Most countries, including Australia, structure their welfare systems so that taxpayers contribute to the country’s welfare systems during their working life and start drawing down on benefits when they are unemployed, unable to work due to illness, or they retire. Benefits paid on retirement are normally structured as fortnightly pension payments.
Australian tax residents are taxed on their world-wide income so any foreign pension income received is taxable. This is irrespective of which foreign country is paying the foreign pension, whether the funds are actually transferred to Australia, or the taxpayer’s age when the pension income is received.
The undeducted purchase price (UPP) of a foreign pension is the amount that the taxpayer contributed to the purchase price of the pension or annuity over their working life. This will not be the total tax paid by the taxpayer, but the percentage of that tax that the country has deemed to be contributed to funding their pension payments on retirement.
This part of the annual pension or annuity represents a return of the taxpayers personal funds, so is tax free. As the total foreign pension income is taxable in Australia a deduction is allowed for the UPP amount so the taxpayer is only taxed on the net amount.
Each countries UPP amount is different and depends on their welfare system. British pensions, for example have a UPP of 8% of the foreign pension amount and Dutch pensions 25%. For all other foreign pensions the taxpayers should apply to the ATO and have them calculate the UPP on the foreign pension.
This strategy encourages taxpayers to correctly calculate and claim the foreign UPPs so that their net foreign pension income is not overstated and unnecessary tax paid.