Astrid Pieron argues that a combination of strong competition and tax and legal discrimination is hampering Belgium as a destination for cross-border pension funds
In line with the single market, European directives now allow cross-border pension funds to be set up within the European Union. Even before these European initiatives, international groups created pension pooling vehicles (PPVs) to manage, in common, the assets of their national pension funds. PPVs aim to achieve financial benefits as well as improved risk management and governance. They should not be assimilated into international or cross-border pension funds which are directly funded by the contributions of the participants (employers and employees) residing in various countries.
On 27 October 2006 Belgium implemented the European Directive 2003/41/EC, dated
3 June 2003, on the activities and supervision of Institutions for Occupational Retirement Provision (IORPs). Belgium stated at the time that its ambition was to become the prime location for pan-European pension funds and has clear arguments to support its aptness for such a role.
An IORP can manage the schemes of companies located in other member states by applying the prudential rules of the member state in which they are located (home country control). An IORP located in Belgium may have cross-border activities and operate several pension plans applicable to employees working in different countries (the host countries). The IORP is solely subject to the Belgian legal and regulatory prudential framework. The framework offers flexibility in the level of funding by sponsoring undertakings. If the employees affiliated to a Belgian IORP are working in countries belonging to the European Economic Area (EEA), the relevant legal provisions of each country's social and labour laws must be respected.
When an international company looks for a suitable environment for its pan-European pension fund, one of the objectives is also to find a location that offers the lowest tax leakage.
Tax leakage has to be evaluated at two levels. The first level is the income tax regime applied to the pension fund in the country of establishment. The second level is the withholding tax cost when the fund invests cross-border, the withholding taxes applied at source on interest and dividends received.
Belgium granted domestic IORPs an innovative tax regime, taking the legal form of an Organisation for Financing of Pensions (OFP).
Before the law of 27 October 2006, Belgian IORPs were only allowed to take the form of a mutual insurance fund or a non-profit association. Those legal forms are not tax neutral, notably with respect to the application of the compensatory tax for inheritance taxes on their assets and the taxation of received interest and dividends.
The OFP has also been granted the favourable tax regime of the well known SICAV (Société d'Investissement à Capital Variable) fund vehicle. As with those latter investment companies, the OFP is subject to the corporate income tax regime but is taxable on a notional tax base. The tax base consists of so-called ‘abnormal and benevolent' benefits received (this mainly covers unusual shifts in income) and disallowed expenses (as specified by the Belgian tax law). Realised and unrealised capital losses on shares are not included in the disallowed expenses.
All the existing Belgian IORPs have to be transformed into OFPs by 1 January 2012.
On 5 January 2010, 245 IORPs were registered with the Belgian competent authority, the CBFA. Of these, 187 have taken the form of an OFP, leaving 58 still needing to convert. The conversion can be decided by a general meeting and does not affect the legal standing of the fund.
According to the list published by the CBFA, just five OFPs carry out cross-border activities and none are involved in true pan-European activities.
Is the lack of enthusiasm for the Belgian regime due to the competition of countries like Luxembourg or Ireland, which have developed a strong know-how in attracting international pension schemes, or to a discriminatory tax and legal environment within European Union?
The truth is likely to be a combination of both. With respect to the discriminatory tax and legal environment, a survey carried out in 2000 showed that most of the EU members were giving tax benefits on employer and employee contributions to local pension funds but not if the contributions were paid into a pension fund located in another (even if EU) country.
In April 2001, the European Commission formally decided that such discrimination was against the fundamental freedoms enshrined in the Treaty of Rome. It decided to closely supervise the required amendments to the various national laws with the help of the European Court of Justice if required. The Commission's efforts have been encouraging member states to progressively remove the tax barriers. Belgium, for example, was allowing tax relief for employer and employee contributions only if paid to a Belgian IORP. This discrimination was removed as of 2007 (at the launch of the new OFP).
The European pension industry has also complained about higher taxation of pension funds when they are investing cross-border. Most EU member states exempt their domestic pension funds from any income tax. In addition, they usually provide for exemption at source or refund of any withholding tax on dividends and interest paid to domestic pension funds. However, foreign pension funds may not qualify for relief at source or the refund procedure.
The Commission has consequently concluded that the higher taxation of foreign pension funds may be a restriction on the free movement of capital as protected by Article 56 EC and article 40 EEA. The Commission decided in May 2007 to send out a first series of requests for information in the form of letters of formal notice to the Czech Republic, Denmark, Spain, Lithuania, The Netherlands, Poland, Portugal, Slovenia and Sweden. Several proceedings were closed in 2008 and 2009 as they had been directed at member states that did go on to change their legislation (such as the Czech Republic and Italy). The Commission also took steps against other countries like Germany (29 October 2009), Poland (14 May 2009), Finland and Denmark (25 June 2009).
Belgian withholding taxes will now be fully refundable to OFPs. Non-Belgian withholding taxes will remain a cost. As OFPs are subject to the corporate income tax regime, they can, in principle, claim the benefit of the tax treaties concluded by Belgium and allowing a reduction (rarely an exemption) of the withholding taxes at source. Some tax treaties are specifically excluding pension funds from their scope and a specific check will be required for each country of investment.
The EU directives applicable to dividends and interest flows will likely not apply, due to the minimum investment levels required (10% for dividends, 25% for interest). Those costs would reduce the attractiveness of the Belgian OFPs.
However, Belgium should not complain, as it does also apply discriminatory withholding taxes towards non-Belgian pension funds. The European Commission announced on 28 January 2010 that it had sent Belgium a reasoned opinion - the second stage of the infringement procedure under article 258 EU - requesting Belgium to amend its provision regarding dividends and interest received by foreign investment funds (including foreign pension funds). If Belgium does not amend its legislation within two months, the matter may be referred to the European Court of Justice.
Despite the foreseen improvement of the tax and legal context, it is premature to conclude on the chances of Belgium becoming the prime location for Pan-European pension funds. At least Belgium has undertaken the steps to stay in the race.
Astrid Pieron is partner at Mayer Brown International LLP in Brussels