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HMRC internal manual

Employment Income Manual

Employer-financed retirement benefits schemes: non-UK service relief

Foreign and overseas service exemptions for payments on or after 5 February 2014

This page explains about two similar but slightly different definitions of non-UK service, and when reliefs may apply to relevant benefits provided on or after 5 February 2014 for service in one or other of these categories. The two categories are:

  • ‘foreign service’ - this term is:

 

  • used in Extra-Statutory Concession A10 (ESC A10) and Section 395B ITEPA 2003,
  • defined in Section 413(2) ITEPA 2003, and
  • explained further in EIM13690); and

 

  • ‘overseas service’ – this term is not a legislated term, but is used in this guidance as a convenient label for:

 

  • the test in Section 554Z4 used in Part 7A ITEPA 2003, and
  • for the criteria in Section 394(4C)(c) ITEPA 2003.

For such payments made before 5 February 2014 see EIM15083.

Changes in law

In the history of EFRBS legislation, exemptions from income tax charges for ‘foreign service’ came first.

It was announced on 31 March 2011 that ESC A10 would largely be withdrawn as new legislation at Part 7A ITEPA 2003 would provide a ‘just and reasonable’ reduction in the amount of employment income chargeable to income tax for duties performed outside the UK. This new ‘just and reasonable’ reduction would operate for ‘overseas service’, however ESC A10 was to continue to apply:

  • to payments of lump sum relevant benefits received directly from the employer; and
  • to payments of lump sum relevant benefits out of rights which had accrued before 6 April 2011.

To put this on a statutory footing, an Order was made on 4 February 2014 under Section 160 Finance Act 2008. Article 5 of The Enactment of Extra-Statutory Concessions Order 2014 (SI 2014/211) inserted Section 395B into ITEPA 2003 and this, together with the working of Part 7A ITEPA 2003, achieves the above limited continuation of the effect of ESC A10 where relevant benefits are provided for ‘foreign service’. The new legislation came into force 5 February 2014.

Note: The expression ‘third party arrangement’ is used on this page to refer to cases coming within the reach of Part 7A ITEPA 2003.

Lump sums paid directly by employer on or after 5 February 2014

A lump sum paid as a relevant benefit may be paid from an employer directly, or through a third party arrangement.

Part 7A does not apply to direct provision of benefits by an employer. If Part 7A does not apply then the EFRBS rules must be considered to see if a charge arises under Section 394 on the provision of a relevant benefit.

For there to be a ‘foreign service’ exemption from such Section 394 charges, the appropriate conditions in Section 395B must be satisfied. These are described in detail further down on this page.

Lump sums paid through a third party arrangement on or after 5 February 2014

The main ‘overseas service’ exemption from Part 7A charges relating to lump sums is found in Section 554Z4 (see EIM45720), which applies when the value of the relevant step is ‘for’ a tax year in which the employee was not UK resident and is in respect of duties carried out outside the UK. It is a different test to that for ‘foreign service’ exemptions discussed above.

There is transitional protection from Part 7A charges relating to lump sums in Section 554W. Such transitional protection, where effective, leaves the payments in question open to being tested under the EFRBS rules and with the potential for charges arising under Section 394. There may be a ‘foreign service’ exemption from Section 394 charges if the appropriate conditions in Section 395B are satisfied. These conditions are described below.

Section 395B ITEPA 2003: conditions and application

Section 395B provides a specific ‘foreign service’ exemption from charges under Section 394 ITEPA 2003. It applies if:

  • the benefit in question is a lump sum provided to or in respect of an employee or former employee;
  • it’s provided under an EFRBS established in a country or territory outside the UK;
  • the recipient is the employee (or former employee) or a related person. A related person is the employee’s (or former employee’s):

 

  • spouse, widow or widower,
  • civil partner or surviving civil partner,
  • financial dependent, or financial mutual dependent,
  • dependent because of physical or mental impairment (includes cases where that was the position at the time of the employee’s or former employee’s death), or
  • personal representative;

 

  • some or all of the lump sum would be employment income under Section 394(1) or would be chargeable to income tax under Section 394(2) (were it not for this Section 395B exemption). The legislation refers to this as the “relevant part” and also states that it should exclude any part of the lump sum covered by the reduction for the employee’s own contributions (under Section 395) and ‘other relevant income’ (under Section 394(4B);
  • the service in respect of which the right to the above ‘relevant part’ accrued, must be or include ‘foreign service’. This is referred to in the legislation as the “reckonable service”.

Location of establishment

A scheme will normally be treated as established in the country or territory where its registered office is located and its main administration is carried out. If there is no registered office, then the location where its main administration is carried out will guide matters.

The scheme’s location of main administration is where the scheme’s decisions are made. In the case of a trust-based scheme, that would normally be determined by reference to where the scheme trustees are resident; as that is where the decision-making responsibilities in respect of the scheme will lie.

Where the scheme is not set up under trust (for example an unfunded arrangement by the employer), it is likely to be governed by the location of the employer, though careful consideration may be needed in group situations or where there are wider contractual arrangements. The location of establishment may also change over time, which could affect the application of Section 395B.

The amount of exemption available also depends on some further service considerations.

Full exemption

Full exemption from the lump sum counting as employment income under Section 394(1), or being chargeable under Section 394(2), is available on the ‘relevant part’ of the lump sum, if:

  • ‘foreign service’ makes up at least 75% of the ‘reckonable service’,
  • if ‘the period of reckonable service’ exceeds 10 years, then all of the last 10 years of that period is made up of ‘foreign service’, or
  • if the period of ‘reckonable service’ exceeds 20 years, then at least one-half of that period, including any 10 of the last 20 years, is made up of ‘foreign service’.

Partial exemption

Where none of the full exemption criteria are satisfied, partial exemption is available on the ‘relevant part’ in the following proportion:

[amount of ‘foreign service’ included in ‘reckonable service’] / [reckonable service]

Example:

In October 2014 an employer creates an unfunded agreement under which he awards a £10,000 lump sum to a retiring employee in recognition of 8 years’ service to retirement. Two years of this service were ‘foreign service’.

Calculation:

Proportion = 2/8 = 25%

Reduction for foreign service = £10,000 x 25% = £2,500

‘The ‘relevant part’ of £10,000 is reduced by £2,500 to £7,500 employment income of the employee.

Service for which the ‘relevant part’ accrues can span numerous employments and include a number of schemes (so more than one EFRBS).