U.S. Tax Treatment of Hong Kongese Provident Funds

Executive Summary

Income and gains within a Hong Kongese Provident Fund in Hong Kong are exempt from U.S. tax during the growth phase prior to retirement pursuant to domestic U.S. tax law that views it as foreign social security, which is taxed in the same manner as a tax-deferred annuity if and only if there is adequate disclosure on your U.S. federal income tax return. In other words, there is no tax until the Hong Kongese Provident Fund annuitizes at retirement and begins paying benefits. In other words, there is no tax during the pre-retirement accumulation growth phase.

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The Social Security System in Hong Kong

The U.S. Social Security Administration’s 2010 publication titled “Social Security Programs Throughout the World” analyzes Hong Kong’s overall comprehensive social security system. The first of laws implementing social security in Hong Kong were enacted in 1971.

Hong Kong’s current social security system is based on the Public Assistance Scheme of 1971, Universal Old-Age and Disability Allowance of 1973, Universal Higher-Rate Disability Allowance of 1988, Comprehensive Social Security Assistance, Social Security Allowance of 1993, and Mandatory Provident Fund Schemes Ordinance of 1995. These laws are all similar to compulsory contributions under the U.S. Federal Insurance Contributions Act.^{^[1]} The three programs are the Universal system, the Provident Funds, and Social Assistance program. The Universal system covers all residents of Hong Kong. The Provident Funds cover employees under contract for at least 60 days (shorter periods for employees in the catering and construction industries) and most categories of self-employed persons. Self-employed hawkers; household workers; persons covered by statutory pension plans or provident funds, including civil servants and teachers are excluded. Members of occupational retirement plans who are granted exemption certificates and foreign workers in Hong Kong (China) for less than 13 months or covered by another country's retirement system are also excluded. The Social Assistance program covers all Hongkongers.

Hong Kongese Provident Funds can most aptly be characterized as state-managed occupational pension scheme with the primary purpose of providing for income at retirement, and it is specifically recognized as social security by the U.S. Social Security Administration.^{^[2]} Moreover, a state-mandated “occupational pension scheme” fits the precise definition of social security according to the OECD.^{^[3]} Furthermore, the International Social Security Association, of which Hong Kong and the United States are members, also recognizes Hong Kongese Provident Funds as forming part of Hong Kong’s overall comprehensive social security system.^{^[4]}

Therefore, based on the foregoing substantial and compelling authorities, it is indisputable that Hong Kongese Provident Funds are social security accounts forming a part of Hong Kong’s overall comprehensive social security system.

International Treaty Law and Social Security

According to the Organization for Economic Cooperation and Development (“OECD”), the term “social security” generally “refers to a system of mandatory protection that a State puts in place in order to provide its population with… retirement benefits.”[5] The OECD commentary broadly interprets “payments under a social security system” to include payments under a “worker’s compensation fund,” which is not considered “social security” in the United States, which is proof that the United States’ definition of “social security” is not the controlling factor.

If both the U.S. and another country are members of the OECD, U.S. courts will generally defer to OECD commentary to determine the prevailing international interpretation of terms, which is published every few years.^{^[6]} The United States joined the OECD in 1961 while Hong Kong never joined. Therefore, although U.S. courts are not legally bound to defer to the OECD with regard to the definition of social security, the OECD interpretation will weigh heavily of a U.S. federal court’s legal analysis since it promotes international consistency.

Therefore, the OECD takes a very broad and inclusive approach as to what constitutes “social security” under international treaty law, which a U.S. federal court should defer to.

U.S.Tax Treatment of Social Security Payments

Under domestic U.S. tax law, with regard to informational reporting requirements for contributions to a nonqualified deferred compensation plan, Congress specifically exempted contributions to a foreign social security account.[7] This clearly evidences Congressional intent to disregard contributions to foreign social security for U.S. informational reporting purposes on IRS Form 3520 and 3520-A.[8] Moreover, the IRS has specifically stated that, under domestic U.S. tax law, “foreign social security benefits… are taxable as annuities.”[9] Gains within annuities are tax-deferred until the contract annuitizes and payments begin or when the owner cashes out the annuity and takes a lump sum.[10]

Although some practitioners have asserted that Hong Kongese Provident Funds are reportable as foreign grantor trusts on IRS Forms 3520 and 3520-A, doing so would subject the gains within the fund to immediate U.S. taxation, which is contrary to IRS guidance.^{^[11]}

Conclusion

During the pre-retirement growth phase, income and gains within a Hong Kongese Provident Fund in Hong Kong are exempt from U.S. tax pursuant to domestic U.S. tax law that views it as foreign social security, which is taxed in the same manner as a tax-deferred annuity if and only if there is adequate disclosure on your U.S. federal income tax return. In other words, there is no tax until the Hong Kongese Provident Fund annuitizes at retirement and begins paying benefits.

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Bluebook Citation: U.S. Tax Treatment of Hong Kongese Provident Funds, Castro Int’l Tax Blog (Dec. 8, 2019) url.

[1] See IRC §§ 3101, 3111.

[2] See Social Programs Throughout the World, U.S. Social Security Administration’s Office of Retirement and Disability Policy; also see Individual Accounts in Other Countries, U.S. Social Security Administration’s Office of Policy, http://www.ssa.gov/policy/docs/ssb/v66n1/v66n1p31.html (Sep. 1, 2015).

[3] See 2014 OECD Commentary, Art. 18, ¶ 10.

[4] See Social Security Country Profiles, International Social Security Association, https://www.issa.int/countrydetails?countryId=HK&regionId=ASI.

[5] See 2014 OECD Commentary, Art. 18, ¶ 28.

[6] See Podd v. C.I.R., 76 T.C.M. 906 (1998) (citing U.S. v. A.L. Burbank & Co., 525 F.2d 9, 15 (2d Cir. 1975); North W. Life Assurance Co. of Canada v. C.I.R., 107 T.C. 363 (1996); Taisei Fire & Marine Ins. Co. v. C.I.R., 104 T.C. 535, 546 (1995) (construing the Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Mar. 8, 1971, U.S.-Japan, 23 U.S.T. 969, with reference to the Model Treaty and its commentary)).

[7] See Treas. Reg. § 1.409A-1(a)(3)(iv).

[8] See Dominion Res., Inc. v. U.S., 681 F.3d 1313 (Fed. Cir. 2012) (Treasury cannot interfere with the unambiguously expressed intent of Congress).

[9] See IRS Publication 17, Page 84; also see The International Tax Gap Series, “Most income tax treaties have special rules for social security payments. In many cases, foreign social security payments are taxable by the country making the payments. Unless specified otherwise in an income tax treaty, foreign social security pensions are generally taxed as if they were foreign pensions or foreign annuities. Unless a tax treaty allows it (see, e.g., the USA-Canada treaty), they are not eligible for exclusion from taxable income the way a U.S. social security pension might be.” https://www.irs.gov/businesses/the-taxation-of-foreign-pension-and-annuity-distributions

[10] See IRC § 72.

[11] If Hong Kongese Provident Funds were foreign private company-sponsored pension plans, they would certainly be subject to reporting on IRS Forms 3520 and 3520-A. However, being social security, they are not subject to reporting since they constitute foreign social security, which is taxable in the same manner as an annuity in accordance with IRS Publication 17.