U.S. Tax Treatment of Nigerian Pension Funds

Income and gains within a Nigerian Pension Fund in Nigeria 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 Nigerian Pension Fund annuitizes at retirement and begins paying benefits.

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The Nigerian Social Security System

The U.S. Social Security Administration’s 2010 publication titled “Social Security Programs Throughout the World” analyzes Nigeria’s overall comprehensive social security system. The first of laws implementing social security in Nigeria were enacted in 1961.

Nigeria’s current social security system is based on the 2014 Pension Reform Act. This laws is similar to the compulsory contribution system under the U.S. Federal Insurance Contributions Act.^{^[1]} The Nigerian Pension system covers federal public-sector employees, state, and local government public-sector employees in the federal capital territory, and private-sector employees working in firms with at least three employees. It does not cover diplomats, noncitizens covered by an equivalent program in another country, self-employed persons, the clergy, or private-sector employees working in firms with fewer than three workers. There are special systems for certain judiciary officers, military, and security personnel. A Micro Pension Plan for workers who are not covered under the mandatory individual account program, including self-employed persons and informal-sector workers, has not yet been implemented.

Nigerian Pension Funds can most aptly be characterized as state-managed individual retirement savings account 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 Nigeria and the United States are members, also recognizes Nigerian Pension Funds as forming part of Nigeria’s overall comprehensive social security system.^{^[4]}

Therefore, based on the foregoing substantial and compelling authorities, it is indisputable that Nigerian Pension Funds are social security accounts forming a part of Nigeria’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 Nigeria 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 Nigerian Pension 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 Nigerian Pension Fund in Nigeria 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 Nigerian Pension Fund annuitizes at retirement and begins paying benefits.

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Bluebook Citation: U.S. Tax Treatment of Nigerian Pension 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=NG&regionId=AFR.

[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 Nigerian Pension 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.