International pension plans involve complex questions of structuring and compliance
International Pension Plans (IPPs) are pension plans sponsored and funded by an employer, for employees assigned to work outside their home country, who are expected to receive IPP benefits while they are resident in their home country, or in another country, including the assignment country.
IPPs are widely used and their use is growing. The Willis Towers Watson International Pension Plan Survey 2016 provided numerous statistics on the product.
There is no uniformity in pension plan legal structure, contribution levels, benefit receipt rules, benefit levels, tax rules, or employment law. So operating a pension plan for employees working outside their home country involves complexity and risks, unless pension plan design and administration are done properly.
Financial security: The wide use of funded IPPs confirmed by the IPP Survey provides financial security, as a separate pool of assets in the IPP fund will pay benefits. An IPP trust should almost always not be exposed to employer credit risk, and will provide maximum financial security.
However, use of a trust increases the likelihood of reporting under the Common Reporting Standards and tax risk – see Reporting and Scrutiny. Using an unfunded employer, IPP structure will involve exposure to employer insolvency, although this may be minimised by using an insurance guarantee, or target date or lifestyle funds.
Reporting and scrutiny: Annual reporting under the Common Reporting Standard (CRS) commenced in September. It will lead to more scrutiny since tax authorities will have data on IPP value and participants, enabling them to raise tax challenges. Before September, tax authorities did not have this data on IPPs. The CRS requires reporting of IPPs by Reporting Financial Institutions, unless the IPP is subject to pensions regulation and qualifies for exclusion as a Broad Participation Retirement Fund (BPRF) or a Narrow Participation Retirement Fund (NPRF).
An IPP is unlikely to be a NPRF, because participants not resident in the IPP country of establishment must not be entitled to more than 20% of IPP assets. The BPRF conditions are complex and include contributions geared to a participant’s earned income not exceeding $50,000 (€42,000) a year, and entitlement to benefits on retirement, death, or disability. IPPs allowing immediate access to benefits will not be BPRFs or NPRFs.
Trust recognition and tax on employer contributions: In many countries, trusts are not recognised as valid legal structures. Where an IPP trust gives vested rights to deferred benefits, or immediate access to benefits, it will likely be regarded as a nominee holding assets for IPP participants. This gives rise to assignment country employee income tax and social security tax liabilities on employer contributions. Where this is the case, employing groups should be making appropriate tax filings and tax payments in the assignment country.
Out of 196 countries in the world, 12 (or about 6%) have ratified the Hague Convention on the Recognition of Trusts, which confirms the scope of the trust recognition problem. Even where trusts are recognised as legally effective structures, tax difficulties can arise. Suppose an employer pays contributions to an IPP trust for the benefit of employees in Hong Kong and the IPP is not registered under the Hong Kong Occupational Retirement Schemes Ordinance. The IPP allows immediate access to benefits. Hong Kong Salaries Tax applies to benefits in cash or convertible into cash, so IPP contributions are liable to salaries tax. Employing groups may have to incur additional tax protection or tax equalisation costs on employer contributions, and gross up those costs.
IPP investment income and capital gains tax: Plan investment income and capital gains may be taxable to IPP participants, especially where they have vested rights to benefits, and immediate or deferred access to benefits. Where a trust vehicle is used and a trust is not a recognised structure in the assignment country, this risk is increased.
“The ideal structure is one central IPP covering personnel in multiple countries, sponsored by a group company. This minimises costs and administration, but increases complexity”
Tax deduction for IPP funding: In most countries, tax deductions are not allowed for contributions to foreign pension plans. Generally, if a tax deduction for direct contributions from the assignment country to a non-assignment country IPP is claimed, it will not be tax-deductible, which increases employing group tax costs.
Benefit taxation: While the IPP can be subject to zero tax, IPP benefits will not be covered by home country tax reliefs for qualifying pension plans. Most countries do not allow favourable tax treatment for benefits from overseas pension plans. Distribution of benefits while the plan member is personally resident in a low or zero personal tax area can protect against benefit taxation, but this will not be feasible in all cases.
Despite this, if pension plan members plan their personal tax residence properly, there are a range of countries in which reduced or zero tax is payable on benefits from foreign pension plans, or on or after employment termination/retirement.
Central IPP: The ideal structure is one central IPP covering personnel in multiple countries, sponsored by a group company. This minimises costs and administration, but increases complexity, because of inter-company dealings. Principal IPP issues are:
• The IPP sponsor company in country A must recharge IPP funding costs to the operating entity in assignment country B, in accordance with country A transfer pricing rules, or have additional revenue equal to the arm’s-length price for personnel assignment (including IPP costs) attributed to the IPP sponsor company.
• Are inter-company charges from the IPP sponsor company to the assignment country for the cost of IPP funding subject to value added tax or goods and services tax?
• Are inter-company charges for IPP funding tax-deductible, or subject to withholding taxes, in the assignment country?
• Do inter-company charges for IPP funding for identified personnel give rise to employment income tax/benefit in kind tax liabilities, social security taxes, or payroll tax liabilities, in the assignment country?
• Are assignment country IPP tax liabilities covered by employer provided tax protection or tax equalisation, so that there are additional employing group costs which are reportable and taxable as benefits in kind in the assignment country?
• Are IPP investment income and capital gains taxable in the assignment country, and do these create employing group tax protection or tax equalisation costs?
The factors referred to in this article can leave employing groups in the position of failing to comply with assignment country corporate tax, employee tax and social security tax rules, and with additional and unexpected tax protection or tax equalisation costs.
Despite these potential adverse impacts of operating IPPs, with the right structure an IPP can achieve tax-deductible employer funding, no taxes on employer funding, tax-free investment income and capital gains and minimum tax on benefits. But there is no substitute for a proper review, taking account of home and assignment country rules.
The need for a tax-effective structure and tax compliance is greatly increased by the reporting that commenced in September under the Common Reporting Standards. Tax authorities are expected to review and challenge IPPs that are not tax-effective and tax-compliant.
Alastair Wilson and Menna Bowen are tax partners at the law firm Gunnercooke