A new UK/US double-taxation treaty came into force on March 31, replacing the previous 1975 treaty. The new treaty is long and complex and space prevents any detailed analysis so I am confining the contents of this article to the possible impact that the treaty might have on pension arrangements.
In the past, one of the great difficulties of dealing with US citizens who are resident in the UK has been that such citizens have been taxed in the US on their worldwide income from whatever source. This has caused problems when dealing with individuals who transfer between the UK and US or vice versa, particularly regarding the provision of retirement and death benefits.
The 1975 treaty sought to avoid double-taxation on the basis of tax credits but the scope of these credits did not extend to pension arrangements, meaning that there could be major tax disadvantages in being a member of a pension scheme in one country while being resident in the other. UK employees on secondment to the US have thus often been removed from UK pension schemes and there has been no incentive for US citizens working in the UK to join a UK pension scheme.
An exempt approved scheme in the UK was not recognised as a tax-qualified scheme in the US and thus all income and gains from the fund were taxable, as was the pension when it finally became payable. Employee contributions were not tax-deductible and any contributions made by a US company to reimburse the UK employer were not tax deductible in the US.
The new treaty came into force in the UK on March 31 and is relevant for 2003/04. In the US, the treaty will take effect from January 1, 2004 – the start of the tax year in the US – but the withholding tax arrangements are already live from May 1.
The general effect of the new arrangements is that if a pension scheme member in one of the contracting states goes to work in the other, the position will be as follows:
Any income and gains in the fund will not be taxed on the member until they are actually paid to the member.
The employer's contributions are not treated as the member's taxable income and will be deductible for corporation tax purposes in the host state.
The member's contributions will be deductible from taxable income provided that the arrangement is accepted as being a generally corresponding scheme. In the UK, that is a scheme approved under chapters I and IV of part XIV of the Taxes Act 1988 (occupational pension schemes and personal pension schemes respectively). The member must have joined the pension scheme of his or her native territory before commencing work in the new or host country.
Any reliefs available must not exceed those that are available to host country residents who are members of schemes set up in those countries.
Thus, a citizen of the US, resident in the UK, employed in the UK, paid by a UK company and taxed in the UK on his earnings, who is a member of a UK approved pension arrangement, is now eligible for tax relief in the US on his contributions to the scheme.
The employer's contributions and any income and gains accrued within the scheme will not be treated as part of the member's taxable income in the US. These reliefs are subject to the maximum amount of relief that would have been available to a US resident contributing to a generally corresponding scheme in the US.
When pension payments become taxable, they are taxable in the country of the member's residence at that time. Any pensions or other distribution of remuneration (say, for example, from a US IRA) that would be exempt in one state will also be exempt in the other state.
As far as lump-sum payments are concerned, it appears that such sums from UK approved pension schemes will not be taxable if the member is a US resident but any lump sum payable to a UK resident from a US scheme will be taxable in the US.
Overall, although the full impact has yet to be determined, the new treaty is to be welcomed greatly and may provide a potential source of new business for those of you who have US citizens working in the UK as clients.