Advisers, however, should not fall into the trap of thinking that all DTAs give a good result, or that a DTA is preferable to having no DTA, for as will be seen below this is simply not the case.
So what should advisers look out for when considering the relevant pensions aspects of a DTA?
- Does the DTA cover the type of scheme from which the pension is being paid (eg occupational or personal, public sector as well as private sector pensions)?
- Who has the primary taxing rights: QROPS country or member’s country of residence?
- Does the DTA revert taxing rights to the QROPS jurisdiction if (as in Hong Kong for example) no tax is applied in the member’s country?
- Could a better tax position be achieved using a QROPS jurisdiction which does not have a DTA?
- How do taxation bands affect the amount of potential tax at retirement?
- Does a nil tax rate band apply?
The way a DTA operates is that taxation is paid in either the country of the QROPS or in the member’s country of residence. By definition taxation is not paid in both countries, but it does have to be paid in one of them. Gross payment from a QROPS that relies on a DTA goes hand in hand with full local taxation for the member in his or her country of residence.
Let’s look at an example to illustrate the point. Malta has a DTA with South Africa, the relevant article of which reads: “Subject to the provisions of paragraph 2 of Article 19, pensions and similar remuneration and annuities arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in the first-mentioned State.”
In this example, with a Malta QROPS, Malta retains the taxing rights on any pensions paid to a resident of South Africa, therefore the member would pay Maltese non-resident tax which, on a £10,000 pa pension, means £2,834 in Malta tax. (Malta tax rates for non-residents are high, typically 30% or 35%).
What if the income was paid from an Isle of Man QROPS? The Isle of Man does not have a DTA with South Africa, and so the IOM QROPS would be taxed at source at 20%, ie. £2,000, a saving of nearly 30%. A similar scenario applies to expatriates living in Hong Kong, in that it will be more tax efficient to domicile the member’s pension scheme in the Isle of Man than in Malta.
So we can see from these two examples that the existence of a DTA does not always give the best result for the client.
Of course DTA pension articles can be drafted in many forms, the most typical of which is for the taxing rights to be provided to the member’s country of residence, as can be seen from the following extract from the IOM’s recent DTA agreed with Singapore:
“Subject to the provisions of paragraph 2 of Article 19, pensions and other similar remuneration paid to a resident of a Contracting Party in consideration of past employment shall be taxable only in that party.”
In this scenario, a pension paid from an IOM QROPS would be paid gross. (The same result is achieved for the same reasons through a Malta QROPS.)
Unilateral Tax Credit Relief (UTCR)
Are DTAs the only method of avoiding double tax? Prior to April 2012 it was a question which didn’t need to be asked, as most QROP business was placed in countries from which pensions could be paid gross. However with HMRC’s revised regulations, this question is now germane.
UTCR is a form of relief given by a member’s home tax authority for income received from foreign sources which has already been subject to tax. The intent of UTCR is to provide double taxation relief in the same way as a DTA would, by recognising the tax already paid.
UTCR is a globally recognised concept, with it being the norm for a country to allow UTCR for tax paid overseas. The effect of this generally puts countries that don’t have lots of DTAs in the same position as those that do.
With most of the world’s countries operating this model, it means that a DTA is of significantly less importance, as UTCR equalises the position regardless of whether a DTA is in operation. In addition, if the DTA is drafted a certain way it can become detrimental, such as the examples shown for South Africa and Hong Kong.
In summary, advisers need to focus in on the client’s likely country of residence in retirement. Advisers should not just look into the relevant DTA, but they also need to look beyond it, as a DTA can result in excessive taxation if the QROPS is based in a country (such as Malta) with high tax rates.
Other considerations
Tax is important, but advisers need to remember that other factors can be even more important. An example is the level of pension drawdown permitted in each QROPS country: is it artificially repressed, as GAD rates are at the present time with gilt yields as low as 2.25%? Or is “actuarial drawdown” permitted, to reflect the expected investment return on a client’s portfolio, enabling the client to realistically draw down the fund in his lifetime? For example, refer to the drawdown rates in the table below:
Drawdown Male 65 IoM 100% GAD 120% GAD
per £100,000 fund 6% growth 2.25% yield 2.25% yield
Gross pension £8,230 £5,500 £6,600
Even anticipating an increase in UK/Malta drawdown to 120% of GAD later in 2013, there is a 25% difference between the gross pension from an IoM scheme and 120% of GAD draw down from a Malta scheme, for example. This has the same effect as a 20% tax differential, which is a very significant handicap, and proof again of the need to look beyond DTAs in isolation.
Mark Kiernan is director of Boal & Co, actuaries & consultants, based on the Isle of Man.
