In December of 2016 BBH issued an In-Focus article discussing various tax treaty challenges encountered by group trusts when investing in certain markets. In this edition, we discuss additional treaty eligibility challenges encountered by group trusts investing in Belgium, Denmark and Indonesia, as well as potential solution being explored by market participants.
When investing in foreign markets, group trusts often experience issues obtaining tax treaty benefits. Foreign tax authorities oftentimes are not assured that the underlying pension plan participants within the group trust are treaty eligible, and therefore require proof in the form of documentation at the underlying participant level. This is a burdensome requirement for the group trust and getting compliance is often difficult to impossible.
An “81-100 Group Trust” refers to a collective investment trust, group trust or collective investment fund that is a commingled pool governed by ERISA. It qualifies for tax exempt treatment under Internal Revenue Service (IRS) Revenue Ruling 81-100 (as modified by Revenue Ruling 2004-67 and Revenue Ruling 2011-1) because all of its assets are derived from either qualified plans or certain governmental plans (group trust) pools that are exempt from U.S. taxation under Section 501(a) of the Internal Revenue Code (IRC).
Markets of Investment That Present Tax Treaty Challenges
Belgian local law provides for a withholding tax exemption for qualifying pension funds. The criteria for eligibility is as follows:
- the pension fund must be managed exclusively for the management and investment of funds collected for the purpose of legal or supplementary pensions to be paid
- the pension fund must be acting on a noncommercial basis
- the pension fund must be tax exempt in its country of residence
- the pension fund may not be under a contractual obligation to transfer the income to entities which cannot themselves benefit from the exemption regime
The exemption is available via a quick refund provided the investor has a self-certification (referred to as an Annex 26 or Annex 29 by some local providers) on file confirming that the referenced requirements are met. If the required document is not on file, a reclaim can be filed, however, when filing a reclaim, the Belgian Tax Authorities require a certificate of residence (CoR) to accompany the reclaim.
The language of the Certificates of Residence (CoRs) issued to 81-100 group trusts is not deemed sufficient by the Belgian Tax Authorities to support eligibility for exemption. The Belgian Tax Authorities require additional documentation of 81-100 group trusts confirming their eligibility to avail of treaty benefits. The local market providers have agreed to accept a self-certification, along with the CoR, when filing reclaims for 81-100 group trusts.
Pursuant to the self-certification, the investor attests that “dividends are derived from assets invested in the framework of the basic activity of a pension fund to provide retirement benefits.” Furthermore, the investor undertakes to communicate to the Belgian Tax Authorities any amendments affecting the validity of the self- certification.
When filing tax reclaims in Belgium on behalf of our 81-100 group trust clients, BBH solicits the additional self-certification to accompany the tax reclaim.
The Danish Tax Authorities (SKAT) have been partially rejecting tax reclaims filed by U.S. trusts and group trust (such as Revenue Ruling 81-100 Group Trusts) for full exemption under the tax treaty between the two countries.
The tax treaty between Denmark and the U.S. provides for a full dividend withholding tax exemption for qualifying pension funds domiciled in the contracting states.
However, according to SKAT, such trusts, even in cases where they are comprised entirely of pensions funds or other tax exempt entities, do not meet the Limitations on Benefits (LoB) provision of the DTAT between the two countries. Consequently, investors are receiving partial refunds of 12 percent, pursuant to the standard dividend withholding tax rate specified in the DTAT.
Local providers met with SKAT to discuss these partial rejections and came away with the following:
- SKAT considers US trusts as beneficial owners of Danish shares that are entitled to dividend payments, however, according to SKAT, the trusts cannot be considered to qualify as pension funds, unless they are directly obligated to pay out pensions (regardless if the entity is entirely owned by tax-exempt pensions funds). SKAT arrived at this conclusion, solely based on its interpretation of the DTAT provisions between the U.S. and Denmark.
- SKAT has not considered the fact that group trusts are regarded as pensions funds in the U.S.
- SKAT has not consulted the Danish Ministry or any external advisor regarding reclaims involving pension trusts based in the U.S.
SKAT noted that there are instances where other tax authorities have made similar conclusions with respect to U.S. trusts, however, there are also instances where other tax authorities regard U.S. trusts as tax exempt. Some countries have entered into a Memoranda of Understanding (MoU) with the U.S. addressing exemptions for group trusts.
Investors that receive partial rejections on claims on behalf of a U.S trusts can raise an appeal to the Nation Tax Tribunal (Landsskatteretten).
BBH continues to file treaty based tax reclaims for full exemption on behalf of eligible pension funds, group trusts and pension trusts and will provide responses and/or requests for additional information immediately upon receipt. BBH is also working with the Association of Global Custodians (AGC) for potential solutions to this issue.
The Directorate General of Taxes (DGT) issued two tax treaty application forms which constitute a Certificate of Domicile (CoD), the DGT-1 and DGT-2. The DGT-1 Form is completed by treaty eligible individuals and nonbank institutions, while the DGT-2 is completed by bank institutions and pension funds. In order to be eligible to complete the DGT-2, the pension fund must meet certain criteria, including:
- being subject to tax in its country of domicile and
- if the title of the pension fund does not clearly indicate that the entity is a pension fund, additional documentation, such as articles of association and a pension fund declaration, must be presented along with the DGT-2 form to prove the legal status of the fund.
The tax treaty between the U.S. and Indonesia provides for a 15 percent withholding tax rate on dividend income and a 10 percent withholding tax rate on interest from bonds. In determining whether a group trust qualifies as a treaty eligible pension fund, Indonesian withholding agents have reached differing conclusion, which impact which DGT form the group trust should complete to pursue treaty benefits. The determining factor appears to be the language on the CoR issued to the investor. Investors that provide CoRs that state the they are a group trust should submit a DGT-1, while investors that provide CoRs that state that they are a pension fund, should submit a DGT-2. In situations where the group trust is not able to provide a DGT-1, and where the title of the investor does not clearly indicate that it is a pension fund, additional documentation is required to prove the legal status of the fund.
These additional hurdles have proven burdensome to 81-100 group trust investors.
Is the current language on Form 6166 causing treaty eligibility issues?
The language on the Form 6166 issued to group trusts has undergone some changes in the past years. An older version of the 6166 issued to group trusts used to state “I certify that, to the best of our knowledge, the above -named entity is a trust forming part of a pension, profits sharing, or stock bonus plan qualified under 401(a) of the US Internal Revenue Code, which is exempt from U.S. taxation under section 501(a), and is a resident of the United States for the purposes of US taxation.”
Over time the contents of the Form 6166 have changed to state “I certify that the above named fund is a group trust arrangement described in Revenue Ruling 81-100, and to the best of our knowledge, each participant is a resident of the United States.”
The current wording on the 6166 may imply to the foreign tax authorities that the group trust is not eligible for treaty benefits in its own right, but only to the extent of its participants being treaty eligible.
The IRS has expressed its willingness to consider proposals for revisions of the wording of the 6166. Such proposals are being provided and reviewed by the Association of Global Custodians (AGC), of which BBH is an active participant.
On February 29, 2016, the Organization for Economic Co-operation and Development (OECD) published a discussion draft titled, Proposed Changes to the OECD Model Tax Convention Concerning the Treaty Residence of Pension Funds. The Discussion Draft builds on the final version of the OECD’s Base Erosion Profit Shifting (BEPS) Report, Action 6 (Preventing and Granting of Treaty Benefits in Inappropriate Circumstances) where it was concluded that work needs to be done so that “… pension funds should be considered to be a resident of that State in which it is constituted regardless of whether the pension fund benefits from a limited or complete exemption from taxation in that State.”
Under the current version of the U.S. Model Tax Treaty, the definition of a pension fund requires that the fund be “operated exclusively or almost exclusively”:
- To administer or provide pension or retirement benefits; or
- To earn income from the benefit of one or more persons established in the same Contracting State that are generally exempt from income taxation in that Contracting State and that are operated exclusively or almost exclusively to administer or provide pension or retirement benefits;
The proposed definition of a “recognized pension fund” under Article 3, paragraph j), subparagraph (ii) of the OECD Model Tax Convention includes specific reference to group trusts, which may help in alleviating some treaty accessibility issues being experienced by group trusts or similar arrangements.
(ii) That is constituted and operated exclusively to invests funds for the benefit of entities or arrangements referred to in subdivision (i)
The commentary to Article 3, further expends on the term “arrangement” to include vehicles such as trusts.
The reference to an “arrangement” is intended to cover cases where pension benefits are provided through vehicles such as a trust, which under the relevant trust law, would not constitute an entity: the definition will apply as long as the trust or the body of trustees is treated for tax purposes, as a separate entity recognized as a separate person.
Another potential consideration is that group trusts can include Puerto Rican pension funds. While the US Model Tax Treaty requires the that the group trust be operated “exclusively or almost exclusively to administer or provide pension or retirement benefits,” which may be interpreted to allow participation by Puerto Rican pension funds in the group trust, the OECD Model Tax Convention does not make such reference in its definition of a “recognized pension fund.”
Once adopted, the Model Tax Convention will be reflected in future bilateral tax treaties, as well as multilateral instruments that would be implemented to facilitate BEPS.
In order to protect our client’s rights to a reduced withholding tax rates, BBH continues to file reclaims in markets where preferential tax rate opportunities are available to group trusts under the tax treaty between the two countries, should the tax authorities renegotiate the tax treaty.
BBH is an active participant in the Association of Global Custodians (AGC) which provides a forum for addressing issues which create impediments for our clients seeking treaty benefits and local law reduction opportunities.
At a recent meeting that took place between the AGC participants and the United States Competent Authority (USCA), the participants requested that the IRS confirm its position regarding treaty eligibility of 81-100 group trusts. Since many markets are seeking to look through the group trust to its underlying participants, it’s imperative that the IRS confirm whether its position is that an 81-100 group trust is a treaty eligible U.S. resident in its own right and the same must be reflected in the language of Form 6166.
For more information please contact your relationship manager or the Global Tax Services Group.
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