Where UK tax is taking the lead
From 6 April 2006, the current UK pensions tax regime will be replaced by a new ‘simplified’ system. The changes will be sweeping and will mainly affect UK employees and UK pension schemes. However, there will also be significant implications for pension planning for expatriate and mobile employees.
Pensions simplification was given the go ahead in the March 2004 Budget. The Finance Bill was published in April and its regulations appeared in June. In July, amendments to the Bill, including provisions on ‘migrant member relief’, were passed.
It is expected that the legislation will be in place by the end of this year, and that the new regime will take effect, as planned, from 6 April 2006 (‘A Day’). Although detail is pending, we are starting to see how the changes will affect expatriate pension planning.
Under current UK tax rules, expatriates who work in the UK but remain in their home country plan may well encounter UK tax problems. They will not be eligible for a tax deduction on their personal contributions and will be liable to pay tax on the employer contribution as a benefit in kind. The exceptions to this rule are if an individual can claim UK tax relief under a double taxation agreement (DTA), such as in Denmark, France, Ireland and the US, or if the UK Inland Revenue grants ‘corresponding approval’. The latter only applies to non UK-domiciled employee under contract with an overseas employer.
Under the new system, the DTA concessions will be limited to the new lifetime and annual allowances, and ‘migrant member relief’ will replace corresponding relief. Migrant member relief will offer tax relief up to the UK limits for individuals who come to the UK as a member of an overseas plan and who were eligible for tax relief on contributions to the overseas plan in their country of residence immediately before coming to the UK. This is good news for inter-country transfers where the new criteria will be satisfied, for example, from the Netherlands to the UK. It is less positive, however, for future international/offshore plan members who will not satisfy the new requirements.
Hardest hit are high earning members of international/offshore plans who may have been using bonus waiver facilities to take maximum advantage of the higher Inland Revenue funding limits in these types of plans. With the new post A Day limits in place, scope for bonus waiver may be restricted.
The results of a 2004 Mercer survey showed that 59% of companies with correspondingly approved plans are likely to seek alternative ways to compensate high earners for the ‘loss’ of tax relief post simplification. The majority are likely to compensate through extra salary or consider flexible benefit options and unfunded arrangements as alternatives in the future. However, many feel that other tax avoidance schemes are unlikely to be ‘quick fixes.’
The survey also found that almost 90% of employers with correspondingly approved plans are investigating how to maximise funding prior to A Day, as there will be no lifetime allowance charge in respect of contributions made pre April 2006.
There will be new, and more relaxed, rules regarding UK plan membership post A Day. Almost anyone will be able to join a UK plan without a time limit, although the benefits of joining depend on the tax situation where they are resident and working. However, almost two-thirds of the Mercer survey sample are more likely to keep UK expatriates in the UK plan, and one in three would consider using the UK plan for pension provision for non-UK nationals.
Broader strategy issues - what might this mean for international pensions?
A lot of activity is anticipated in the expatriate pensions area, particularly for those hardest hit such as high earners in correspondingly approved plans. The improved flexibility and wider eligibility conditions for UK plan membership will also mean that the UK can be used as a solid base from which to provide tax effective pension provision for an increasingly international population.
It is also expected that many expatriates who come to the UK and remain in overseas plans will apply for migrant member relief, making the UK a leading light in respect of tax effectiveness for cross-border plan membership. Again, this option will make pension planning for expatriates - which traditionally presents enormous challenges - simpler and more equitable.
Expatriate pension strategy has always been complex, with as many potential one-off solutions as there are individual problems. The improved flexibility granted by pensions simplification gives a new set of tools with which to establish a stable, secure pension strategy - for UK multinationals in particular. This, when coupled with additional EU regulations requiring member states to afford the same tax concessions to both local and other EU country pension plans, will make the UK a leader in this field.
Yvonne Sonsino is a European partner with Mercer in London