Taxation of foreign superannuation: matters not in the bill

Issue: Change to the United Kingdom’s pension transfer rules – transfers out of KiwiSaver

No clause

Submission

(Charter Square Services)

As a result of a change to the Qualified Recognised Overseas Pension Scheme (QROPS) rules under the domestic law of the United Kingdom (UK), no KiwiSaver schemes qualify as QROPS and therefore a person who has transferred their UK pension scheme into a KiwiSaver scheme cannot even transfer to any other KiwiSaver scheme. The only feasible way to address this issue is with an urgent change to New Zealand legislation that allows those that have previously transferred their UK pension funds into a KiwiSaver to transfer out either back to a UK pension scheme or to another QROPS. This will require urgent action on behalf of the New Zealand Government.

Comment

This submission does not relate to any of the remedial amendments contained in the bill and is not a New Zealand tax issue.

The UK’s QROPS rules set out the conditions under which a person with a UK pension scheme may transfer their funds to an overseas pension scheme. One of the reasons that the UK allows transfers of pension savings to be made free of UK tax is so that individuals leaving the UK permanently can simplify their affairs by taking their pension savings with them. However, there are safeguards in place to protect the integrity of the UK tax system and pension regime.

In order to transfer out of a UK scheme, the receiving overseas scheme must be a QROPS. To qualify as a QROPS, a number of requirements must be met, including that the scheme is locked in until retirement.

If a transfer is made from a UK scheme to a non-QROPS scheme, the individual is subject to a penalty of up to 55 percent of the transfer. This could be to discourage individuals from transferring to schemes where individuals have easy access to their funds or where HMRC does not have access to information about an individual’s funds. After this, there may be little that the UK is able to do to control what happens to the funds.

Officials understand that the QROPS eligibility rules have recently changed, in particular with respect to the “pension age test” that schemes must satisfy. Officials understand that under the pension age test, funds must remain locked in until at least the age of 55, with early withdrawal only in cases of serious illness.

This change came into effect on 6 April 2015 as part of the UK’s new policy on “pension flexibility”, which allows individuals to withdraw their entire UK pension as a lump sum, rather than requiring them to use a certain portion to fund a “pension for life”. As part of this policy change to make it easier for people to access their funds at and after the age of 55, they have tightened access to the QROPS regime.

Previously, for a New Zealand scheme to qualify as a QROPS they either had to be a KiwiSaver scheme or they had to satisfy the pension age test. From 6 April 2015, officials understand that all schemes must satisfy the pension age test and carve-outs are no longer provided. While KiwiSaver schemes are locked in until the age of 65, there are a number of permitted early withdrawals which mean that KiwiSaver schemes breach the pension age test. These include for example, withdrawals for the purchase of a first home and in the case of financial hardship, as well as the tax withdrawal facility.

New Zealand officials are engaging with HMRC officials in order to fully understand the nature and implications of the recent changes to the QROPS regime. Officials understand that KiwiSaver schemes will not be able to qualify as QROPS on a go-forward basis, because of inherent differences between the UK and New Zealand retirement savings systems, but are working towards finding a practical solution in relation to “legacy transfers”. These legacy transfers are where a UK scheme and New Zealand QROPS scheme have signed off on a transfer, but the funds were not received by the New Zealand scheme until after 6 April 2015 (or have not yet been received).

Recommendation

That the submission be declined.

Issue: The United Kingdom’s pension transfer rules – New Zealand receiving scheme should pay the tax liability out of a client’s transferred funds directly to Inland Revenue

No clause

Submissions

(Baucher Consulting Limited, Charter Square Services)

The foreign superannuation tax liability should arise upon the transfer of a foreign superannuation interest into the New Zealand scheme and the tax liability should be paid directly by the New Zealand receiving scheme to Inland Revenue out of the individual’s transferred funds. This would ensure a more prompt payment of tax.

There is uncertainty about whether withdrawals from KiwiSaver are allowed under the UK’s QROPS rules and whether they could be classed as an unauthorised payment. Payment of the tax directly to Inland Revenue would not be an unauthorised payment under the UK’s rules and therefore would not be subject to an unauthorised payments charge. (Baucher Consulting Limited)

The foreign superannuation tax withdrawal mechanism is preventing KiwiSaver schemes from qualifying as QROPS. If the tax liability were paid by the scheme, then no payment has been made to the member and therefore no issue exists. (Charter Square Services)

Comment

Officials note that under the foreign superannuation rules, a tax liability is triggered at the time the foreign superannuation interest is transferred into a superannuation scheme in New Zealand. However, as with other forms of taxable income where there is no withholding, the income needs to be included in a person’s income tax return at the end of the income year.

As part of the introduction of the new foreign superannuation rules, a new category of permitted withdrawal was introduced into the KiwiSaver Act 2006 to allow individuals who have transferred their foreign superannuation interest into a KiwiSaver scheme to withdraw the amount of tax payable on the transfer (schedule 1, clause 14C). This recognises that people may wish to transfer their foreign superannuation into a locked-in New Zealand scheme such as KiwiSaver, but may not have the funds available to pay their tax liability. Officials note that this facility is available to transfers from all foreign superannuation schemes, not just those originating in the UK.

Officials also note that the legislation already mandates direct payment of the tax liability to Inland Revenue in certain circumstances when the tax withdrawal facility is used. Clause 14C(5)(b) provides that “if payment to a person other than the member is possible, [the trustees or the manager of the KiwiSaver scheme must] pay to the Commissioner the amount of the withdrawal.”

Impact on ability to qualify as QROPS

Charter Square Services’ submission is on the basis that the foreign superannuation tax withdrawal mechanism is what is preventing KiwiSaver schemes from qualifying as QROPS. They submit that if the tax liability were paid by the scheme, then no payment has been made to the member and therefore no issue exists.

As noted above, the KiwiSaver rules already require the direct payment of the tax liability to the Commissioner in certain circumstances.

At the time that the foreign superannuation withdrawal tax facility was designed, officials confirmed with HMRC that the introduction of the withdrawal facility would not in itself impact the ability of KiwiSaver schemes to qualify as QROPS. This was stated on page 27 of the Officials’ Report on the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill.

Unauthorised payments

Officials understand that under the QROPS rules, once a person has transferred their pension scheme to a QROPS (with no UK tax or penalty), if they make a withdrawal and have been a UK tax resident in any of the five preceding tax years, the withdrawal could be deemed to be an “unauthorised payment” and could be subject to an unauthorised payments charge and surcharge of up to 55 percent.

Baucher Consulting Limited submits that there is uncertainty about whether withdrawals from KiwiSaver are allowed under the UK’s QROPS rules. These withdrawals could be classed as unauthorised payments and could be subject to a penalty charge and surcharge in the UK. They also submit that payment of the tax directly to Inland Revenue would not be an unauthorised payment under the UK’s rules and therefore would not be subject to an unauthorised payments charge.

Note that unauthorised payments are not exhaustively defined in the UK’s legislation, but are simply payments that do not meet the legislative definition of an “authorised payment”.

Officials understand from HMRC guidance that whether the payment is made to or on behalf of the member is not relevant in determining whether a withdrawal from the person’s transferred funds is an unauthorised payment.

Immediacy of tax payment

The submitters state that having the tax liability created at the time of transfer and paid directly by the receiving scheme to Inland Revenue would mean that Inland Revenue “would not have to wait for a year-end income tax return to determine the tax liability and payment would be made immediately” (Charter Square Services) and that “it should also ensure prompter payment of the relevant tax liabilities on transfer” (Baucher Consulting Limited).

Officials understand that the basis of these submissions is that the tax should be withheld when a transfer is made from a foreign superannuation scheme into KiwiSaver.

A clip-the-ticket approach was considered when the foreign superannuation rules were designed, but was not chosen partly due to the costs and complexities associated with implementation, both for Inland Revenue and providers.

An important feature of the foreign superannuation tax withdrawal facility is that the use of the facility is optional. It provides taxpayers with flexibility in the event that they wish to use other funds to pay their tax liability, or if the laws of their previous country of residence place strict restrictions on what can be done with their funds post-transfer, as with the UK’s QROPS rules, for example.

Including the relevant amount in their income tax return ensures that the individual pays the correct amount of tax depending on their circumstances, as the amount of tax payable depends on a number of factors, including the gains derived by the foreign superannuation while the person has been a New Zealand resident, the person’s total taxable income for the year, and whether they are eligible to take any deductions.

Recommendation

That the submissions be declined.

Issue: Taxation of UK pension schemes

No clause

Submission

(Baucher Consulting Limited)

There should be a less regressive tax treatment of UK pension schemes to encourage funds into New Zealand.

Comment

The decision to transfer a financial asset, such as a pension scheme, to New Zealand is a significant one and tax should not be the only consideration.

The intent of the foreign superannuation rules is to provide a tax-neutral setting in which an individual can make a fully informed decision about whether or not to transfer their foreign superannuation interest to New Zealand.

The rules were designed to create a level-playing field between foreign superannuation assets and other financial assets, while recognising special features of retirement savings – particularly the fact that superannuation schemes are often locked in until retirement. The amount of tax payable as calculated under the foreign superannuation rules is dependent on the gains that have accrued in the person’s foreign superannuation scheme while they have been a New Zealand resident. The amount of tax payable reflects the amount that should have been paid on accrual, but rolls up the tax liability until a lump sum is received with an interest factor to account for the deferral benefit.

Recommendation

That the submission be declined.

Issue: Tax rate on foreign superannuation transfers should be lower

No clause

Submissions

(Baucher Consulting Limited, Charter Square Services)

Transfers to schemes should be taxed based on an individual’s prescribed investor rate. (Baucher Consulting Limited)

There should be a flat tax rate on the transfers, rather than a variable income tax–related rate. The rate could be set with reference to income tax and if it is we would suggest a rate between 15% and 17.5%. (Charter Square Services)

Comment

Officials note that similar submissions were made following the release in 2012 of the issues paper on the taxation of foreign superannuation and again when the foreign superannuation rules were considered by the Finance and Expenditure Committee as part of the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill. While not identical to these submissions, they similarly provided that lump sums should not be taxed at a person’s marginal tax rate and instead should be subject to a lower rate of tax.

Officials noted on page 47 of the Officials’ Report on submissions on the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill that the general issue also exists in relation to other lump-sum payments (for example, compensatory payments). No relief is provided in relation to other lump sums, so a change here would set a precedent for other lump-sum payments.

Recommendation

That the submissions be declined.

Issue: Drafting clarification – further contributions to a foreign superannuation scheme while New Zealand tax-resident are taxed under the foreign superannuation rules

No clause

Submission

(Independent Advisor to the Select Committee)

The rules should be amended to clarify that when an individual first acquires rights in a foreign superannuation scheme while non-resident (and is therefore subject to the foreign superannuation tax rules in section CF 3 of the Income Tax Act 2007), any subsequent contributions made to the scheme while they are New Zealand-resident are considered to be part of the interest in the superannuation scheme acquired while non-resident, and are taxed under the foreign superannuation rules, rather than under the FIF rules.

Comment

An interest in a foreign superannuation scheme is taxed under the foreign superannuation tax rules in section CF 3 of the Income Tax Act 2007, if the rights in the scheme are acquired while the person is non-resident for tax purposes. If they are a New Zealand tax resident at the time of acquisition, they must account for tax under the FIF rules.

When an individual first acquires an interest in a foreign superannuation scheme while non-resident, and continues to contribute to the scheme while New Zealand-resident, the policy intent is that the person is taxed under the foreign superannuation tax rules in relation to the whole interest.

On pages 6 and 7 of the Officials’ Report to the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill, officials considered that in such a case, the individual should not be required to apportion their interest in the scheme between the foreign superannuation rules and the FIF rules as this would be highly complex and compliance-heavy.

Officials consider that the current drafting achieves this policy intent, but could be clarified to provide greater certainty, particularly when the foreign superannuation scheme is constituted as a trust because each contribution to the scheme could constitute a new settlement on the trust and could therefore be considered a separate interest in the foreign superannuation scheme. When a person first acquires interests in a foreign superannuation scheme while non-resident and makes additional contributions to the scheme while New Zealand-resident, these together should be considered a single interest in the scheme for the purposes of the foreign superannuation rules.

Officials consider that the amendment should be retrospective to the beginning of the new foreign superannuation rules, 1 April 2014, as it clarifies the existing position.

Recommendation

That the submission be accepted.