QROPS (Qualifying Recognised Overseas Pension Scheme) & US Tax

QROPS (Qualifying Recognised Overseas Pension Scheme) & US Tax

Recently, the Internal Revenue Service and the tax authority in Malta issued a CAA Competent Authority Arrangement involving the taxation of certain personal pension schemes. When it comes to Malta, one of the most common tax issues involves Non-US Persons who exchange their pension plan (such as a UK pension) for a QROPS (Qualifying Recognised Overseas Pension Scheme). The idea behind the transition is that some countries — such as the United Kingdom — recognize approved QROPS for UK tax purposes. Unfortunately, the United States does not have the same tax arrangement with Malta –– and while there is a US/Malta tax treaty in place, some US Taxpayers were being misled into taking advantage of certain components of the treaty and treating Malta personal pension schemes as it if they were the same as Roth IRAs — but with no contribution limitation — noting, that in the United States the maximum contribution for the Roth IRA is around $6,000/$7,000 per year in accordance with wages/earnings — and it only accepts cash contributions. Thus, some US Taxpayers contributed millions of dollars into a Malta (non-employment-based) retirement plan — and then sought to avoid any tax (or minimal tax) on the distributions.  Let’s take a look through what happened with Martha and what the situation is involving certain personal pension schemes.

Saving Clause & Exceptions

• • • 4. Except to the extent provided in paragraph 5, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens. Notwithstanding the other provisions of this Convention, a former citizen or former long-term resident of a Contracting State may, for the period of ten years following the loss of such status, be taxed in accordance with the laws of that Contracting State.

    • 5. The provisions of paragraph 4 shall not affect: 

      • a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), paragraphs 1 b), 2, and 5 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support), and Articles 18 (Pension Funds), 23 (Relief from Double Taxation), 24 (Non-Discrimination), and 25 (Mutual Agreement Procedure); and

      • b) the benefits conferred by a Contracting State under Articles 19 (Government Service), 20 (Students and Trainees), and 27 (Members of Diplomatic Missions and Consular Posts), upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State

Article 17 Pension

• • • 1 (a) Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State.

    • Notwithstanding subparagraph a), the amount of any such pension or remuneration arising in a Contracting State that, when received, would be exempt from taxation in that State if the beneficial owner were a resident thereof shall be exempt from taxation in the Contracting State of which the beneficial owner is a resident.

Article 18 Pension Funds 

• • • Where an individual who is a resident of one of the States is a member or beneficiary of, or participant in, a pension fund that is a resident of the other State, income earned by the pension fund may be taxed as income of that individual only when, and, subject to the provisions of paragraph 1 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support), to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund in that other State).

Article 17 Pension (Technical Explanation)

• • • Subparagraph (b) contains an exception to the State of residence’s right to tax pensions and other similar remuneration under subparagraph (a).

    • Under subparagraph (b), the State of residence must exempt from tax any amount of such pensions or other similar remuneration that would be exempt from tax in the Contracting State in which the pension fund is established if the recipient were a resident of that State.

    • Thus, for example, a distribution from a U.S. “Roth IRA” to a resident of Malta would be exempt from tax in Malta to the same extent the distribution would be exempt from tax in the United States if it were distributed to a U.S. resident.

    • The same is true with respect to distributions from a traditional IRA to the extent that the distribution represents a return of non-deductible contributions.

    • Similarly, if the distribution were not subject to tax when it was “rolled over” into another U.S. IRA (but not, for example, to a pension fund in the other Contracting State), then the distribution would be exempt from tax in Malta.

IRS Summary of CAA for Personal Retirement Schemes

• • • The CAA confirms the U.S. and Malta competent authorities’ understanding that (except in the case of a qualified rollover from a pension fund in the same country) a fund, scheme or arrangement is not operated principally to provide pension or retirement benefits if it allows participants to contribute property other than cash, or does not limit contributions by reference to income earned from employment and self-employment activities.

    • Because Maltese personal retirement schemes contain these features, they are not properly treated as a pension fund for Treaty purposes and distributions from these schemes are not pensions or other similar remuneration.

    • Accordingly, U.S. citizens and residents may not claim benefits under paragraph 1(b) of Article 17 and Article 18 of the Treaty with respect to the type of fund, scheme or arrangement described in the paragraph immediately above, including a personal retirement scheme established in Malta under the Retirement Pensions Act of 2011. Additionally, these funds, schemes or arrangements may not apply paragraph 2(e) of Article 22 of the Treaty to be treated as a qualified resident and may not claim the benefits of paragraph 3 of Article 10 of the Treaty.

Summary Explanation of Personal Retirement Schemes in Malta & US Persons

The idea behind the recent CAA agreement between the United States and Malta on the issue of personal pension retirement involves a misconstrued section of the tax treaty. Article 17 of the tax treaty was designed with the concept that when a person receives certain pension distributions, there would be limitations on the tax of the pension — if it was tax-exempt in the other country — such as a Roth IRA. Noting, contributions into a Roth IRA derive from income generated from wages/earnings). Since the Treaty provision was overly broad as written, it led some Tax Attorneys and Promoters to float the strategy that anyone could simply create and contribute to a non-employment based personal retirement scheme in Malta, and then take the money out tax-free —including contributing assets instead of money and assets that have unrealized capital gains which could then be avoided at distributions through the Malta pension. Clearly, this was not the idea behind the tax treaty language (e.g., to authorize contributions of cash and assets into foreign non-employment personal pension funds and provide unlimited tax benefits when the comparable Roth IRA in the United States has an annual contribution limitation of $6,000/$7,000 — depending on the age of the contributor).

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