OVERSEAS PENSIONS Offshore solutions
Rhys Thomas, solicitor, looks at the tax breaks available for UK residents from overseas pension arrangements
- tax measures in the UK have raised interest in offshore pension arrangements
- offshore schemes can be a valuable retirement, tax and inheritance planning tool
- however, UK and relevant foreign laws must be carefully analysed and the government is alert to potential avoidance issues.
Members of UK registered pension schemes enjoy tax relief on contributions and tax free investment returns. This has to be weighed against:
- income tax plus the various pension taxes introduced from 6 April 2006 (A Day) – the lifetime allowance charge (LAC) on excess benefits, the annual allowance charge (AAC) on excess contributions/benefit accrual and the unauthorised payment etc charges on benefits taken in “unauthorised” ways and
- the slashing of the annual allowance and other measures recently announced by the Treasury.
These tax hits have raised interest in other, especially offshore, types of pension arrangement potentially available to UK based individuals. In particular:
- employer financed retirement benefit schemes (EFRBSs)
- qualifying recognised overseas pension schemes (QROPSs)
- qualifying non-UK pension schemes (QNUPSs)
- international pension plans (IPPs).
EFRBSs have been heavily used by UK nationals (including those with no intention of leaving the UK). QROPSs, QNUPSs and IPPs are more likely to be of interest to internationally mobile individuals. Let us take a look at each type of scheme.
An EFRBS is funded purely by employer contributions. It can be set up in the UK, but, typically it is set up offshore (eg in Guernsey) and is usually a DC arrangement.
EFRBSs have since A Day been publicised as a great way to obtain some key tax breaks also available under UK registered schemes – no income tax on employer contributions and (where the EFRBS is set up offshore) no tax on most investment gains and avoidance of the various “A Day” pension taxes, such as the LAC.
From the employer’s perspective, the much publicised problem has been the statutory bar on obtaining corporation tax relief until benefits are paid. HM Revenue & Customs’ (HMRC’s) anti-avoidance Spotlight No. 6 (August 2009) stressed its opposition to attempts to obtain immediate corporation tax relief.
However, since A Day there have also been potential dangers for members of EFRBSs, which have largely been glossed over. In particular, there has never been any automatic statutory exemption from the LAC or AAC – nor from income tax on employer contributions. Provisions in the Finance Act 2004 and the Income Tax (Earnings and Pensions) Act 2003 do enable these taxes to be avoided in certain circumstances. Special care is needed where an EFRBS is being marketed on the basis that tax breaks can be obtained both up front and when benefits are taken. There could be historic problems in respect of monies paid into EFRBSs in the past.
In addition, the Treasury announced on 14 October 2010 that new laws would be introduced with the aim of making EFRBSs either “no more attractive” or “less attractive” (there are conflicting references) than other forms of remuneration. This was followed on 9 December 2010 by the issue of draft legislation for consultation which, inter alia, appears to impose an immediate income tax charge on employer contributions to EFRBSs. The legislation is intended to take effect from 6 April 2011 – but with “anti-forestalling” provisions effective as from 9 December 2010. We do not yet know exactly what the new laws will do, nor precisely to what extent they will apply on a retrospective basis.
In any case, there are already anti-avoidance provisions contained in Schedule 35 to the Finance Act 2009, in respect of activities designed to avoid or reduce liability to, inter alia, the AAC. HMRC’s newsletter No. 42 (dated 11 November 2010) states that, in light of the Treasury’s announcement, “HMRC will look more closely at cases, where contributions stop being paid to registered pension schemes and are paid into an EFRBS instead, when considering whether or not anti-avoidance provisions relating to the annual allowance apply.”
A QROPS is an overseas pension scheme funded by the transfer of existing UK pension monies. It must be set up in a jurisdiction which has a suitable pensions and tax regulatory system and also an appropriate double tax treaty (DTT) with the UK, or else satisfy certain other conditions.
A transfer payment can be made to a QROPS from a UK registered scheme on a tax efficient basis (no UK tax unless and to the extent the transfer payment triggers the LAC). A QROPS can be set up in many overseas countries (Guernsey, Ireland and Australia are popular locations). The Isle of Man is also expected to become a popular location following reforms, effective from 22 October 2010, removing withholding tax on benefit payments to non-residents. A QROPS can be set up in the country to which the individual is moving or to a “third country” location.
The key advantage of a QROPS is to avoid the “A Day” taxes that apply to members of UK registered schemes, irrespective of UK residence or domicility. Pre-A Day, retaining money in UK pension schemes was less of an issue, as income tax on benefits taken could often be avoided if UK residency had ceased.
There is no statutory bar on use by permanent UK individuals. However, a QROPS is most tax efficient for persons intending permanently to leave the UK – especially as the taxes on unauthorised payments will apply unless and until the member has ceased to be UK tax “resident” (an increasingly strict test, as shown in the recent Gaines-Cooper case) for five complete tax years (the five year period).
A member can potentially be liable to UK tax even after the five year period has expired – in particular, investment in residential property may trigger a UK tax charge. A QROPS’ bona fides must also be carefully scrutinised – otherwise the original transfer payment could retrospectively be deemed unauthorised and subject to UK tax.
Many commentators have claimed that every QROPS must provide at least 70% of benefits in lump sum form/not pay benefits before age 55. In fact, the UK legislation only imposes these restrictions where alternative criteria are not satisfied. However, “trust busting” concerns should always be taken seriously (as shown by HMRC’s withdrawal of authorisation from Singapore QROPSs in 2008), as the legislation is complex and contains risk areas. Local laws (plus those of the QROPS jurisdiction, if different) must also be considered.
Regulations passed in February 2010 extended the UK inheritance tax (IHT) provisions enjoyed by UK registered schemes to QNUPSs.
A QNUPS must satisfy most of the same conditions as a QROPS. However, there does not need to be a DTT in place with the UK. Also, unlike a QROPS, a QNUPS does not have to be formally authorised by HMRC. As a result, every QROPS will automatically also be a QNUPS. A non-QROPS can, however, be a QNUPS.
QNUPS status will just be the “icing on the cake” for a QROPS. The big attraction of “pure” QNUPSs is that the A Day taxes do not automatically apply, even in the case of current/recent UK residency. A QNUPS can be funded by onward transfer payments from a QROPS or other pension scheme, or by way of regular/one off contributions. However, UK tax relief on contributions will not usually be available.
There is, however, no “blanket” IHT exemption for QNUPSs. A QNUPS funded with the main intention of avoiding IHT is therefore ripe for attack (potential IHT charges could apply, not only on death, but earlier too). There are also other UK taxes (eg income tax) that could potentially apply to payments made out of a QNUPS (both during the member’s lifetime and on death).
IPPs are only likely to be relevant to internationally mobile individuals. This is because strict restrictions on UK tax relief on individual contributions to overseas pension schemes apply. Such tax relief is normally given only where:
- “migrant member relief” is applicable (the individual must, among other things, have been a member of the IPP when he/she came to the UK) or
- a suitable DTT applies.
Arguably, these restrictions breach EU legal requirements as reflected in European Court of Justice judgments like Danner (2002) and Skandia (2003). This is an area to watch.
Using an IPP avoids having pension pots scattered around the world. Also, the IPP may have more flexibility in paying out benefits than is available to UK registered schemes.
But there is a catch! Where UK tax relief is given up front, there’s a UK tax hit later. Basically, the LAC and other A Day taxes will bite in relation to that part of the pension pot referable to UK contributions. This can be the case even after the member has ceased to be UK resident – the LAC can potentially apply indefinitely, other taxes subject to the five year window.
Offshore pension schemes, in the right circumstances, can be a valuable retirement, tax and inheritance planning tool. But UK and relevant foreign laws must be carefully analysed.
Interest in offshore pension schemes is likely to increase following the recent reduction in the annual allowance and other tax measures. The government is, however, alert to potential avoidance issues, as indicated by the warnings on EFRBSs. This is an area to watch closely.
Rhys Thomas is a pensions lawyer; email@example.com
Rhys Thomas is a pensions lawyer