USA Withholding Tax and Pension Schemes

At the end of last year I was asked some questions by a client on the USA withholdiing tax position of pension unit linked business.

As the current UK/USA treaty as been in force since 2003/2004 I thought it would be be useful to set out how the treaty and the associated competent authority agreement ("CAA") mesh together.

Article 10 (3) (b) of the the UK / USA treaty provides for a 0% rate of withholding where dividends are paid to:

"a pension scheme, provided that such dividends are not derived from the carrying on of a business, directly or indirectly, by such pension scheme."

I think it would be fair to say that there was a misunderstanding at the time that the treaty was signed. In the UK it was understood that the unit linked business of a life insurance company would be able to benefit from the 0% pension scheme rate.  However, when after the treaty was signed, this point was raised with the USA authorities they were of the opinion that UK life insurers would not be able to benefit from the 0% rate.

This caused rather a kerfuffle (almost breaking out into a fully fledged brouhaha) and as a result the competent authority agreement between UK /USA was signed. The purpose of this was to extend (or you could argue clarify) the definition of what constitutes a pension scheme so as to extend the 0% rate to linked pension business. There is a link to the CAA in Philip Govan's post of 16th April 2013.

This gave  UK life insurers with significant amounts of UK business sufficient assurance for them to proceed to claim the 0% rate.  However, the CAA is not a particularly clear document, I think it must have been drafted by US officials and tries to define what is unit linked business from scratch.  As a result in some circumstances its hard to advise clients on whether they meet the criteria in the CAA.  

For instance condition b (i) requires that:

"Contributions by the pension scheme are placed by the insurance company in a fund that is generally exempt from tax in the United Kingdom."

 

You can see what this means but its not very precise.

In a perfect world the CAA would be replaced with something that states that "pension unit linked business of a UK life insurer qualifies for 0% withholding."  However,  both HMRC and the "industry" are reluctant to revisit this issue for fear we would end with something worse than the CAA.