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The tax management of international pension plans - striking the balance

The tax management of international pension plans - striking the balance
15 Jul 2013
Multinational corporations are required to participate in a large number of statutory pension plans imposed by countries with respect to employees working in their territory. Statutory coverage typically includes old age, death and disability benefits.

Specific mandatory industry pension schemes may also be applicable, for example under collective bargaining agreements. In addition to required statutory coverage, additional company-specific supplementary pension benefits are widely used to provide enhanced remuneration to employees and to retain and incentivise key executives. Taxand’s Global Compensation Tax team investigates the pension plans on offer in various jurisdictions, and the tax benefits of these for multinationals.

Employer-provided supplementary pension plans come in various forms. In most cases, the tax treatment of the supplementary plan is a decisive factor when choosing how to structure the coverage. In most jurisdictions, qualifying plans entitle the employer to claim a corporate tax deduction upon payment of the contributions, whereas employee taxation is deferred until payment of the benefits. In some countries, benefits related to qualifying plans also include tax exempt accrual of investment proceeds within the pension fund, and reduced tax rates for employees. On the other hand, benefits paid out of a qualifying pension plan are usually taxable in that country, whether or not the beneficiary is resident there upon delivery of benefits.

The requirements for a pension plan to qualify for favourable tax treatment vary between countries. For example, in the United States, the funds in a qualifying retirement plan must be held in a trust organised and maintained in the US. This requirement makes most foreign pension plans tax inefficient for US citizens. In addition, the US qualifying plan must satisfy many complicated requirements set forth in Internal Revenue Code section 401(a) including coverage of a broad cross-section of employees, satisfaction of complicated non-discrimination requirements, and individual benefit limitations in order to qualify for favourable tax treatment. 

In Spain, the combination of corporate income tax deduction and employee tax deferral can be achieved through pension plans. Collective insurance contracts are equally attractive for the employee but the corporate income deduction is postponed until distribution. However, they are widely spread due to their increased flexibility, allowing  for the discriminatory treatment of employees and unlimited contribution amounts. In Switzerland, employees benefit from reduced tax rates if they elect to withdraw their benefits from a qualifying plan as a lump sum, instead of as periodic payments. In South Africa, there are no compulsory statutory pension plans to participate in. Approved plans have to comply with legislative requirements, the tax treatment of which depends on the type of pension plan. Across jurisdictions, the design of the additional pension coverage is crucial in order to meet these requirements. The factors typically considered include contribution basis and amounts, definition of collective employee groups, terms under which the premiums are allocated to employees and paid out of the plan, as well as location of pension fund.

For multinationals, the different requirements for tax-efficient pension plans across jurisdictions often render the use of one single international pension plan virtually impossible. If the number of involved countries is small, it may be possible to negotiate country specific variations to a single insurance policy issued by the same insurance company or pension fund.  In most cases, however, personnel located in one country will have a pension coverage designed for that location only. The use of non-qualifying pension plans leads to additional cost for the company, and should in most cases be avoided. The use of additional pension coverage, as a means of incentive, is often restricted by anti-discrimination rules and the requirement for equal treatment in employment legislation, which further reduces the available options. For example, qualifying collective pension plans where the group of insured persons only includes one individual (eg a CEO) are allowed in Spain, but usually not in countries like Belgium, Finland, Netherlands, Sweden or the US.

Today, employer provided pension coverage is typically organised as a defined contribution plan or as a defined benefit plan. In the former, the insurance policy or plan document specifies the amount of contributions, but not the level of final benefits that will be paid to the employee. The employer’s liability is capped to the amount of contributions and related social security payments, and future benefits fluctuate on the basis of investment earnings. In defined benefit plans, the employee is guaranteed a certain benefit level upon retirement. Although this type of plan may provide better incentive for the beneficiary, they may lead to unpredictable compensation costs for the employer. Historically, some of the worst examples of excessive executive compensation and unexpected employer liabilities have involved defined benefit plans. It follows that in corporate acquisitions, defined benefit plans should be carefully looked at by the purchaser in connection with due diligence work.

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Taxand's Take

In today’s labour market, more and more white collar employees require good pension benefits in addition to the statutory coverage. The use of company specific pension plans isno longer limited to top executives, but spans across employees in various jurisdictions. The employer may even be required to take out additional pension coverage, for example as a result of collective bargaining agreements. When designing and implementing pension plans, whether internationally or locally, the tax consequences should be among the first issues considered. A pension plan that qualifies for favourable tax treatment both in the hands of the employer and in the hands of the employee offers better a incentive for the employee and lower cost for the company.

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