UK pension transfers and double tax agreements: opportunity, or false promise?
Ever since March 8, when UK chancellor Philip Hammond announced a new 25% tax on most pension transfers out of the UK, social media venues like LinkedIn and the financial advisory blogosphere have been full of comment about the possibility that British “expats” resident in the United Arab Emirates could, after transferring their pensions there, be able to take them there “tax free”.
According to this theory, this would be possible as a result of a double taxation convention (treaty) between the UK and the United Arab Emirates which was signed on 12 April 2016, and came into force a little more than eight months later, on Christmas Day.
As written, it covers:
a) taxes withheld at source, in respect of amounts paid or credited on or after 1 January 2017; and
b) other taxes, in respect of taxable years (and in the case of United Kingdom corporation tax, financial years) beginning on or after 1 January 2017.
Before we consider the matter of the UAE double taxation agreement (DTA) with the UK in detail, it’s useful to review the reasons, such treaties exist in the first place.
Why DTAs exist
The simple answer is to prevent income and gains being taxed twice; firstly in the country in which the income arises, and secondly, in the country in which the recipient of the income is resident.
Essentially, double taxation treaties provide a “tie breaker” whenever two states are in a position to claim taxing rights over a single financial amount – such as an individual’s pension pot.
Most, but by no means all, treaties follow a template suggested by the Organisation for Economic Co-operation and Development (OECD).
As far as treaties involving the UK are concerned, the HMRC Double Taxation Manual sets out the general principles to be applied in respect of pension income. It states:
“Pensions, other than Government pensions, paid in consideration of past employment to a resident of a country with which the United Kingdom has a double taxation agreement, are normally taxable only in the country of which the pensioner is a resident, but there are exceptions to this.
“For example, the agreement with Sweden gives limited taxing rights to the source country; the agreement with Zimbabwe gives sole taxing rights to the source country if the employment in respect of which the pension is paid was exercised in the source country; and some other agreements enable both countries to tax such pensions, or only give exemption in the source country if the pension is subject to tax in the country of which the recipient is a resident.
“Claims by residents of agreement countries to exemption from United Kingdom tax on such pensions are made to HMRC. The relevant office will authorise non-deduction of United Kingdom tax if a claim is accepted.”
The UK – UAE treaty contains the following provision:
1. Subject to the provisions of paragraph 2 of Article 18, pensions and other similar remuneration paid to a resident of a Contracting State shall be taxable only in that State.
[Article 18 refers to government pensions, which are often treated differently from occupational pensions.]
So, if the pensioner is resident in UAE, the pension is taxable there, rather than in the UK. The fact that the UAE charges little or no tax on income is irrelevant. This is not “tax avoidance”. Think of the flip side. A UAE citizen resident in the UK would pay tax on a UAE source pension, even though it would not suffer tax if that citizen was resident in the UAE.
There is nothing particularly special about the UAE. The UK has more than 130 tax treaties, and many contain similar provisions. For example:
The UK – Turkmenistan treaty, for example, provides:
1. Subject to the provisions of paragraph 2 of Article 18, pensions and other similar remuneration paid to a resident of a Contracting State, shall be taxable only in that State.
2. Notwithstanding the provisions of paragraph 1, a lump sum payment derived from a pension scheme established in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in the first-mentioned State.
Again, “Article 18” here deals with government service.
As for the case of a European “neighbour”, the UK – Spain treaty provides:
Subject to the provisions of paragraph 2 of Article 18, pensions and other similar remuneration paid to an individual who is a resident of a Contracting State, shall be taxable only in that State.
Article 18 deals with government service.
The UK – Israel treaty has a slightly more complex structure.
(1) Any pension (other than a pension of the kind referred to in paragraphs (1) or (3) of Article X) and any annuity, derived from sources within Israel by an individual who is a resident of the United Kingdom and subject to United Kingdom tax in respect thereof, shall be exempt from Israel tax.
(2) Any pension (other than a pension of the kind referred to in paragraph (1) of Article X) and any annuity, derived from sources within the United Kingdom by an individual who is a resident of Israel and subject to Israel tax in respect thereof, shall be exempt from United Kingdom tax.
(3) The term “annuity” means a stated sum payable periodically at stated times, during life or during a specified or ascertainable period of time, under an obligation to make the payments in return for adequate and full consideration in money or money’s worth.
Article X refers to pensions in respect of government service.
US residents with ‘foreign source’ pensions
Double tax treaties also deal with the position of UK residents with a “foreign source” pension. In general, the UK’s treaties provide that these pensions are taxed in the UK rather than in the countries from which they are paid. (There will often be special rules for government pensions.)
Two examples of this treatment are:
“Pensions (including government service pensions), in consideration of past employment, and annuities that are paid to a United Kingdom resident individual are exempt from tax in Argentina (Article 18).”
“(1) Any pension (other than a pension referred to in paragraph (1) of Article 8) and any life annuity, derived from sources within Burma by an individual who is a resident of the United Kingdom and subject to United Kingdom tax in respect thereof, shall be exempt from Burma tax.”
So what should advisers do?
The first thing, if double tax agreements aren’t one’s specialist subject, is to take specialist advice, or else refer one’s client to specialist tax advisers.
In general terms, though, the tax treaty between the two countries concerned needs to be reviewed. Because what the current practice is, with respect to each jurisdiction, varies, as we saw above.
There is also still a need to analyse the relevant legislation applying in the country with “taxing rights”. In other words, where the client is resident in country X, the adviser needs to know the tax rules applying in country X.
For example, in some countries, such as France, all payments from a pension scheme, including lump sums, are taxed as income.
This research needs to be conducted before any actions are taken.
Finally, although the principles are clear, UK pension providers as a general rule seem to adopt a “deduct tax first; ask questions later” approach. This may be because the pension provider needs to have an instruction from HMRC to pay pensions without the deduction of tax, and it can take time to get all the ducks in a row.
There might therefore be a need to suffer a tax deduction in some cases, and make a subsequent reclaim. Such an eventual outcome is likely to be pleasing to the client.
In the meantime, it is worth noting that when it comes to the use of double tax agreements to consider the tax implications of transferring UK pensions, the UAE is not, contrary to what many have been saying, unique.
Thus it would seem that advisers should be encouraged to help their clients decide on their ultimate retirement locations on the basis of a number of factors, one of which would be the rate at which their pensions would be taxed.
Other considerations, such as the cost of living in the jurisdiction, healthcare costs, and quality of life issues, might also be taken into account.
Gerry Brown is an Edinburgh-based chartered accountant and tax commentator who began his professional career as an Inland Revenue inspector of taxes.