FATCA and Foreign Retirement Plans: An Analytical Road Map

Now that we have reached the first of the cascading deadlines for implementation of the Foreign Account Tax Compliance Act (FATCA), ¹Hiring Incentives to Restore Employment (HIRE) Act of 2010 (Pub. L. No. 111-147, 124 Stat. 71, enacted March 18, 2010, H.R. 2847). it is fair to assume that most multinational corporations have at least some understanding of the task at hand and many have begun the due diligence necessary to comply with the regime.

Non-financial companies have finally come to terms with the fact that this “banking” law, in fact, has significant implications for their operations at home and abroad. They also understand that, although no one may think of them as “financial,” FATCA has a way of tagging even the plainest vanilla non-financial companies with potential financial status.

As we know, FATCA was enacted in the wake of various tax evasion scandals involving U.S. taxpayers with significant undeclared assets in overseas accounts. Congress responded by requiring that all foreign financial institutions register with the Internal Revenue Service and disclose information regarding substantial U.S. owners and account holders. Foreign financial institutions (FFIs) that don’t comply with the required disclosures will incur a 30% “withholding tax” on certain U.S. source financial payments.

Conceptually, it isn’t difficult to grasp non-financial companies’ responsibilities on the withholding agent side of FATCA—upon making in-scope payments to foreign payees, a non-financial company must document, track, report and potentially withhold on the payments. And at this point, many (if not most) non-financial companies are closely reviewing their global groups to determine if any of their foreign affiliates could be FFIs required to disclose substantial U.S. owners or account holders, or face 30 percent FATCA withholding.

We would suggest that companies widen their view even farther—outside of the expanded affiliated group, in fact. The specific challenge discussed below is reviewing your foreign retirement plans to determine if they possibly constitute foreign financial institutions for FATCA purposes.

This FATCA project likely landed in your department because FATCA is a tax law, and you are a tax professional. You will need to put on your non-tax hat, however, to understand why a foreign retirement plan sponsor (that is, the employer who sponsors the plan) may need to concern itself with whether its plan has FATCA obligations.

Most jurisdictions have legal and regulatory requirements designed to protect employee pensions. For example, in the U.S., we have the Employee Retirement Income Security Act of 1974, known as ERISA. ²We aren’t ERISA attorneys, and this article isn’t intended to provide ERISA advice nor is it intended to imply that ERISA applies to any such foreign retirement plans. Please consult qualified ERISA counsel, or equivalent foreign benefits counsel, if you have any questions with respect to any potential fiduciary obligations. Other countries also have fiduciary rules that apply to amounts held in pension funds (e.g., U.K. and Australia). Under these rules, the employer/plan sponsor may retain some degree of fiduciary responsibility for management of the plan assets, even when the contributed assets have moved off the employer’s books and into some form of separate entity. (As an example, if the employer engaged unqualified asset managers, the employees might argue that they have a cause of action against the employer.)

Many, if not most, foreign pension plans include some U.S. investment assets in their portfolio. A potential 30% haircut of the U.S. investment returns should raise red flags for anyone conscious of the company’s fiduciary responsibilities toward plan beneficiaries.

This line of discussion isn’t intended to conclude that fiduciary responsibilities apply to specific foreign companies or foreign pension plans (a non-tax issue beyond our area of focus). However, if an employer established and maintains the plan, the employer may retain some level of responsibility and may have to undertake due diligence with respect to FATCA, even if the ultimate conclusion is that another person is directly responsible for signing the fund’s Form W-8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities), and performing the necessary FATCA compliance if the fund doesn’t qualify for an exemption.

How could FATCA apply to your foreign pension plans? If you have begun the process of analyzing your foreign affiliates, you are aware that the FATCA regulations and the various applicable intergovernmental agreements (IGAs) define a financial institution to include, among other things, a collective investment vehicle, i.e., an investment vehicle established with an investment strategy of investing, reinvesting or trading in financial assets. ³§1471(d)(5). The regulatory definition is even more elaborate. Reg. §1.1471-5(e)(4)(i)(C).

In a typical pension plan, the employer and its employees make contributions to an entity that will hold and invest the assets (often a complex trust). Typically, the complex trust is the beneficial owner of the collective assets, which are invested for the purpose of funding future benefits distributions. This activity puts the pension plan squarely in the cross hairs of FATCA as a collective investment vehicle and, consequently, a presumptive FFI. As such, its U.S. investment income—primarily U.S. source dividends, interest and, starting in 2017, gross proceeds from the sale of U.S. securities—is subject to 30% U.S. withholding tax.

The various compliance obligations applicable to FFIs don’t apply, however, to the extent that a pension fund qualifies as an “exempt beneficial owner.” Reg. §1.1471-6 provides a list of exempt beneficial owners. As relevant here, exempt beneficial owners include certain foreign retirement funds that fit within six enumerated exemptions. ⁴Reg. §1.1471-6(f).

These exemptions, described more fully below, are roughly based on either the legal status of a pension fund or the fund’s specific features and its regulatory environment—treaty-qualified funds, funds that satisfy §401(a) qualified plan rules, “narrow” and “broad” participation funds, investment vehicles formed exclusively for retirement funds and pension funds of an exempt beneficial owner. ⁵Id.

For FATCA purposes, as with other tax rules, the final regulations never quite represent the full analytical story. At the time of this article’s publication, the U.S. Treasury has negotiated IGAs with around 100 foreign jurisdictions, ⁶In jurisdictions subject to an IGA, the IGA definitions and obligations take precedence over the relevant definitions and obligations in the regulations, although there is some leeway cherry-picking the more favorable set of rules. See, e.g., Agreement between the United States of America and the Kingdom of the Netherlands to Improve International Tax Compliance and to Implement FATCA, Article 4(7). and the list of completed or substantially completed IGAs grows almost daily. Each IGA includes an Annex II describing local foreign entities that will be considered exempt beneficial owners. The annexes vary in their degree of specificity. Some of them contain a specific cite to local tax or pension law; many of them cross-reference the pension definition of that country’s income tax treaty with the U.S. An increasing number of annexes replicate some or all of the six exemptions enumerated in the FATCA regulations.

It is a lot to take in. Below, we lay out a practical road map to help guide your analysis.

Step-by-Step: How to Analyze Your Company’s Foreign Retirement Plans

Pull Together a Spreadsheet

A little organization is worth a whole lot in this particular exercise. Ask someone in the human resources department to pull together a list of your foreign plans, including the following information:

• name of plan (i.e., how this name would be shown on an IRS Form W-8BEN-E);
• country of formation and, if different, country of operation;
• number of participants;
• whether the plan is funded or unfunded (or insured or non-insured);
• whether the plan is invested in U.S. assets; and
• the contact information of the plan administrator and/or trustee, or an indication that the plan is foreign government-administered.

This data will help you effectively focus on the specific exemptions that could apply to your plan. For example, based on the spreadsheet data you will be able to tell whether IGA or treaty benefits could be available (in the U.K. yes, in Kenya currently no); or whether the plan could qualify for the narrow participation exemption (applicable to plans with fewer than 50 participants) or the broad participation exemption (applicable to plans with 50 or more participants).

Figure Out Which Plans Are Funded and Which Aren’t

One of the most critical pieces of data on the spreadsheet is whether or not the plan is funded. This will help you pin down which entity must be classified (and any applicable exemptions certified) for FATCA purposes. In the typical unfunded situation, an employer has no specific assets set aside for meeting its pension obligations; its pension plan is merely a liability on its balance sheet. In this case, absent any streams of investment income, FATCA isn’t an issue.

Alternatively, an employer may place assets into a grantor or simple trust. The assets remain on the employer’s own balance sheet, for example, because they are subject to the claims of the employer’s creditors. While such a plan may be “unfunded” from a U.S. benefits tax standpoint, there is a legal trust holding the assets. Therefore, if and to the extent that any withholding agent is looking for a FATCA classification related to the trust’s investment returns, it is the employer who should be providing it. (Note, the employer is much less likely to constitute an FFI.)

Determine Whether the Funded Plan Has Assets in Separate Entities or Financial Accounts

If a plan is funded, your next step is to figure out how, and to identify the owner of the plan assets.

In some foreign plans, an employer may contribute assets into a series of financial accounts set up for its employees (like U.S. individual retirement accounts). In this case, the employees may own the retirement accounts, although they may not have current rights to receive the assets held in the accounts. The accounts are maintained by an entity, typically a foreign investment adviser or insurance company that may itself be an FFI. The FATCA classification of an unrelated financial institution isn’t the employer’s responsibility.

Still, if the unrelated financial institution becomes a participating FFI or a Model 1 or Model 2 IGA Reporting FFI, its own due diligence and reporting may include these retirement accounts. You may want to get a copy of the entity’s Form W-8BEN-E and verify its global intermediary identification number (GIIN) on the IRS portal. You may also consider reaching out to employees/beneficiaries to let them know that they may be receiving inquiries about their citizenship, residence, etc., which would permit the FFI to complete its due diligence regarding those retirement accounts.

In the more common situation, an employer may contribute assets into a separate entity—usually a complex trust—formed with a separate trustee to administer the “funded” plan. Assets settled on the trust are off-balance sheet to the employer and owned by the trustee. Here, FATCA classification is a trust-level issue. ⁷Reg. §1.1471-1(b)(39), §1.1471-1(b)(100); §7701(a)(1). The employer is no longer the relevant entity for FATCA classification purposes. Nevertheless, as the plan sponsor who has contracted with the trustee, you may wish to ensure that the trustee has addressed FATCA and consider the employee/beneficiary communication issues discussed above.

In the case of a plan that is partially funded, pension experts typically bifurcate the analysis and consider only the characterization of the funded portion. The rest of this article focuses on classifying funded plan entities for FATCA purposes.

Consider Whether the Plan Is Foreign Government or Privately Administered

If the local company has a legal obligation to contribute to a government plan (e.g., one that is analogous to our U.S. Social Security system), the funds are foreign government-owned. A government-owned plan could qualify for its own FATCA exemption, and in a true government-only arrangement the employer has little or no control over the plan’s classification. ⁸See Reg. §1.1471-6(f)(6), §1.1471-6(g).

Employers may take these plans off their to-do list. Be careful, however, to ensure you only consider plans where the assets are owned and administered by the government, rather than plans that are “government-mandated” but privately administered. Private administration usually means the employer, who hires the plan administrators and trustees, may still be responsible for the plan’s FATCA status.

Talk with the Foreign Fund Managers

Where a funded plan entity is managed by third-party administrators and/or trustees, the employer’s due diligence exercise involves coordinating with these persons to confirm that someone is ably managing the fund’s FATCA responsibilities. After all, the fund’s trustee or administrator is likely the person filing tax returns on its behalf, and would be the person with capacity to sign and provide the Form W-8BEN-E. And, although you may understand the applicable rules, the plan’s trustee or administrator is likely much closer to the relevant facts than you are.

There is no substitute for a live conversation, with written confirmation regarding the determined status. As we discuss further below, some of the requirements for the various exemptions can be confusing, particularly for fund managers who don’t speak English as their first language. You may need to provide technical interpretation and assistance to prevent the foreign fund manager from defaulting to non-exempt status simply because he or she doesn’t understand the rules. (The Form W-8BEN-E, after all, must be signed under penalties of perjury, and foreign fund managers are sometimes reluctant to risk asserting exempt status.)

A word of caution here: Although different types of plans may qualify for exempt status, the FATCA regulations appear to be written with an eye toward defined contribution plans. Fitting the features of other types of plans into the requirements may be awkward, so consider having a U.S. benefits expert on the phone to facilitate the analysis.

Confirm Your Understanding of the Plan Structure, Participants, Features and Parameters for Contributions and Distributions

Your internal employee benefits group may have out-of-date or inaccurate information regarding the number and features of your company’s foreign pension plans. It is worth taking a moment up front to double check your understanding of the plan structure and features.

Check Whether the Foreign Pension Plan Is Invested in U.S. Assets

FATCA withholding will only be an issue to the extent the plan has U.S. investments and receives U.S. source payments subject to withholding. If the plan has no U.S. assets, there may be no immediate concerns. However, as long as there remains a possibility that the plan could invest in U.S. securities, there remains the spectre of FATCA withholding; it is best to tackle the status issue now, when you are conducting the analysis on all of your foreign plans.

If in fact there is a restriction under local law on overseas (including U.S.) investments by the pension fund—as is the case for some plans in some countries—you can put aside this worry from the tax perspective. (However, if an IGA goes into effect in that country, it may make FATCA relevant from a regulatory perspective. That is, even if there is no possibility of 30% withholding, the pension fund could be required to take steps to remain in compliance with its local regulating agencies.) Ask for a cite to the local law restriction, note it in your files, and you can check this type of plan off your to-do list. However, it is important to keep in mind that local laws can change so it may be a good idea to check back periodically for any changes in investment restrictions.

If There Is an Applicable IGA, Pull the Annex II Language Off the U.S. Treasury Website

IGAs often, though not always, make the exemption analysis a little easier. Annex II of an IGA generally provides a list of pension or retirement plans that would be treated as “Non-Reporting Financial Institutions” for purposes of the IGA and as “exempt beneficial owners” for purposes of the FATCA regulations.

This list differs from country to country. Sometimes Annex II identifies specific types of local exempt plans, including the statutory authority under which they were formed. ⁹See, e.g., Bilateral Agreement between the U.S. and Bermuda to Implement FATCA (April 23, 2014), Annex II (listing as exempt “Any pension fund established in Bermuda under the National Pension Scheme Act of 1998”). Your due diligence exercise involves confirmation of the plan type—e.g., under the plan documents, registration paperwork and on annual statements or returns filed by the plan. Alternatively, Annex II may simply replicate some or all of the exemptions included in the FATCA regulations. ¹⁰See, e.g., Bilateral Agreement between the U.S. and Belgium to Implement FATCA (Dec. 19, 2013), Annex II; Bilateral Agreement between the U.S. and Bermuda to Implement FATCA (Dec. 19, 2013), Annex II. As described further below, the analysis may be a little more involved in this case.

Either way, no withholding would apply to the plan’s U.S. investment returns, and the plan would be able to certify on Form W-8BEN-E, line 5, that it is a Nonreporting IGA FFI. (In contrast, if no IGA applies and the pension plan proceeds under an exemption in the FATCA regulations, the plan would certify on Form W-8BEN-E, line 5, that it is an Exempt Retirement Plan.)

If the Pension Plan Is Located in a Treaty Jurisdiction, Confirm Whether the Plan Is Currently Claiming Treaty Benefits

For many foreign pension plans, eligibility for income tax treaty benefits—even if benefits aren’t, in fact, being currently claimed—is a fairly straightforward path for exempt status. This is one of the few ways in which U.S. income tax treaties can play a role in alleviating potential FATCA withholding. Otherwise, treaty exemptions (e.g., zero percent rate levied on interest paid by a borrower resident in a treaty partner jurisdiction) apply only to relieve withholding burdens in the context of traditional Chapter 3 withholding and have no bearing on FATCA withholding.

Note, not all U.S. income tax treaties allow pension funds to access treaty benefits. You will need to check whether the treaty language itself, or the U.S. Treasury’s technical explanation issued with respect to the treaty, defines “Resident” to include your pension plan. ¹¹See, e.g., Convention between the United States of America and New Zealand for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (entered into force Nov. 2, 1983). You will also need to confirm the plan’s eligibility under the treaty’s limitation on benefits provisions. ¹²Reg. §1.1471-6(f)(1). See, e.g., Convention between the United States of America and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Art. 26(2)(d) (entered into force Dec. 31, 1983) (“a person described in Article 35 (Exempt pension trusts) of this Convention, provided that (i) more than 50 percent of the person’s beneficiaries, members or participants are individuals, who are residents of either State; or (ii) the organization sponsoring such person is entitled to the benefits of the Convention pursuant to this Article.”). You can, if you wish, shortcut the process by asking the plan’s trustee or administrator for a current copy of the plan’s pre-FATCA Form W-8BEN.

Check Whether the Plan Has Been Issued an IRS Determination Letter Concluding That the Plan Is 401(a)-Equivalent

The FATCA regulations permit a foreign fund to claim exempt status if the fund is formed pursuant to a pension plan that would meet the requirements of §401(a), other than the requirement that the plan be funded by a trust created or organized in the U.S. Here, again, you may be able to shortcut the process.

As background, U.S. plan sponsors of U.S. qualified plans often apply to the IRS for a determination that their plan meets the requirements of §401(a) in form and design, which is received in the form of an IRS determination letter. ¹³See Rev. Proc. 2014-6, 2014-1 I.R.B. 198. Historically, certain foreign plans have applied for and received such letters confirming that the plan is equivalent to a qualified pension plan as described in §401(a).

If a plan sponsor of a foreign plan has obtained such a determination letter, this is a step toward meeting this particular FATCA exemption; however, if the determination letter is very old and/or the plan has substantially changed since the determination letter was received, it is a good idea to ensure the plan can still rely on the determination letter before concluding that this particular FATCA exemption is satisfied. Alternatively, though it poses a greater risk given the practical difficulties of applying U.S. tax rules to the features, requirements and terminology of a foreign plan, you may be able to obtain an opinion of a qualified U.S. tax adviser or benefits counsel concluding that the plan is §401(a)-equivalent.

If the `Legal Status’ Exemptions Don’t Apply, Dig Deeper Into the Terms and Features

If the status-based exemptions don’t work, you will need to consider the features-based exemptions. As noted above, your plan spreadsheet can be very useful in triaging your analysis.

First look at the number of plan participants. If the plan has fewer than 50 participants, go directly to the narrow participation exemption requirements below. For 50 or more participants, skip to the broad participation exemption rules. If the pension arrangement includes both a plan (entity or account) and a separate investment entity, you will want to analyze the plan first, then take a look at the “piggyback” rules for the investment entity.

Narrow Participation Exemption.

If the fund has relatively few participants (fewer than 50), test it under the rules applicable to narrow participation retirement funds. ¹⁴Reg. §1.1471-6(f)(3). A fund may qualify for this exemption if it was established to provide retirement, disability or death benefits to beneficiaries that are current or former employees or their designees (i.e., their survivors) in consideration for services rendered. ¹⁵Id.

The fund can be a single or multi-employer plan, but at least one employer must be something other than an investment entity or a passive NFFE. ¹⁶Reg. §1.1471-6(f)(3)(ii). (Don’t ask the trustee or administrator to do this analysis; it is a lost cause. It is worth it to buckle down and do this part yourself.) Contributions to the fund must be limited by reference to earned income and compensation of the employee, though there is no requirement that contributions be subject to a specific monetary cap. ¹⁷Reg. §1.1471-6(f)(3)(iii). No more than 20% of the fund’s assets should be earmarked for participants that aren’t residents of the country in which the fund is established. ¹⁸Reg. §1.1471-6(f)(3)(iv).

Finally, the fund must be subject to government regulation and provide annual information reporting about its beneficiaries to the relevant local tax authorities. ¹⁹Reg. §1.1471-6(f)(3)(v). This last piece may be problematic, as these types of filings may be more typically made with the local department of labor (and not the local tax, treasury or revenue authority). ²⁰In fact, for U.S. qualified plans, reporting occurs with both the U.S. Department of Labor and the IRS. The IRS Form 5500, which contains information on the numbers and certain classifications of beneficiaries in the plan, is filed with the U.S. Department of Labor, not the IRS. The Form 8955-SSA, Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits, however, is filed with the IRS. Finally, distributions are reported on Form 1099-R to the IRS and to the distributee.

Broad Participation Exemption.

Larger pension funds have somewhat different requirements. Like the narrow participation funds, the broad participation funds must be established to provide retirement, disability or death benefits to current or former employees, or their designees. ²¹Reg. §1.1471-6(f)(2). They must also be subject to government regulation and annual filing requirements (again to tax authorities) regarding beneficiaries. ²²Reg. §1.1471-6(f)(2)(ii). In addition, a broad participation retirement fund must satisfy at least one of the following requirements:

• the fund must have a local tax exemption for its investment income, based on its status as a retirement or pension plan ²³Reg. §1.1471-6(f)(2)(iii)(A).;

• employers must provide at least 50% of the total contributions to the fund ²⁴Reg. §1.1471-6(f)(2)(iii)(B).;

• distributions and withdrawals must be linked to specific events related to retirement, disability or death ²⁵Reg. §1.1471-6(f)(2)(iii)(C).; or

• employee contributions to the fund must either be limited by reference to the earned income of the employees or capped at $50,000. ²⁶Reg. §1.1471-6(f)(2)(iii)(D).
  
  

Finally, no single beneficiary may have a right to receive more than 5% of the fund’s assets. ²⁷Reg. §1.1471-6(f)(2)(i). This last requirement may be a real sticking point; especially in countries where the executive-level job market is less robust, it isn’t unusual to see long-term, highly compensated employees with significant pension benefits built up over time.

`Piggyback’ Exemptions.

If a foreign pension plan qualifies for an exemption under any of the categories described above (and receives “exempt beneficial owner” status), the FATCA regulations will also exempt pension funds established exclusively to earn income for the qualifying plan. ²⁸Reg. §1.1471-6(f)(5). This exemption would apply to investment vehicles set up by a qualifying plan.

A very similar exemption applies if the foreign fund is established exclusively to earn income for the benefit of a retirement or pension account that meets certain criteria (i.e., tax-favored, contribution limits, annual information reporting to tax authorities, conditional withdrawals). ²⁹This applies to accounts described in Reg. §1.1471-5(b)(2)(i)(A). Reg. §1.1471-6(f)(5).

Finally, other types of exempt beneficial owners, such as foreign governments, can form pension funds that will benefit from piggyback exemptions. ³⁰Reg. §1.1471-6(f)(6).

If a Funded Plan Doesn’t Qualify for Exempt Beneficial Owner Status Under an IGA or Reg. §1.1471-6, Register It as a Participating FFI

Plans that don’t qualify for one of the exemptions described above constitute FFIs, and must register with the IRS as participating FFIs (or become reporting FFIs under an applicable IGA) to avoid any U.S. withholding tax on their U.S. investment income. Even plans that don’t have such income (and, thus, avoid the biggest out-of-pocket cost of being a “non-participating FFI”) may need to consider registration, particularly if the plan is located in an IGA jurisdiction. In that case, due diligence and reporting under the IGA may still be required as a regulatory matter, and compliance failures may have other, non-tax ramifications.

Complying with participating FFI obligations may require a coordinated effort by the plan administrator, trustee and the employer. After all, a pension plan doesn’t typically need to maintain significant background information regarding participants. The relevant party or parties may have the employee or former employee’s name, contact information and perhaps employment data—but none of that is significant for establishing U.S. tax status. Beyond what is necessary for initial identification or other purposes when hiring employees (which can vary significantly from country to country), it is unlikely that birth certificates, passport information, etc., are maintained at the employer level or obtained by an employer’s human resources department.

Assuming that privacy concerns don’t preclude HR from sharing this information—something you will want to confirm as soon as you know that participating FFI registration is necessary—the fund may need to work out a joint compliance process in advance of its registration.

Conclusion

As you can see from the above descriptions, the FATCA rules are designed to exempt foreign pension plans in most cases. Thus, the pension analysis is more of a due diligence exercise than the analysis you would perform when classifying your foreign affiliates. The real challenge lies in the information gathering.

Your objective is to secure highly localized employee-related information, which isn’t typically provided to the U.S. tax department of a large multinational corporation. You may have several false starts as you attempt to locate the local personnel and information necessary for classifying your plans. Moreover, you may need some assistance as you try to fit foreign benefits terminology into U.S. “FATCA speak.”

At the end of the day, analysis of your worldwide pension plans will be a complex collaborative effort, but one that could be necessary to avoid significant exposures in the future.