founded by Alan’s father, Daryl Dixon, purportedly one of the three people who understood Australia’s entire superannuation system. He was one of its most trusted experts. He and his wife established Dixon Advisory in 1986 and grew it into the fourth- largest superannuation advice firm in Australia. See Shapiro and LaFrenz, “Dixon Name to Go,” supra note 19; see also Shapiro and LaFrenz, “ASIC Action,” supra note 19. Daryl and his son were on the investment committee of the company. He left the business in 2019. Id
21. See John Wasiliev, “How In-House Investments Unraveled Dixon,” Australian Financial Review, Nov. 6, 2020.
22. Evans & Partners was co-founded by former Essendon Football Club Chair David Evans. See Samantha Bailey, “Adviser in ASIC’s Crosshairs,” Herald Sun (Australia), Sept. 5, 2020. See also Myriam Robin and Shapiro, “No Regrets Over Evans Dixon Merger: David Evans,” Australian Financial Review, Nov. 11, 2019.
23. Just recently, the shareholders of Evans Dixon voted to approve the rebranding of the company to E&P Financial Group after the ASIC, one of the five government agencies with oversight over Australian superannuation funds, filed a court action against Dixon Advisory & Superannuation Services, a wholly-owned subsidiary of Evans Dixon, alleging breaches of its best interest duty obligations in September 2020. See LaFrenz and Shapiro, “Evans Dixon Quiet on ASIC Case Fallout,” Australian Financial Review, Nov. 12, 2020. The corporate regulator also filed a multimillion-dollar Federal Court of Australia claim alleging Dixon Advisory failed to act in its clients’ interests or provide appropriate advice in recommending investments, raking in hundreds of millions of dollars in fees. See Shapiro and LaFrenz, “Dixon Name to Go,” supra note 19.
24. See Wasiliev, supra note 21.
25. See Shapiro and LaFrenz, “Evans Dixon Makes Changes to Walsh & Co Board,” Australian Financial Review, Dec. 19, 2019.
26. Dixon Advisory & Superannuation Services became a wholly-owned subsidiary of the new public company.
27. See Bailey, supra note 22.
28. It was reported that the URF was a “one-time $1 billion sharemarket-listed” fund that was discovered to be in serious trouble after the 2017 merger. As of November 2020, the fund apparently has a “meagre market capitalization of over just AUD 80 million with shares that cost investors up to $2 to buy having a market value at just 21c this week.” See Wasiliev, supra note 21.
29. See Shapiro and LaFrenz, “Dixon Name to Go,” supra note 19.
30. See Shapiro and LaFrenz, “Evans Dixon Model Under Scrutiny as Stocks Plunge,” Australian Financial Review, June 7, 2019.
31. See Wasiliev, supra note 21.
32. See Shapiro and LaFrenz, “Dixon Name to Go,” supra note 19; and Shapiro and LaFrenz, “ASIC Action,” supra note 19. The Australian Financial Review reported that the ASIC federal court claim tallied up to AUD 135.9 million of fees paid by the URF to Dixon Advisory and other related parties from September 2015 to June 2018. These included management fees charged on gross assets of AUD 25.8 million, responsible entity fees of AUD 12.54 million, stamping and handling fees of AUD 5.8 million, and property transaction fees of AUD 18 million. It also paid AUD 68 million to Dixon Projects, which was hired to renovate properties in the fund located in New Jersey and Manhattan.
33. See Shapiro and LaFrenz, “Evans Dixon Model,” supra note 30. See also Shapiro and LaFrenz, “Dixon Name to Vanish, Leaving Behind Devastated Clients,” Australian Financial Review, Oct. 16, 2020; and Shapiro and LaFrenz, “ASIC Action,” supra note 19.
34. The Australian Financial Review reported that “most of Dixon Advisory’s 4,000-odd clients are middle-class Australians with reasonable wealth accumulated over decades in white-collar professions. The balances range between AUD 500,000 to 3 million.” See Shapiro and LaFrenz, “Dixon Name to Go,” supra note 19. See also Wasiliev, supra note 21, stating that the URF was capitalized with “hundreds of millions of dollars provided by thousands of Dixon Advisory SMSF clients.” Id.
35. See Defendant’s Memorandum at 2, Dixon III, No. 19-270T (Fed. Cl. Nov. 15, 2019). As a 16.7 percent shareholder of Evans Dixon, he would be required to include as taxable income dividends he received from DAG-Australia and pay U.S. taxes on those amounts.
36. See id. at 5, 11, and 12.
37. His original 2013 and 2014 income tax returns were filed on October 14, 2014, and October 6, 2015. See Petitioner’s Motion at para.1(a), Dixon II, No. 13874-19 (T.C. July 25, 2019).
38. See Defendant’s Memorandum at 4, Dixon III, supra note 35. See also Defendant’s Answer and Additional Defense at 3, Dixon III, No. 19-270T (Fed. Cl. Sept. 13, 2019).
39. See Sarah Thompson, Anthony Macdonald, and Tim Boyd, “360 Capital Storms Into Evans Dixon,” Australian Financial Review, Aug. 30, 2020. It was reported that Dixon held 39,122,625 shares in Evans Dixon (equivalent to 16.7 percent ownership), which sold for 45 cents each. It was listed on the ASX in 2017 at AUD 2.50 per share. He walked away with total consideration of AUD 17.6 million for selling all his shares in Evans Dixon.
40. See Form 886-A attached as Exhibit A to Respondent’s Answer, Dixon II, No. 13874-19 (T.C. Sept. 19, 2019).
41. As qualified dividends, these amounts would be subject to a reduced tax rate of 20 percent rather than the prevailing ordinary income tax rate (which would have been 39.6 percent).
42. Defendant’s Memorandum at 9, supra note 35. The IRS stated in footnote 10 that: Although Castro identified himself as an “international tax attorney,” Castro was (and is) not, in fact, a licensed attorney. (See, e.g., Def. Ex. 14, July 18, 2016, Letter from Florida Bar Counsel to John Castro (filed in Castro v. Berg et al., N.D. Tex. No. 3:18cv573-N, Dkt. 15-3 (Aug. 16, 2018)); Def. Ex. 15, October 21, 2016, Letter from Florida Bar Counsel to IRS Office of Professional Responsibility (filed in Castro v. Berg et al., N.D. Tex. No. 3:18cv573-N, Dkt.15-4 (Aug. 16, 2018)).)
43. He is also running for the Republican nomination for senator of Texas. See Peter J. Reilly, “Wrong Signature Voids Million-Dollar Plus Refund Claim,” Forbes, Feb. 24, 2020.
44. See Plaintiff’s First Amended Complaint at para. 13, Castro v. Berg, No. 3:18-cv-00573-G (N.D. Tex. Aug. 8, 2018).
45. Castro’s position is that a super is a form of foreign social security and therefore exempt from tax under the Australia-U.S. tax treaty; see John A. Castro, “U.S. Tax Treatment of Australian Superannuation,” 2 Nev. L.J. Forum 91 (2018).
46. See Plaintiff’s First Amended Complaint at paras. 18, 19, 32, and 40; Castro, supra note 44.
47. Id. It was also represented that “Dixon Advisory principals and employees have been a faithful source of referral work for Plaintiff Castro & Co.” Id. at para. 18.
48. See Defendant’s Memorandum, Dixon III, No. 19-270T (Fed. Cl. Feb. 21, 2020). See also Plaintiff’s Memorandum at 2, Dixon III, No. 19-270T (Fed. Cl. Jan. 3, 2020).
49. Castro filed the Form SS-4 on February 8, 2016. See Petitioner’s Motion at para. 5(c), Dixon II, supra note 37.
50. We note that the election to be classified as a partnership under the check-the-box regulations would require a Form 8832 filing and not a Form SS-4 filing.
51. Or its subsidiary, which was alleged to be a disregarded entity for U.S. tax purposes. See Defendant’s Memorandum at 9, Dixon III, supra note 35.
52. See Petitioner’s Motion at para. 1(c), Dixon II, supra note 37. The IRS denied Castro’s assertion that it approved DAG-Australia’s classification as a foreign partnership retroactive to 1986. See Respondent’s Answer at para. 5(c), Dixon II, supra note 8.
53. See Defendant’s Answer and Additional Defense at 4, Dixon III, No. 19-270T (Fed. Cl. Sept. 13, 2019).
54. See Rev. Proc. 2009-41, 2009-39 IRB 439, which provides that an eligible entity may file Form 8832 to request relief for a late classification election. The effective date for that election cannot be over 75 days before the date on which the election is filed and cannot be over 12 months after the date of filing.
55. See T.D. 8697, part C.
56. The amended 2013 Form 1040X was filed on or about April 11, 2017. The amended return claimed a refund amount of $137,656 on grounds that the original return had erroneously included taxable income within Dixon’s privatized social security fund, also known as Australian superannuation fund. Dixon claimed that this income was exempt from U.S. taxation under the Australia-U.S. tax treaty. He also claimed that he needed to remove Forms 8621 attributable to assets held by his super. See Defendant’s Memorandum at 13, Dixon III, supra note 35.
57. The amended 2014 Form 1040X was filed on or about April 11, 2017. The amended return claimed a refund of $1,588,653 on grounds that passive nonbusiness income was incorrectly reported as dividends. That income allegedly was sourced from a disregarded entity. It also alleged that Dixon had a certificate of coverage under the Australia-U.S. social security totalization agreement. See Defendant’s Memorandum at 15, Dixon III, supra note 35.
58. The amended 2015 Form 1040 was filed June 20, 2016.
59. Dixon’s amended returns reflected $137,656 in tax refunds on his 2013 Form 1040 for taxes attributable to his SMSF earnings 15, Dixon III, supra note 35. that purportedly were erroneously included in his U.S. taxable income and $189,329.96 in taxes that he paid after the 2013 tax return was audited by the IRS; $1,588,653 in tax refunds on his 2014 Form 1040 attributable to incorrectly reported dividends and SMSF earnings; and $1,490,948 in tax returns on his 2015 Form 1040 for business income reported as dividends, FTCs, and SMSF earnings erroneously included as part of his U.S. taxable income.
60. The notice of deficiency was dated February 12, 2018.
61. The IRS initiated an audit of the amended 2014 tax returns in May 2018. See Defendant’s Memorandum at 9, Dixon III, supra note 35.
62. See Petitioner’s Motion at para. 1(1), Dixon II, supra note 37. An overpayment credit of $192,271.56 attributable to Dixon’s 2017 income tax return was applied to his 2013 tax liability.
63. See Amended Complaint, Dixon III, No. 19-270T (Fed. Cl. July 24, 2019).
64. See Defendant’s Memorandum at 10, Dixon III, supra note 35.
65. In the pleadings, Dixon alleges that although he filed his 2015 amended tax return on June 20, 2016, the IRS agent did not commence his examination until February 22, 2019, less than two months before the deadline for assessing tax against Dixon. See Petitioner’s Motion at para. 1(r) Dixon II, supra note 37.
66. See Petitioner’s Motion at Exhibit A, Dixon II, supra note 37. The examination report was dated April 1, 2019. See also IRS notice of deficiency dated April 30, 2019, provided as Exhibit A, Respondent’s Answer, Dixon II, supra note 8.
67. See Respondent’s Answer at Exhibit A, Dixon II, supra note 8.
68. See Order Denying Petitioner’s Motion to Stay Proceedings, Dixon II, No. 13874-19 (T.C. Dec. 17, 2019).
69. See Memorandum Opinion, Dixon III, No. 19-270T (Fed. Cl. Feb. 21, 2020).
70. See, e.g., George Cochrane, “US-Australian Tax Law Remains a Complex Web,” The Sydney Morning Herald, Aug. 1, 2020. See also Reilly, supra note 43.
71. See Respondent’s Answer at para. 5(t), Dixon II, supra note 8. Dixon’s 2015 amended tax returns included a Form 8833, “Treaty-Based Return Position Disclosure,” which specifically excluded Dixon’s SMSF earnings from his U.S. taxable income on grounds that Australian superannuation funds constituted foreign social security under article 18(2) of the Australia-U.S. tax treaty. See also Respondent’s Objection to Motion to Stay Proceedings at para. 12, Dixon II, No. 13874-19 (T.C. Sept. 24, 2019).
72. See Respondent’s Motion for Leave to File Amendment to Answer at para. 2, Dixon II, No. 13874-19 (T.C. Mar. 12, 2020).
73. See id. at para. 7. The IRS identified Dixon’s interests in the following ATO-regulated SMSFs: Dixon Duffield Property Superannuation Fund, Mr. Orange Accumulation Fund, and Mr. White Pension Fund. Id.
74. See Notice Setting Case for Trial, Dixon II, No. 13874-19 (T.C. July 1, 2020).
75. See Joint Motion for Continuance, Dixon II, No. 13874-19 (T.C. July 27, 2020). See LaFrenz and Shapiro, “Evans Dixon Quiet,” supra note 23.
76. See Shapiro and LaFrenz, “Corporate Regulator Investigates Dixon Advisory,” Australian Financial Review, Jan. 6, 2020. See also Thompson, Macdonald, and Boyd, supra note 39.
77. See also Shapiro and LaFrenz articles, supra note 33.
78. See supra note 39.
79. See Notice of Change of Address, Dixon II, No. 13874-19 (T.C. Sept. 24, 2020).
80. See LaFrenz and Shapiro, “Evans Dixon Quiet,” supra note 23.
81. See Association of Superannuation Funds of Australia, August 2020 Superannuation Statistics (Dec. 6, 2020).
83. Industry funds are established for employees working in the same industry or related industries; for example, the legal, hospitality, and construction industries. Corporate funds are generally established by large employers for the benefit of their employees (which may include relatives and former employees). As of June 2020, industry funds comprised AUD 748 billion out of AUD 2.9 trillion in superannuation assets. See id.
84. Corporate funds were common in Australia; however, in recent years the use of corporate funds has decreased to comprise just AUD 57 billion of the total AUD 2.9 trillion investments. See id.
85. Retail funds are investment funds, in a trust structure, that are often operated by financial institutions and offer superannuation products to the public on a commercial basis. Members are provided with expertise for investing and managing the money placed into the funds and are charged management fees for these services. As of June 2020, retail funds comprised AUD 591 billion out of the AUD 2.9 trillion in superannuation assets. See id.
86. Public sector funds are established for employees of the commonwealth, state, and territory governments. A public sector fund is part of the public sector superannuation scheme broadly being a scheme for the payment of superannuation, retirement, or death benefits established under a commonwealth, state, or territory law. Superannuation Industry (Supervision) Act 1993 (SISA), section 10(1).
87. SMSFs are established by members, commonly family members, or friends, who run the fund for their benefit and are responsible for compliance with legislative and regulatory requirements. To constitute an SMSF, a fund must have one to four members and each individual member must be a trustee or the director of a corporate trustee. Accordingly, in contrast to other types of funds, the members of an SMSF are also its trustees. SMSFs are regulated by the ATO.
88. Funds with fewer than five members that do not meet the definition of an SMSF are subject to prudential regulation by APRA under the SISA, rather than by the ATO. These funds are known as small APRA funds (SAFs). An SAF operates as an SMSF; however, it must have a registrable superannuation entity licensee as its trustee. Accordingly, in contrast to SMSFs, SAFs may be preferable to members who consequently do not carry the associated trustee responsibilities and risk of regulatory breaches, which lies with the professional trustee.
89. See LaFrenz and Shapiro, “Evans Dixon Quiet,” supra note 23.
90. See IRS private letter rulings issued in June 2015: LTR 201538008, LTR 201538007, and LTR 201538006. In all three, the foreign trust was governed by foreign legislation and regulated by several government entities. Although it was not explicitly named, the trusts at issue in the IRS private letter rulings were Australian super funds.
91. Based on Australian government data. See broadly “Retirement Income Review, Consultation Paper” (Nov. 2019). Australia’s retirement income system is known to have three pillars. The first pillar, the foundation of Australia’s retirement system, is the provision of social security in the form of the age pension. The second pillar constitutes compulsory employer contributions under the superannuation guarantee scheme. The third pillar broadly comprises all voluntary savings, including member contributions and home ownership.
92. SISA provides a comprehensive regime for the regulation of superannuation funds and associated entities. The superannuation industry is regulated by APRA, ASIC, and the ATO.
93. Complying superannuation funds, including SMSFs, are taxed concessionally under division 295 of the Income Tax Assessment Act 1997 (ITAA 1997) at the rate of 15 percent on the fund’s income, including realized capital gains and taxable contributions received.
94. The lower capital gains rate of 10 percent would apply when the fund has held the asset for over 12 months and is eligible to apply the capital gains tax general discount.
95. In 2017 the Australian government introduced legislative amendments to improve the integrity of the superannuation system to ensure that it is used for the purpose of providing income in retirement to substitute for or supplement the age pension, and not for tax minimization and estate planning purposes.
96. Published ATO data provide that there were 598,582 SMSFs in Australia as of September 2019, with a combined total of 1,124,699 members. See ATO, “Self-Managed Super Fund Quarterly Statistical Report” (Sept. 2019).
97. The legislation amended the SISA to establish SMSFs as a new category of fund, broadly replacing the former category of small funds known as excluded funds and expanding on the fund requirements. In addition to requiring the fund to have fewer than five members, the legislation further required that all members of the fund have a business or family relationship and be trustees of the fund. Further, because members of SMSFs would be able to protect their own interests, SMSFs were to be subject to a less onerous prudential regime under the SISA.
98. The U.S. tax regime imposes punitive throwback taxes on U.S. beneficiaries of a foreign trust with undistributed net income.
99. In November 2016 the Australian Parliament passed legislation to implement superannuation reforms to make the widely popular superannuation system more sustainable for its aging population by increasing flexibility and incentives for savings. See Superannuation (Objective) Bill 2016, which sets out a clear objective for superannuation: to provide income in retirement to substitute for or supplement the age pension. The provisions of the superannuation reform package pertaining to a formal legislated objective for the superannuation system was split from the other elements of the reform package that was passed by the Senate in November 2016. Rather, the legislated objective provision was referred by the Senate to its Economics Legislation Committee for inquiry and report by February 14, 2017. The committee report, issued February 2017, recommended passage of the provision.
100. The regime is governed by the SGAA and the Superannuation Guarantee Charge Act 1992, which both commenced on July 1, 1992.
101. See subdivision 295-C of the ITAA 1997. Employer superannuation contributions for employees, including contributions made under pre-tax salary sacrifice arrangements, are “concessional contributions” under the ITAA 1997 and are subject to contributions tax in the fund, as discussed below. An employer contribution is generally subject to tax of 15 percent when it is made to a complying superannuation fund. Broadly, contributions made to a superannuation fund are not considered to constitute assessable income of the fund and rather constitute contributions of capital to the fund.
102. Part 7 of the SGAA (sections 59 to 62A).
103. Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income, United States-Australia, August 1, 1982 (the tax treaty) (as amended by the protocol signed September 27, 2001).
104. Respondent’s Answer at 4(t), Dixon II, supra note 8.
105. See Respondent’s Motion for Leave to File Amendment to Answer at 1, Dixon II, No. 13874-19 (T.C. Mar. 12, 2020).
106. See Treasury, 2016 U.S. Model Income Tax Convention (hereinafter the 2016 U.S. model tax treaty), and Joint Committee on Taxation, “Comparison of the United States Model Income Tax Convention of September 20, 1996, With the United States Model Income Tax Convention of November 15, 2006,” JCX-27-07, at 23-24 (May 8, 2007).
107. Articles 18(2) and 18(4) of the 2006 model treaty and article 18(3) of the 2016 model treaty apply to situations in which the individual is a U.S. citizen and resident of the host country. It provides that contributions attributable to employment paid by or for the individual during the employment period to a pension fund are deductible or excludable in computing the individual’s U.S. tax; further, any accrued pension benefits or employer contributions attributable to employment made by the U.S. person’s employer are not treated as taxable to the individual in the United States.
108. To do so, Dixon attached a Form 8833 to each of his amended returns that claimed that his Australian superannuation fund was exclusively taxable in Australia as social security under article 18(2) of the Australia-U.S. tax treaty. Respondent’s Motion for Leave to File Amendment to Answer at 1, Dixon II, supra note 105.
109. See Explanatory Memorandum to the Income Tax (International Agreements) Amendment Bill 1983 at 28.
110. See Respondent’s Motion for Leave to File Amendment to Answer at 1 and 2, Dixon II, supra note 105.
111. The three pillars are a social security program (including the age pension), the superannuation guarantee (which is a mandatory contribution by employers), and supplemental voluntary savings. See Jonathan Barry Forman and Gordon D. Mackenzie, “Optimal Rules for Defined Contribution Plans: What Can We Learn From the U.S. and Australian Pension Systems?” UNSW Australian School of Business Research Paper No. 2013 TABL 1000.
112. See Office of Parliamentary Counsel (Canberra), SSIA, part 1(4) (compiled Jan. 1, 2016). SSIA was enacted in March 2000 to form part of Australia’s social security law.
113. See id. at part 2(5) and (6).
114. See id. at part 2.6(1), which states that “the provision of a scheduled international Social Security agreement have effect despite anything in Social Security law.” Id.
115. See id. at Schedule 13 — Agreement Between the Government of Australia and the Government of the United States of America on Social Security, U.S.-Australia (Oct. 1, 2002).
116. For a detailed analysis of the similarities between the U.S. FICA and SECA payroll taxes and the Australian superannuation guarantee, see Roy A. Berg and Marsha-Laine Dungog, “U.S. Income Tax Treatment of Australian Superannuation Funds,” Tax Notes Int’l, Oct. 10, 2016, p.
177. See Berg and Dungog, “What US Workers Need to Know About Australian Superannuation Plans,” BNA Int’l J., Aug. 11, 2017.
120. As a corollary, we would also conclude that earnings accrued in the SMSF and distributions from those portions would constitute foreign social security benefits that would be extended the same treatment as exempt foreign social security under article 18(2).
121. See Respondent’s Answer at para. 4(t), Dixon II, supra note 52.
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