It is commonplace for multi-member personal schemes, such as a large proportion of UK based Self Invested Personal Pensions (“SIPP’s”) and Qualifying Recognised Overseas Pension Schemes (“QROPS“) around the world, to use a ‘Master Trust’ and individual Sub-Funds are then created for each individual pension scheme member in order to provide segregation of individual funds.
It is also possible to replicate this arrangement using a contract based scheme, which still allows for a multi-participant personal scheme with the individual Sub-Funds but without using trust legislation. The schemes have been developed in order to ensure that an individual scheme member, (of a trust based personal scheme) and an individual participant, (of a contract based personal scheme) will be entitled to the same lifetime and death benefit options.
In simple terms both types of scheme offer the same benefits. The primary differences arise in the legal structure. These differences are considerations for the principal parties of the trust or contract based schemes and have little, if any, direct effect on the individual scheme member or participant. In most cases a trustee under a trust and authorised custodian under a contract are the same people and have the same responsibilities where a company offers both solutions.
So when might a contract personal retirement benefits scheme be better that a trust personal retirement benefits scheme or vice versa?
The concept of a trust arrangement is not understood and/or not formally recognised in many civil law countries and as such membership of a trust based personal scheme can sometimes result in complex and onerous discussions between an individual scheme member and the relevant tax authority within the civil law country in which the individual scheme member is resident.
Therefore it is possible that for individuals resident in certain civil law jurisdictions, in which the concept of a trust is not necessarily understood or may not be formally recognised in local law, that a contract based personal scheme might be considered as an alternative as this can remove the uncertainty in the relevant jurisdiction and simplify the ongoing affairs and obligations of the individual.
Examples of civil law countries or territories include; Austria, Belgium, Bulgaria, China, Czech Republic, Denmark, France, Germany, Greece, Italy, Latvia, Netherlands, Poland, Portugal, Russia, Spain and Switzerland.
Several jurisdictions are now introducing legislation specifically targeting the use of offshore trust arrangements and are not necessarily differentiating or exempting a personal pension trust. The legislation being introduced often requires detailed and onerous reporting of the interests and assets held within the trust to be declared to the relevant local tax authority in the individual’s country of residence which in turn results in additional charges being levied by the Trustees for the additional time spent and work involved in preparing and submitting the necessary reports. Failure to report and meet the deadlines to report can also often result in punitive charges being due on the member and/or Trustees.
As a contract based personal scheme does not utilise a trust, these legislative amendments and reporting obligations being introduced in certain jurisdictions will not apply to this type of scheme. The majority of QROPS are set up under a trust deed with independent trustees responsible for the implementation of the deed and its accompanying rules, with the member as the beneficiary. This would therefore indicate that such a structure might be treated as a trust in a beneficiary’s tax jurisdiction in the absence of a Double Tax Treaty (DTA) recognising officially the underlying structure as a pension fund. While at first glance this might not seem substantive, it might well become important to the beneficiary who is in receipt of, or entitled to, payments from such a structure.
QROPS in Spain
Certain jurisdictions give preferential tax treatment to income paid from a pension or a pension annuity. In some countries such as Spain, the definition of a pension annuity is somewhat blurred and different local tax inspectors will have a different view.
However, if a Spanish tax resident beneficiary for example, can convince his local tax inspector that income from his QROPS is an annuity, there are substantial savings to be had. If the underlying QROPS contract is viewed just as a trust, without the legal standing granted to it through a bilateral DTA, clients may be taking an unnecessary risk, particularly when a contract based QROPS is available through an EU member state which the Spanish tax authorities are obliged to recognize, such as Malta.
QROPS in France
France interprets temporary annuities as not being subject to tax. Subject to due diligence, a QROPS could be reviewed in a similar manner as to that of Spain, provided the pension is managed by an approved pension plan as, in accordance with European Union Law, it is difficult for the French tax administration to argue with the validity of the pension plan despite it being managed by a trust company. It is important to note that capital lump sums distributed will be considered as taxable revenue. An annuity created in France by way of a transfer could be considered to be a distribution of the original pension plan.
The application of the pension funds should conform with the domestic legislation of the European member state. The non respect of the application of the invested transferred funds in the QROPS could be deemed to be a sham thereby being deemed a taxable distribution.
QROPS is relatively new legislation and to protect a tax payer it is important in France to be protected by EU law. A transfer outside the EU could be considered as income. The QROPS legislation in Malta is an advantage to a French resident as it takes advantage of treaty protection and minimises UK taxes on death. By using a contract based solution it also protects against the potential of being seen as Foreign Trust and taxed accordingly.
QROPS in USA
Qualifying Recognised Overseas Pension Schemes (QROPS) is a legitimate retirement planning tool for the majority of British expatriates. However, care needs to be taken when you are a US resident using a QROPS as there may be significant disadvantages. There is no structure in place to transfer a pension to the United States therefore those with UK based pension are being advised to use QROPS as a solution to their pension planning. There are a range of jurisdictions that provide QROPS and indeed both trust and SICAV contract based structures.
Maltese based pensions are excluded from FATCA reporting within the terms of the intergovernmental agreement between Malta and the USA. The DTA between Malta and the US clearly defines the tax treatment of the benefits from a Maltese pension too. Same protections – more in fact as the treaty with Malta is very specific about the protected capital element of the PCLS – the UK one is not. The US/Malta treaty applies far more widely too rather than just between the US and the UK. There is potential that if you haven’t amassed enough foreign tax credits, that the transfer to the QROPS may be a taxable event.
We are comfortable that a transfer to a QROPS is not taxable as long as at the time the pension holder is resident in the UK or the US. However, the next stage of FACTA is due to be released in 2017 and this could result in a trustee based foreign pension scheme (e.g. QROPS) becoming classed as a foreign pension held in a trust and therefore becoming a foreign grantor trust. That would mean the additional filing of forms 3520 and 3520a. Quite a complicated task and would involve additional costs with filing agents or attorneys. There could also be the potential for trust maintenance tax to be come due and if classed as non-compliant, there is also a 30% withholding tax levied on any internal income received by the pension fund (or the loss of gross roll up). However, to reiterate, Malta pensions (and therefore QROPS) are currently non-reporting under FACTA in its current guise.
One way to avoid this issue in future would be to consider the use of a contract based solution specifically designed for use by US residents, thus avoiding the potential future trustee issue while still retaining the same benefits as a trust based solution. These are also more secure as the funds are fully segregated and would never be held anything other than completely separately unlike in a trust custodian arrangement.