Income tax treaties simplify and resolve a lot of cross-border tax matters. Unfortunately, most firms don’t generate revenue when matters are simple. Their revenue is contingent on complexity. For that reason, they ignore the existence of income tax treaties to justify their fees. Our firm only does what’s best for our clients.
Any “pensions and other similar remuneration” (i.e., treaty-qualified pensions and all ERISA retirement plans) are covered. There is a very low threshold for what constitutes Treaty-Qualified Retirement Pay as outlined below. Although some treaties (e.g., U.S.-U.K. Income Tax Treaty) source lump sum payments in the same manner as compensation (i.e., source of area of performance), the manner by which the pension distribution is made is typically irrelevant. In fact, even when a treaty uses the phase “periodic” with regard to the manner of distribution, this does not preclude application to lump sum distributions. Generally, pension distributions are exclusively taxable in the taxpayer’s country of residence. Coupled with other planning techniques, it is possible to achieve double non-taxation whereby neither the country of source under the treaty nor the country of residence under domestic tax law impose any tax on the distribution.
Please take note that many treaty-covered foreign pension plans and other similar account may be exempt from PFIC reporting on IRS Form 8621. This alone could save you a significant amount in taxes.
As mentioned before, there is a very low bar for what constitutes a Treaty-Qualified Pension. Generally, both countries agree that plans qualified under domestic law are qualified under the treaty. The Internal Revenue Code is not controlling; however, it does provide non-binding guidance. If either country party to an income tax treaty could set the standard independently of the other, it would defeat the purpose of the treaty, which is to promote cross-border consistency. Anyone that says otherwise is wrong and incompetent.
The 3 non-controlling requirements under the Code are: (1) the employee had to have given at least 5 years of service or be over the age of 62, (2) the payment must be an annuity or on the account of disability, death, separation from service after the age of 55, and (3) all payments must be made either after separation from service or after the age of 70½.
This brings us to Section 409A Non-Qualified Deferred Compensation Plans.
Application to Section 409A NQDC Plans
Under treaty law, deferred compensation is typically taxed as regular salary income. However, Section 409A was enacted in 2004 in response to the Enron Scandal to disqualify certain pension plans of executives. In other words, although Section 409A plans are referred to as deferred compensation, they are actually intended to operate as pension plans; albeit not qualified for tax benefits under domestic U.S. tax law.
For this reason, in 2004, our firm obtained a Private Letter Ruling from the Internal Revenue Service, which confirmed that Section 409A Non-Qualified Deferred Compensation Plans are Treaty-Qualified Pensions. What’s the significance of this? The significance is that it means all payments from the NQDC Plan is eligible for treaty benefits, which generally exempt the payment from U.S. taxation.
However, taxpayers are not permitted to rely on a PLR not specifically issued to that taxpayer. As such, it is critical you obtain a Tax Opinion from our firm. Securing a formal, written Tax Opinion is the only way to guarantee against penalties. If you read our article on Tax Opinions, you’ll see how that was a costly lesson for one taxpayer who was hit with $39 million in penalties for failing to secure a formal, written Tax Opinion. Don’t be cheap, or it’ll cost you.
As mentioned above, this legal position coupled with other planning techniques, it is possible to achieve double non-taxation whereby neither the country of source under the treaty and the country of residence under domestic tax law impose any tax on the distribution.
Compliance for Payor: Securing Form W-8BEN
The Internal Revenue Code explains that all persons, in any capacity, that have control, receipt, custody, disposal, or payment of any class of income items of any nonresident alien individual shall deduct and withhold tax at a rate of either 30 or 14 percent. The classes of income include interest, dividends, rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical income, such as pension income. However, amounts “may be exempt from, or subject to a reduced rate of, withholding under an income tax treaty. Documentation establishing the eligibility for benefits under an income tax treaty is required for this purpose… [and] also serves as documentation establishing a foreign status.” Therefore, it is necessary to look to the Regulations for further clarification on the mechanics of a withholding agent’s duties.
Regulations provide that a withholding agent may “treat a payment as [being] made to a foreign beneficial owner” if the individual provides a Form W-8BEN “absent actual knowledge or reason to know otherwise.” Regulations further clarify that a “withholding agent may rely on the information and certifications stated on withholding certificates… without having to inquire into the veracity of this information or certification, unless it has actual knowledge or reason to know that the information or certification is incorrect.”
Therefore, unless a withholding agent has actual knowledge that a claim of treaty benefits is incorrect, the withholding agent is allowed to fully rely on the content of the form without any further inquiry.
Compliance for Payee: Reporting on Form 8833
Code section 6114 requires any person relying on a tax treaty to disclose such position on his or her federal income tax return unless an exception applies. IRS Form 8833 is used to make a disclosure regarding a treaty-based return position. A separate form is required for each treaty-based return position taken by the taxpayer. If the treaty position results in no taxation whatsoever, then IRS Form 8833 must be filed along with a federal income tax return that only includes the taxpayer’s name, address, taxpayer identification number, and signature under the penalty of perjury. This effectively creates a de facto treaty election procedure for which there are penalties for noncompliance.
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Contact our firm today to schedule a free consultation. This article only scratches the surface of the basics. There are still sophisticated treaty-based tax planning strategies that can substantially reduce your tax exposure.
 See USMT, Art. 17(1); OECD 2010 Commentary, Art. 18, ¶ 5, 60.
 OECD 2010 Commentary, Art. 18, ¶¶ 5, 60; but see U.S.-U.K. Income Tax Treaty, Art. 17(2) (to prevent non-citizen U.S. residents from avoiding IRA distribution taxation by changing residence to the U.K., tax authority was changed from residence-based to source-based).
 See PLR 200416008 (“The word periodic in Article 18(4) does not preclude the application of Article 18(1) to lump sum distributions.”).
 See USMT, Art. 17(1)(a).
 See IRS Notice 2014-28.
 See PLR 200209026 (An IRA is a treaty-qualified pension).
 See OECD 2014 Commentary, Art. 15, ¶ 2.11; also see Rev. Rul. 71-478.
 See American Jobs Creation Act of 2004, PL 108–357, October 22, 2004, 118 Stat 1418.
 [Redacted]. Contact our firm or risk significant penalties. We will provide a formal, written Tax Opinion that cites, references, and thoroughly discusses the PLR. We do not provide it here to protect taxpayers from themselves. There are significant penalties for blindly relying on a PLR issued to another taxpayer.
 See IRC § 1441(a).
 See IRC § 1441(b).
 Treas. Reg. § 1.1441-1(b)(4)(xv).
 Treas. Reg. § 1.1441-1(e)(1)(i).
 Treas. Reg. § 1.1441-1(b)(4).
 See IRC § 6114.
 See Treas. Reg. § 301.7701(b)-7.