Lowtax International Pensions
By Lowtax Editorial
03 October, 2012
One of the ironies of the modern world is that, while it is now probably easier than ever to live abroad, for instance as an international assignee or as one of the growing army of expats choosing to leave colder northern climes for sunnier shores, pension rules are, in the main, stuck firmly in the 20th century, and are anything but mobile.
Pension schemes in high-tax countries are usually tax-privileged to encourage more people to save for their retirement. However, move abroad and you may find that your ability to contribute to such schemes is much curtailed. In the UK for example, if you belong to a stakeholder scheme and become non-resident, you can only continue to contribute for a maximum of five years (although this is at least an improvement on the previous two-year contribution limit). What's more, switching from plan to plan as you change host country can mean that retirement income is fragmented and potentially whittled away by taxes and other costs.
Slowly though, governments, legislatures and tax authorities around the world have come to recognise that tax complexity is as much a drag on investment and economic activity as high tax rates, if not more so in certain cases. Finally therefore, it seems that, drip by painfully slow drip, the drive towards tax simplification is filtering through to the highly-complex world of international pensions, and in this feature we round up some of the latest tax developments in the area of cross-border pensions and international retirement planning.
QROPS (Qualified Registered Overseas Pension Schemes) are a British innovation designed to smooth the process of moving a pension overseas. Simply put, under the QROPS rules as introduced, if a British citizen has become non-resident on a permanent basis, and has no present intention of returning to the UK, they can move their pension fund out of the UK to another country, and it doesn't have to be the country they are living in. For the first five years of non-residence, the fund will remain subject to HMRC's rules, but after that the rules that apply will be those of the destination country of the fund.
QROPS first emerged as a significant product sector in 2008, and have seen rapid growth ever since. Data from HMRC shows that the value of funds transferred into QROPS globally was GBP121.5m in 2007, before trebling to GBP358m in 2008 and then rising nominally to GBP366m in 2009, regaining momentum in 2010, with funds growing to GBP471m. That took the cumulative total of funds transferred to more than GBP1.3bn by the end of 2010 and it has been estimated that the amount transferred during 2011 surpassed the GBP500m mark.
However, the UK tax authority, HM Revenue and Customs (HMRC), threw a spanner into the QROPS works earlier this year when it indicated that tax relief available on pension transfer QROPS structures will no longer be available from April 2012 unless the scheme is offered within the territory in which the expatriate is newly resident, putting a substantial and growing offshore industry at jeopardy.
Guernsey, having captured the largest slice of the QROPS cake, was not surprisingly up in arms about these changes. HMRC data shows that of the total number of pension transfers out of the UK into QROPS between January 1, 2011 and June 30, 2011, 32% went into QROPS based in Guernsey. New Zealand was the second most popular destination with a share of 28%, with Australia third (20%). Guernsey is, however, primarily a third country' QROPS destination, meaning that most of the QROPS transferred to the island are for individuals who have left the UK to live elsewhere, such as in Europe or Asia. In contrast, Australia's QROPS market is comprised almost exclusively of those going to the country to live, while other popular UK expat destinations, like New Zealand, are a mixture of third country QROPS and those of individuals moving permanently from Britain.
The subsequent decision by HMRC to remove all Guernsey-based QROPS from its approved list was condemned as an "unjust attack on the island" by the jurisdiction's official financial services lobby organisation, Guernsey Finance. "HMRC had given us an indication that only Guernsey pension schemes for Guernsey residents would remain on their list of QROPS," Fiona Le Poidevin, the Deputy Chief Executive of Guernsey Finance, commented shortly after the new measures were introduced. "By implication this meant that they were going to delist Guernsey pension schemes for non-residents. This raised the question as to whether it was just Guernsey being targeted or whether it was going to impact other jurisdictions and in particular, those offering third-country QROPS."
"What we have determined from the publication of the new list is that, in broad terms, it is Guernsey which has been singled out by HMRC," she contended. "It is difficult to work out precisely why this is the case. HMRC's amendments to its legislation contained in the UK Budget were clearly focused on targeting abuses in the system and Guernsey has always upheld itself as a model of compliance with the QROPS regulations."
In July 2012, the Guernsey government announced that it will revise its Section 157E pension scheme structure in an effort to have it recognized by the UK tax authority as facilitating QROPS that can accept both resident and non-resident taxpayers. Guernsey's response, announced recently by Guernsey Treasury Minister, Gavin St. Pier, would revert the island's Section 157E pension structure back to its pre-existing form - undoing amendments aimed at complying with the new rules - but would add new taxing provisions on pensions transferred by non-residents to ensure equitable taxation between resident and non-resident persons.
According to St. Pier, the plans would involve income from occupational pension schemes being taxable for non-residents as well as residents, by removing the exemption for pensions and annuities paid in respect of services performed wholly outside Guernsey. The payer of a pension or annuity would be required to deduct tax whether or not the recipient is resident in Guernsey and whether or not the services which led to the payment of that pension or annuity were performed in Guernsey. Secondly, a legislative amendment will remove the exemption from tax on annuities and lump sums paid to non-resident members of approved retirement annuity schemes and retirement annuity trust schemes. This will mean that such annuity income or lump sums will be taxable on the same basis as if paid to a resident of Guernsey, albeit subject to Guernsey provisions that allow for the exemption of certain lump sums from taxation.
Rex Cowley, principal of the Jersey-based New Dawn Consultancy told International Adviser that in essence the plans seek to enable Guernsey to "potentially tax all payments from a Guernsey pension at the domestic rate of tax, i.e., 20%, but allow an exemption on certain lump sum payments, in order to create the ability to revive a tax free [benefits commencement] lump sum, i.e., 30%. The net result is 20% tax on pension income, with a 30% tax free lump sum, irrespective of the member's residence."
The changes were due to be brought before the island's legislative assembly, the States of Guernsey, in September, but, if adopted, will have retrospective application from June 27, 2012. However, the government has confirmed that provision would be made to ensure no retrospective impact on schemes being managed on behalf of non-residents who transferred their UK pensions to Guernsey prior to the rule change.
Guernsey wasn't the only offshore jurisdiction to fall foul of HMRC's new rules however. In April 2012, the Isle of Man government indicated that transfers to structures under Section 50C of the Income Tax Act 1970, known as 50C pensions would also be excluded under the QROPS reforms. Pensions arranged under Section 50 were removed from HMRC's approved list, although other schemes, established under the Income Tax (Retirement Benefits Schemes) Act 1978, and Part I of the Income Tax Act 1989, have been approved.
In a stoic response from the Isle of Man, Treasury Minister, Eddie Teare stated: "The UK has made clear that it wishes a QROPS to be broadly similar to a UK registered pension scheme. Although I am disappointed that our 50C schemes can no longer be QROPS, the Isle of Man retains a powerful international pension management offering through having both occupational and personal pension schemes which can be approved as QROPS. We can move on from this point to further consolidate our position as a key pension management jurisdiction and continue both to grow and diversify our economy."
It remains to be seen, however, how these changes will impact QROPS business in places like Guernsey and the Isle of Man, which cater largely for third country transfers.
Levelling The EU Playing Field
If the European Commission's grand scheme to create a level pensions playing field across the European Union under its portability of pensions Directive remains stuck in the mud, efforts to achieve the harmonisation of pension tax rules continue unabated.
The proposed pension portability Directive aims to help the growing numbers of EU workers who are switching jobs, and is designed to support the Commission's 'Jobs and Growth' strategy by making it easier for workers to move jobs and countries. The proposals first surfaced back in October 2005 but the proposed legislation has not had an easy ride. A Green Paper was eventually issued in July 2010 which tried to bring together the various strands of the attempt to improve cross-border pensions provision in the EU, and it was expected that a White Paper would be published by the Commission by the end of summer 2011. This has been delayed several times however, and at the time of writing, little further progress has been made.
For the time being, therefore, hopes for a Europe-wide pensions market probably rest with the European Court of Justice (ECJ), which has issued frequent rulings against member states since the European Commission issued a communication seven years ago stating that it would sue member states that did not allow 'reasonable' tax treatment of mobile employees' income. One of the earliest of these rulings was issued in 2007 against Denmark, which was found to be in breach of European law on freedom of movement of workers and capital by not granting tax deductions on contributions to pension contracts with foreign insurers. That same year, the European Commission launched infringement proceedings against nine member states for taxing dividend and interest payments to foreign pension funds (outbound payments) more heavily than dividend and interest payments to domestic pension funds. Member states however have failed to heed the Commission's warnings, and these types of case continue to pile up.
In June 2012, the Commission sent a formal request to the Netherlands to remove restrictions in place on allowances for elderly taxpayers that have re-domiciled to retire in another European Union member state. Under Dutch legislation introduced from June 1, 2011, elderly Dutch taxpayers are only entitled to receive an allowance, known as 'koopkrachttegemoetkoming oudere belastingplichtigen' (purchasing power allowance for elderly taxpayers) if they can demonstrate that at least 90% of their world income is taxable in the Netherlands. This condition means that the allowance is not available to those people living outside of the Netherlands, such as Dutch expatriates. Under European Union (EU) law, entitlement to an old age benefit cannot be conditional on the pensioner living in the member state where he or she claims the benefit. Additionally, EU law on the free movement of persons stipulates that member states should not introduce discriminatory policies regarding where a taxpayer chooses to retire whilst retaining their pension. Under EU law, the Netherlands must pay the allowance of EUR33.65 (USD42) per month to recipients of a pension who have chosen to live in another EU member state, Liechtenstein, Norway, Iceland or Switzerland. The Netherlands was given two months to inform the Commission of measures taken to bring its legislation into line with EU law, or face being hauled before the ECJ.
Earlier in the year the Commission took action against Sweden in a similar situation, noting that the legislation at issue discriminates against non-resident pension funds compared to domestic pension funds when it comes to taxing dividends distributed in Sweden. According to Swedish legislation, non-resident pension funds are subject to domestic withholding tax on dividends. The withholding tax rate amounts to 30%. This may be reduced to 15% as a result of Swedish double tax conventions. Resident pension funds are exempt from the withholding tax on dividends as well as from corporation tax. They are however subject to a 15% tax on their yield. The taxable base for this tax is not based on actual profits but on a notional calculation with the possibility to deduct costs. As a result of this system, the effective tax rate on dividends received by resident pension funds will frequently be lower than the tax rate that is applied to non-resident pension funds. In a second reasoned opinion' sent to the Swedish government in March 2012, the Commission said that it considers this to be discriminatory against non-resident pension funds and to be contrary to European Union (EU) rules on the free movement of capital. In addition, it says that it can deter non-resident pension funds from investing in Sweden.
Good News From Down Under
Even if international pension taxation remains a tangled web of disparate national legislative rules which threatens to ensnare the mobile worker or expat retiree at every turn, some governments at least are trying to do something about it. One of them is New Zealand, which in July 2012 launched a public consultation on proposals designed to offer clarity on tax arrangements for foreign superannuation funds.
The issues paper released by Revenue Minister Peter Dunne contains plans intended to help new immigrants and returning New Zealanders understand more clearly the tax obligations they face on their foreign superannuation entitlements. He said that such workers often do not fully grasp the tax rules that New Zealand applies to the pension schemes they set up in another country. "For the most part, people comply with their tax obligations, but being able to understand those obligations is the critical point. The main objective of the proposals in the issues paper is to simplify the tax treatment of foreign pensions and foreign pension schemes by providing a more uniform treatment than the present, rather complex situation," Dunne stressed.
Three main proposals are made, which would apply retroactively from the 2011/12 tax year. In the first instance, tax would be payable when a person receives a pension or lump sum, or transfers a lump sum to another scheme (rather than on an annual basis). Periodic pensions would continue to be taxed as they currently are. Finally, a portion of any lump sum amount would be taxed. The portion would depend on the length of time between when a person arrived in New Zealand and when they withdraw or transfer their lump sum. Transitional issues are also addressed, Dunne said. Under the new rules, those who withdrew or transferred a lump sum between January 1, 2000 and March 31, 2011 would be able to choose to use a simple "short-cut" option with a low effective tax rate. Those choosing this option will have to disclose their decision to the Inland Revenue Department (IRD) before April 1, 2014.
On the other hand, taxpayers who declared income before March 31, 2012 on their foreign superannuation under the foreign investment fund (FIF) rules for the 2010/11 year would continue to apply the FIF rules and they would not be subject to the proposed new regime. Under the FIF rules, New Zealand taxes offshore investments over NZD50,000 (USD39,000) at a rate of 5% of their market value at the start of the tax year. There will also be no change to the rules arising from the Australia-New Zealand double tax agreement (DTA). In general, the DTA ensures that lump sum transfers from an Australia superannuation scheme are tax-free. "New Zealand is a great country to live, work and eventually retire in. The proposals in this issues paper should make it simpler for people to bring their pension schemes with them from different parts of the world," Dunne said.
In something of an Antipodean trend, in September 2012, the Australian government also launched a consultation designed to simplify pension arrangements for migrant workers, in this case for Australian individuals working in New Zealand and vice versa.
Currently, Australians and New Zealanders working in Australia cannot take their superannuation with them when they permanently leave the country. Under the new regime, individuals will be permitted to transfer their retirement savings between an Australian complying superannuation fund regulated by the Australian Prudential Regulation Authority and a New Zealand KiwiSaver scheme. Participation in the portability scheme will be voluntary for members and for superannuation funds and schemes. The aim is to complete transfers with minimal costs. The savings will generally be subject to the rules in the host country. New Zealand retirement savings transferred to Australia will be treated as non-concessional contributions and will be subject to the Australian non-concessional cap arrangements at the initial point of entry. Approximately 50,000 New Zealanders moved to Australia in the last year, while around 14,000 Australian residents went to New Zealand.
Unveiling the legislation, which is expected to take effect from July 1, 2013, Australia's Minister for Financial Services and Superannuation Bill Shorten said: "The new scheme will help Australians and New Zealanders make the most of their retirement savings, as they will be able to take their retirement savings with them across the Tasman when they move. This will make it easier for people to move freely between the two countries, help consolidate their retirement savings in their country of residence and avoid paying fees and charges on accounts in the two countries. The scheme is intended to enhance labour mobility between Australia and New Zealand. This measure is an important step in our closer economic relations with New Zealand, and supports progress toward the goal of a single economic market, to which the Australian and New Zealand governments are committed.
UK Launches Tax Transparent Fund Vehicles
While the UK made few friends with its sudden and ill-communicated changes to its QROPS rules, affecting many expat pensioners in the process, it is due some praise for the recent introduction of regulations allowing the creation of tax-transparent pooled fund structures.
The UK tax-transparent fund will enable fund managers and institutional investors to pool their assets to achieve cost and administrative efficiencies through withholding tax treaties that exist between countries in which investors are based, and those in which they invest. It is being established to ensure the UK can compete with other leading financial centres, and is aimed at establishing London as the prime location for the management of master feeder funds under the fourth Undertakings for Collective Investment in Transferable Securities (UCITS IV) Directive, which further harmonized the regulatory environment within the European Union. Such vehicles are already used in other territories, such as Ireland, Luxembourg and the Netherlands.
Northern Trust, a leading industry player in the field, was actively involved in pushing through the inception of tax-transparent pooled funds in the United Kingdom, first announced for consultation in the 2010 UK Budget, and the firm indicated earlier in 2012 that it would begin offering these vehicles from late summer, when the regulations became effective. "In order for the master-feeder provisions in UCITS IV to be attractive to investors on a cross-border basis, the master fund needs to be a tax-transparent vehicle," Aaron Overy, of business development, asset pooling and retirement solutions department at Northern Trust, explained: "We believe the introduction of a tax transparent fund in the UK would become the natural choice for asset managers already operating large UK fund ranges as well as support UK pension funds wishing to pool all their assets in the UK, [while] helping life insurance companies mitigate the effects of the Solvency II directive. In addition, we would expect interest from Europe, Asia and US-based asset managers looking to operate a central platform in the UK for their global fund distribution needs."
Cracking The Code In The United States
Unfortunately, simplicity is not a word you would ever associate with the Internal Revenue Code, and the tax situation is especially confusing when it comes to the taxation of foreign pensions. This led to a call by New York State Society of Certified Public Accountants (NYSSCPA) in May 2012 for the Internal Revenue Service (IRS) to provide additional guidance on the taxation of foreign retirement and pension plans due to consumer confusion over the filing procedures required by such programs. In particular, the NYSSCPA wants the IRS to provide a simplified method of electing deferral of US taxation on Canadian pension plans.
As noted in a comment letter sent to the IRS on May 3, the NYSSCPA says that the IRS must consider mechanisms and policies for addressing potential inequities associated with foreign retirement plans, noting that US taxpayers with retirement or pension plans in Canada and other countries are unaware that these plans could be subject to US tax and US tax reporting, despite the fact that many savers cannot yet access these plans. The NYSSCPA is therefore asking the IRS to simplify the election mechanism that saves US taxpayers from current US taxation as the Canadian retirement savings plan derives income. The NYSSCPA also wants the IRS to address how to more equitably treat retirement savings plans from countries that do not have tax treaties similar to the US - Canada agreement.
Currently, those who fail to timely file the election with respect to a Canadian retirement savings plan are either taxed on the retirement plan's income or must apply for a private letter ruling from the IRS to make a late election. But, according to the comment letter, private letter rulings can be prohibitively expensive. In order to address this issue, the NYSSCPA suggests the IRS either treat all relevant taxpayers as having made the election, unless the taxpayer opts out, or create a streamlined process to facilitate late elections rather than requiring a full private letter ruling from the IRS. For those with retirement savings accounts in countries that do not currently have specific tax treaties with the US, the NYSSCPA is asking the IRS to put forth legislation that would provide for the deferral of tax on foreign retirement plans which had compulsory participation required by the foreign country.
"It is not the taxpayers' intent to avoid taxation," said the NYSSCPA International Taxation Committee Chair Melissa Gillespie. "One of the biggest issues we are seeing is a general lack of familiarity with foreign pensions and retirement plans and the related US taxation."
"Many taxpayers and tax-return preparers are unaware of the election mechanism and requirements," said NYSSCPA International Taxation Committee member Ryan Dudley. "To have no practical way to correct this oversight, when the result is accelerated tax on retirement savings, would be unjust."
« Go Back to Features