Superannuation Contributions are Deductible Foreign Taxes Despite Being Voluntary
The distinguishment between voluntary and involuntary taxes stems from the foreign tax credit provisions. Under the foreign tax credit provisions, a foreign levy must be an objectively and subjectively involuntary forced payment collected by a foreign governmental taxing authority. Treas. Reg. § 1.901-2(a)(2)(i). If the payment is objectively voluntary, it is not creditable. Treas. Reg. § 1.901-2(e)(5). If the payment is subjectively voluntary (i.e., the taxpayer does not exhaust all effective and practical means of lowering its tax), it is not creditable. Treas. Reg. § 1.901-2(e)(5)(ii) Examples 2 and 3; Procter & Gamble Co. v. U.S., 1:08-CV-00608, 2010 WL 2925099 (S.D. Ohio July 6, 2010) (taxpayer failed to pursue treaty benefits). However, a taxpayer may rely on the advice of a professional in deciding not to pursue litigation. Treas. Reg. § 1.901-2(e)(5)(i). The United States Tax Court has held that all payments to a foreign system of social security that is "financed through national insurance contributions" in the form of taxes that are "calculated on a percentage of the worker's gross income" are creditable for foreign tax credit purposes. Eshel v. C.I.R.,142 T.C. No. 11 (2014).
Now, if a tax fails to be creditable under the foreign tax credit provisions, it is still deductible under Section 164. Section 164 allows a deduction for tax “imposed” (i.e., put in place to be collected by an authority or instrumentality of the foreign government) but not necessarily involuntary as required under the foreign tax credit system.
This raises a very important question: what happens when a foreign country has a privatized social security system that permits voluntary social security tax contributions into the fund?
Let’s use the Australian Privatized Social Security Superannuation System as an example. The Australian Tax Office (ATO) collects a 9.5% “superannuation guarantee,” which is really a mandatory tax imposed on the company with reference to the employee’s salary for tax calculation purposes. This tax is then remitted by the ATO into the individual’s Superannuation Fund.
Now, the individual is still permitted to make “concessional contributions” thereby subjecting that income to lower preferred rates. Moreover, once the limit on those concessional contributions is reached, the individual may still make after-tax non-concessional contributions akin to our Roth contributions.
Once these funds are contributed into the Superannuation Fund, they are “preserved and restricted” (locked-in) until retirement or permanent disability; much like our own social security system.
In essence, these “contributions” are voluntary taxes paid by the individual. Therefore, they would not be creditable under the foreign tax credit provisions. However, the voluntary nature of the contributions may not necessarily result in a denial of a deduction for those contributions.
It is our firm’s position that both concessional and non-concessional contributions in the context of both standard industry superannuation funds as well as self-managed superannuation funds (SMSFs) are deductible as voluntary foreign taxes pursuant to Section 164(a)(3) and (b)(3).
- Related Reading: US Tax Treatment of Australian Superannuation