FATCA and foreign retirement plans: two case studies.

Author:Majure, Kimberly Tan
Position:Foreign Account Tax Compliance Act

It seems inexorable: Every time you turn around, you find something else to add to your FATCA workplan. As a non-financial company, it may have been a surprise to find that, in fact, you are within the scope of the Foreign Account Tax Compliance Act ("FATCA"). Then, not only have you wrestled with your withholding and reporting processes, you have had to comb through your global group looking for "foreign financial institutions" ("FFIs"). Not a problem--unless, like a lot of other "non-financial" companies, you have foreign cash pooling, hedging, intercompany financing, or other group financial activities that could trigger FFI status. In that case, you may have needed to work your way through the various exceptions to resolve your entities' classifications. (1) You can finally see the light at the end of the tunnel. Except ...

What about your foreign pension funds?

Surprised? You aren't alone. But at the highest level, foreign pension funds are collective investment vehicles formed for the purpose of investing, reinvesting or trading in financial assets (e.g., securities). An employer sponsors a pension or retirement plan and the employer and/or employee participants contribute funds into the plan--often to a complex trust formed for the purpose of providing pension, retirement, and/or death benefits. The entity invests these funds in securities and other financial assets for the ultimate benefit of the participants. Investment returns are used to fund future distributions to plan participants. These foreign pension funds sit squarely within the definition of "investment entity" for FATCA purposes. Unless an exemption applies, a foreign pension fund will need to register as a participating FFI and satisfy due diligence and annual reporting requirements in order to avoid the 30 percent penalty on its U.S. investment returns. (2) And, unless there are local law restrictions on offshore investments, it is hard to find a retirement plan that does not make, or contemplate making, investments in U.S. assets.

How Do the FATCA Rules Apply to Foreign Pensions?

Let's face it: A foreign pension scheme is not likely to be at the top of anyone's list as a tax evasion mechanism. Still, it is conceivable that, if a U.S. person participated in a foreign pension plan and received distributions, there could be a temptation not to report pension distributions--particularly if the foreign pension plan was under no obligation to report the distributions to any tax authority. This temptation may be exacerbated if participants can contribute non-wage related funds (e.g., gifts) to, or freely take distributions from, the pension plan.

Nonetheless, foreign pension plans are mostly outside the eye of the FATCA storm. The FATCA rules contain several provisions designed to exempt certain retirement funds from FFI status. Foreign funds may qualify for "exempt beneficial owner" ("EBO") status if they fit into any one of six categories of qualifying funds. At a high level, the fund must satisfy several requirements focused either on its legal status or on other "legitimizing" features. (3) Here are some highlights regarding each of the exemptions:

Treaty-qualified fund. This is a fund established in one of the United States' tax treaty partners, and qualified to receive tax treaty benefits (including under the limitation on benefits provisions of the treaty). This fund must be operated principally to administer or provide pension or retirement benefits. (4)

401(a)-equivalent fund. This is a fund formed pursuant to a pension plan that, if the fund were created or organized in the United States, would qualify as a section 401(a)-qualified retirement plan. (5)

Broad participation fund. As an initial issue, the broad participation fund exemption applies to a fund established to provide retirement, disability and/or death benefits to current or former employees (or their designees) in consideration for services rendered. The fund must be subject to government regulation and must provide annual information reporting about its beneficiaries to the tax authorities in its country. In addition, the fund must satisfy one of the following requirements:

(i) The fund's country (where it was established or operates) has granted a tax exemption with respect to the fund's investment income, based on its status as a retirement or pension plan;

(ii) The fund receives at least 50 percent of its total contributions from the sponsoring employer(s);

(iii) Participants may receive distributions or make withdrawals only upon specified events related to retirement, disability or death, or must be subject to penalties for early withdrawals; or

(iv) Employee contributions must be limited either by reference to the employee's earned income or subject to a $50,000 annual cap. (6)

Narrow participation fund. A narrow participation fund must have fewer than 50 participants. Like a broad participation fund, a narrow participation fund must be established to provide retirement, disability and/or death benefits to current or former employees (or their designees) in consideration for services rendered. It must also be subject to government regulation and must provide annual information reporting about its beneficiaries to the tax authorities in its country. Moreover, the fund must meet all of the following requirements, which are somewhat different from those applicable to broad participation funds:

(i) The fund must be sponsored by at least one employer that is not an investment entity (7) or a passive non-financial foreign entity ("NFFE"); (8)

(ii) Contributions (employer and employee) must be limited by reference to the employee's earned income; and

(iii) No non-resident participant can be entitled to receive more than 20 percent of the fund's assets. (9)

Retirement fund investment vehicle. Entities established to earn income for the benefit of one or more qualifying retirement funds described above, for qualifying retirement or pension accounts, or for funds otherwise described in an applicable intergovernmental agreement ("IGA") (discussed below) may themselves qualify for exemption. (10)

EBO-owned fund. This is a fund established or sponsored by an EBO other than a qualifying retirement fund (all as defined in the FATCA regulations). This would include a retirement fund of a foreign government or U.S. territory, international organization, or a foreign central bank. (11)

In addition, foreign pension funds resident in a country that has entered an IGA with the United States may have the benefit of additional, IGA-based, exemptions. Annex II of each IGA provides a list of local foreign entities that are to be treated as "non-reporting financial institutions" in a particular country, or considered EBOs for purposes of the FATCA regulations. The Annex II language differs from IGA to IGA, sometimes dramatically. In some countries, Annex II merely cross-references the pension provisions in an existing tax treaty between the relevant country and the United States. (12) In other instances, Annex II references specific types of local plans that qualify for EBO status. Annex II of the Bermuda IGA, for example, specifically describes as exempt "[a]ny pension fund established in Bermuda under the National Pension Scheme Act of 1998." (13) Note, however, that IGA analysis is not always easier than analysis under the FATCA regulations. Often an Annex II will replicate or refer to exemptions contained in the FATCA regulations, particularly the broad and narrow participation fund rules. (14)

Getting Started

The analysis necessary to confirm a pension plan's FATCA status can be difficult, in part because responsibility for a company's global plans may fall outside the bailiwick of the U.S. tax or perhaps even U.S. benefits departments. (15) Furthermore, day-to-day management of the foreign pension plans is often outsourced to third-party trustees and administrators, and in-house personnel may only have a passing familiarity with foreign plans' features and regulatory obligations.

The first thing you will want to accomplish is a detailed inventory of your global pension plans. Create a spreadsheet that will note several key pieces of information for each plan:

What You Need...

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