Double Taxation Relief Manual: Guidance by country: United States of America: Pensions from 2003
Article 17 in the new Agreement is a fairly standard pensions article, which provides for the taxation of pensions and other similar remuneration only in the state of residence of the beneficial owner. But there are two provisions that have generated particular interest. The new Agreement applies from 1st January 2004 for US taxes and 6th April 2003 for UK Income Tax.
Paragraph 1(a) sets out the general rule above. For this purpose, a payment is treated as a pension or other similar remuneration if it is a payment under a pension scheme, as defined at Article 3(1)(o).
However, the residence state, under paragraph 1(b), must exempt from tax any amount of such pensions or other similar remuneration that would be exempt from tax in the State in which the pension scheme is established if the recipient were a resident of that State. Thus, for example, a distribution from a US “IRA” to a UK resident will be exempt from tax in the UK to the same extent the distribution would be exempt from tax in the US.
An IRA is a trust (or similar arrangement known as a custodial account) set up for the exclusive benefit of the taxpayer and, on his death, nominated beneficiaries, which satisfies certain conditions imposed by United States tax law. Contributions to an IRA are tax deductible in the United States and the funds can be invested in a wide range of investments. IRA funds can be withdrawn at any time, but if withdrawals are made before the taxpayer reaches the age of 591/2 he must pay an additional penalty tax of 10% unless he is disabled.
IRAs: Years up to 2002/03
The UK tax position for income tax years up to and including 2002/2003 is as follows;
Provided that the taxpayer has not nominated a beneficiary to receive the balance of the IRA on his death, the trust is transparent for UK tax purposes. Income of the IRA trust is chargeable as it arises, unless the Remittance Basis applies (see IM1560 et seq). The nomination of a beneficiary creates a settlement within the terms of the provisions of ICTA88/S672. In such a case the taxpayer is liable to UK Income Tax under Case VI of Schedule D on the IRA income arising in the tax year (ICTA88/S675).
Whether or not a beneficiary has been nominated, an IRA is a bare trust for the purposes of TCGA92/S60. The taxpayer is therefore chargeable to United Kingdom Capital Gains Tax in respect of any chargeable gains arising on the disposal of IRA investments. Changes in IRA investments will generally involve acquisitions and disposals of chargeable assets by the taxpayer.
Withdrawals from an IRA do not of themselves give rise to a charge to Income Tax or Capital Gains Tax, but they will often be preceded by the disposal of IRA investments (including the conversion of dollars to sterling) giving rise to a chargeable gain or an allowable loss.
IRAs: Year 2003/04 et seq.
This will not be the position for years 2003/04 onwards. The new Agreement takes precedence and this will mean that no liability will arise until it would have done so under US tax law. Under US law, this will be when distributions are made. As indicated above, this will generally not be before age 591/2 but must be before age 701/2. The important point to note is that income will no longer be assessable in the UK on the basis of income arising within the IRA.. Any case of doubt or difficulty should be referred to HMRC, Customs & International, Tax Treaty Team.
Under the old Agreement, a lump-sum payment from a pension scheme was taxable only in the country of residence. So if an individual moved from the US to the UK before receiving a lump sum from a US pension scheme, they would be taxable on the lump sum neither in the US (because of the treaty) nor in the UK (which does not tax lump sums anyway).
The new provision prevents this occurring by providing that a lump-sum payment derived by a resident of one State from a pension scheme established in the other State shall be taxable only in that other State.
The provision preserves the exemption from income tax of a lump sum relevant benefit where it is paid by a UK approved pension scheme to a beneficial owner who is a US resident. However, Article 1(4) will apply in respect of US citizens as the provisions of Article 17(2) are not amongst those listed at Article 1(5). So the US are able to tax lump sums received by US citizens from UK schemes.