Misplaced enthusiasm?

  • Author : Paul Garwood
  • Date : February 2011
ABOUT THE AUTHOR: Paul Garwood is Director, pensions and financial planning at Smith & Williamson

T he acronyms QROPS, QOPS, QNUPS and EFRBS have created much interest since their introduction as of 6 April 2006. Many pensions, tax and financial advisors have enthused about them and how they might benefit their clients, but is their optimism justified?

The following explanations of why they were introduced into tax and pensions legislation might help advisors avoid potential pitfalls if they are misused.

Qualifying Recognised Overseas Pension Schemes (QROPS)

QROPS1 were introduced to allow individuals who had either left the UK or are intending leaving to transfer their UK registered pension scheme into an overseas pension scheme without suffering unauthorised payments or scheme sanction charges. However it is also possible for individuals who do not intend leaving the UK to transfer their UK registered pensions to them.

HM Revenue & Customs (HMRC) will only allow administrators of UK registered pension schemes to transfer a member’s funds to an overseas scheme if that scheme has been given QROPS status by HMRC.

While it might be expected that the QROPS would have to be situated in the jurisdiction in which the emigrant was headed for or already resident, they can be established in any EU Member State, Norway, Liechtenstein, Iceland or a country or territory with which the UK has a double taxation agreement with exchange of information and non-discrimination provisions. Membership of the scheme must also be open to persons resident in the country or territory in which it is established.

If it is not so situated, the rules of the scheme at the time of the transfer must not allow benefits relating to the transfer to be paid before the member reaches 55, even if the QROPS became registered when the minimum pension age was 50. They must also provide that at least 70 per cent of the fund will be used to provide the member with an income for life and the scheme must be open to persons resident in the country in which it is established.

Under S169(2) the QROPS must also undertake to comply with HMRC’s prescribed information requirements, which can be found in SI 2006 No. 208 The Pension Schemes (Information Requirements – Qualifying Recognised Overseas Pension Schemes and Corresponding Relief) Regulations 2006.

These require the QROPS to notify HMRC when a member receives or is treated as receiving a payment, including those that are unauthorised.

These reporting requirements do not apply if the member is either resident in the UK when such a payment is made or, if not resident at the time of the payment, they were so resident earlier in the tax year in which it is made or in any of the five tax years immediately preceding that tax year.

Assuming that the overseas scheme qualifies it should notify HMRC using form APSS251. HMRC will send the scheme manager a letter of acceptance if it satisfies the relevant requirements.

It can also decide whether to be included on HMRC’s list of QROPS. If it does not, the transferring UK scheme will have to ask HMRC whether the overseas scheme qualifies, for which it needs the authority of the scheme manager of the QROPS.

Qualifying Overseas Pension Schemes (QOPS)

The QOPS rules were introduced to enable individuals coming to the UK to continue to get relief for pension contributions paid into overseas pension schemes of which they were members before they became resident in the UK.

Individuals coming to work in the UK short-term will qualify for migrant member relief (i.e. tax relief in the UK) on their pension contributions if they pay them into a QOPS as defined by S150(7), S243 and Para 5 Schedule 33 FA 20042.

The rules in SI 206 2008 are relevant to determine which schemes are considered overseas pensions. It should be noted that the territorial scope and type of scheme accepted is wider than under the QROPS rules.

Like QROPS, under Para 5(2) QOPS must undertake to give HMRC information requested in SI 2006 No. 208, but it is not as onerous, although there are no time limits. In broad terms, they need only provide HMRC with pension benefit crystallisation information for relevant migrant members, as defined in Para 4 Schedule 33 FA 2004.

A QOPS cannot receive transfers from UK pension schemes unless it has QROPS status.

Qualifying Non-UK Pension Schemes (QNUPS)

These rules were introduced to correct an anomaly that potentially brought overseas pension schemes into charge to tax under the UK’s discretionary trust rules and also granted relief for the estate on death under s151.

Prior to pensions simplification, which was introduced on 6 April 2006, protection from inheritance tax (IHT) charges applied to both UK approved and unapproved pension schemes as well as certain non-UK pension schemes. However, pensions simplification restricted IHT protection to registered pension schemes and Section 615(3) Income and Corporation Taxes Act 1988 schemes, which were set up in the UK for an individual employed wholly outside of the UK.

Paragraph 18 Schedule 29 FA 2008 inserted S271A Inheritance Tax Act 1984 (IHTA 1984) defining QNUPS to which IHT protection is given under S151(2) IHTA 1984.

QNUPS are defined in SI 2010 No. 51 The Inheritance Tax (Qualifying Non-UK Pension Schemes) Regulations 2010, which are similar to the requirements in Regulation2 of SI No. 208 2006 and specify that they must, in the country in which they are established, satisfy certain regulatory requirements and be tax recognised.

If the country in which the scheme is established has no system of regulation or tax recognition, or if it is a scheme established by an international organisation, then the scheme must provide for 70 per cent of the funds to be paid out as a pension income for life.

Employer Financed Retirement Benefit Schemes (EFRBS)

Such schemes are generally established by employers who want to provide pension benefits to top up those provided by registered pension schemes and have become a popular way of avoiding National Insurance Contributions (NIC) and income and capital gains tax on investment growth. As will be seen later, though, the advantages of such schemes may be short lived, as a result of the proposed draft legislation published on 9 December 2010 (see below for further comments on this aspect).

Contributions paid into such schemes by employers are not deductible for corporation tax until benefits are paid to members of the scheme. There are no restrictions or funding limits and there is no tax on the member until benefits are withdrawn.

Pension planners advocate the inheritance tax advantages of overseas EFRBS (and QROPS), relative to registered pension schemes, under the QNUPS provisions post age 75 and the potential IHT benefits, should the member die before they have received benefits, relative to other forms of trust.

It should also be noted that UK resident members of schemes that are established offshore can benefit from the 10 per cent reduction in the amount of pension that is liable to UK tax, while non-UK residents might escape tax altogether on pension income, although lump sums and soft loans made to non-residents would be caught under S394 Income Tax (Earnings and Pensions) Act 2003.

NIC will be avoided on a cash lump sum benefit if it is, broadly speaking, an amount that could have been paid under a registered scheme provided that no more than 25 per cent of the fund is received and the individual in question has left the relevant employment. This lump sum is nevertheless still liable to income tax unlike an equivalent amount from a registered scheme.

If the EFRBS is UK based, income and capital gains will be taxed as though it were a discretionary trust, while offshore EFRBS are only subject to income tax on their UK source income.

It was announced in the March 2010 Budget that action would be taken to address avoidance using trusts and other vehicles used either to defer or reduce income tax and national insurance, or avoid restrictions on pensions tax relief, and the June Budget confirmed that EFRBS were within its scope.

Draft legislation was issued on 9 December 2010, which will become effective in 2011.

The draft provisions have now been published. They are to be introduced with effect from 6 April 2011 but they will be, broadly, effective for transactions from 9 December 2010. The purpose of the draft legislation is to seek to counteract perceived avoidance concerning what is described as ‘disguised remuneration’. As regards EFRBS, the current proposed effect of the legislation will be to tax as employment income any making available of cash or assets (including most loans) or any allocation, including mere earmarking, for specific employees of funds held in EFRBS.

There are to be certain exceptions to these rules. The exceptions will include tax-advantaged share plans and registered pension schemes. The drafting of the new rules is somewhat ambiguous and it is possible that certain kinds of ‘harmless’ EFRBS benefits, which would be authorised benefits under the registered pension scheme rules, may be excepted. This is by no means clear, however, so the better view must be that in order to be certain of the taxation treatment of any EFRBS arrangement post 9 December 2010 it may be best to await the enactment of the 2011 Finance Act, at which point there should be some certainty on the issue.

Comment

The rules relating to overseas pension schemes in their various guises were introduced mainly as relieving provisions and HMRC has made it clear that it will come down hard on schemes that abuse the rules.

For example, QROPS were initially allowed to be established in any country with which the UK has an appropriate double taxation agreement. However, very shortly after the new rules were introduced, it is understood that Singapore was struck off the list of those countries whose pension schemes were able to apply for recognition for alleged abuse by some of its scheme administrators.

While most QROPS comply with the rules, certain providers will, after the UK reporting window has closed after five years, allow transfers to other offshore pension schemes that allow benefits to be taken outside of the QROPS rules generally in the form of a lump sum.

This might be seen as an abuse of the legislation but Regulation 3(4) No. 206 2006 only requires that benefits should be provided in a particular manner ‘at the time of a transfer of sums or assets’. Whether members of such schemes find that HMRC seek to charge tax under the unauthorised payment rules as well as withdrawing the scheme’s QROPS status post the five-year reporting window is a moot point, assuming they become aware of rule changes to the pension scheme after that time.

Apart from currently providing some IHT benefits, QROPS tend to be an expensive alternative to a UK-registered scheme, which, in many cases, remain the cheapest and most tax-efficient option for UK investors.

EFRBS will be generally less tax efficient where the various limits on pension contributions and lifetime allowances have not been breached. Over these amounts the position is far less clear.

It should also be noted that establishing pension schemes for IHT reasons might be seen as anti-avoidance so it will probably be necessary to ensure that the transfer can be clearly justified for other reasons.

Having said this, some pension jurisdictions have tax-approved schemes that qualify for QROPS status and that offer more generous benefits than UK schemes to its own residents, for example, Australia and New Zealand, so transfers to such schemes might be an option in the right circumstances.

It is also worthy of note that the predecessor to EFRBS, Funded Unapproved Retirement Benefits Schemes (FURBS) continue to benefit from IHT protection provided no further contributions have been paid into them post 5 April 2006.

We recommend that individuals considering using these rules take proper advice and care to understand them and be aware that HMRC will not tolerate any abuse.

These schemes are defined in Sections 150(8) and 169(2) Finance Act 2004. Further guidance, prescribed by HM Revenue & Customs (HMRC) for overseas pension schemes and QROPS specifically, can be found in SI No. 206 2006, The Pension Schemes (Categories of Country and Requirements for Overseas Pension Schemes and Recognised Overseas Pension Schemes) Regulations 2006.
Further information can be obtained from RPSM 13101070 – 13101170.

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