Does HMRC ever apply the saving clause (Article 1.4 and 1.5)

After a number of posts about the UK taxation of US Government pensions by HMRC to get the current situation where a US citizen, resident in the UK is not taxed by HMRC on a US Government pension I have to conclude that HMRC ignores the saving clause. Is this correct?

Use of the savings clause by HMRC seems to be at least envisaged in principle. This is because Article 1 5 protects from the savings clause Article 17 1(b) and thereby prevents HMRC from using the savings clause to tax, "by reason of residence", US source IRA distributions paid to a UK resident, of a type which are US tax free.

But I cannot think of any example where HMRC use the savings clause to impose a tax "by reason of citizenship or residence" that would otherwise not be payable.

I have read people to say that the UK tax-free pension lump sum is US taxable. But it is hard to discover the reason for this and it looks as if tax advisors differ. It is surprisingly difficult to find any authority for the truth of the matter.

Someone put to me recently the plausible-sounding idea that the UK tax-free pension lump sum payment (perhaps soon to be abolished anyway) is not a lump sum in IRS definition because it is not a disbursement in a single year of the entire pension savings. Therefore it is not Article 17 2 which applies to such a disbursement, and which can be overridden by the savings clause. Rather Article 17 1 (b) applies and this is protected from the savings clause by Article 1 5, with the result that the US cannot tax the UK tax-free pension lump sum payment.

Use of the savings clause by HMRC seems to be at least envisaged in principle. This is because Article 1 5 protects from the savings clause Article 17 1(b) and thereby prevents HMRC from using the savings clause to tax, "by reason of residence", US source IRA distributions paid to a UK resident, of a type which are US tax free.

But I cannot think of any example where HMRC use the savings clause to impose a tax "by reason of citizenship or residence" that would otherwise not be payable.

In the case of 17.1.b HMRC does not tax US tax free "pension" income when paid to a UK resident and example is ROTH payments made to a UK resident. A straight reading of the article produces the current UK tax situation. There is no need for the saving clause or exception to it. So it looks to me as if HMRC simply ignores the saving clause (leaving that to the US to apply) and allows all of the treaty to be directly applied.

Someone put to me recently the plausible-sounding idea that the UK tax-free pension lump sum payment (perhaps soon to be abolished anyway) is not a lump sum in IRS definition because it is not a disbursement in a single year of the entire pension savings. Therefore it is not Article 17 2 which applies to such a disbursement, and which can be overridden by the savings clause. Rather Article 17 1 (b) applies and this is protected from the savings clause by Article 1 5, with the result that the US cannot tax the UK tax-free pension lump sum payment.

Yes that's something that I've thought about. Additionally you no longer have to take the  25% tax free amount in one payment. You can do regular income drawdown and stretch the payment out over a number of years with 25% of it being tax free. So Article 17.1.b would apply there.

However, the saving clause is only needed to get this result for any US tax liability.

The option to take the 25% tax-free in income drawdown is not available in some pension schemes. In Universities Superannuation Scheme, for example, you must take the 25% lump sum at retirement or not at all. There is no possibility to stretch it out over several years.

However, the saving clause is only needed to get this result for any US tax liability.

I don't understand what you mean by the above. The reason we want Article 17 1(b) to rule over the lump sum (rather than Article 17 2) is that this is protected from application of the savings clause by Article 1 5, whereas Article 17 2 is not so protected.

The option to take the 25% tax-free in income drawdown is not available in some pension schemes. In Universities Superannuation Scheme, for example, you must take the 25% lump sum at retirement or not at all. There is no possibility to stretch it out over several years.

I don't understand what you mean by the above. The reason we want Article 17 1(b) to rule over the lump sum (rather than Article 17 2) is that this is protected from application of the savings clause by Article 1 5, whereas Article 17 2 is not so protected.

The pension situation in the UK is ridiculous and the application of the new pension reforms is spotty. Many times pension companies will say something is not possible because they don't have a mechanism to do it. If you push you might get some joy. If your USS is final salary it's more difficult and it's often a good benefit to keep, and in that case I would not take the 25% tax free amount, but would use it to increase the pension and then claim the tax free amount on the income side. If it's a DC pension some offer flexible drawdown where you take the 25% tax free amount and are allowed (that makes me smile) to invest the remaining money in funds for drawdown rather than buying an annuity.

Regarding the saving clause and the 25% tax free amount. If we can get 17.1.b to apply, we only need to apply the exclusion to the saving clause for US tax purposes, it's already tax free in the UK so the saving clause is moot for the UK.

A quick post to agree with comments from RW on UK schemes.

Although retired, I still receive the yearly pension letter stating the position of the funds, latest news, etc. This is not some small 1000 person pension scheme. It's a large company scheme. As I remember from recent letters:

The scheme, although still allowing the 25% lump sum on retirement, will not issue the lump sum in segments. Take it now, and take all 25%, or forget it and take an increased pension payment.

The scheme also refused, upon an individual retiring, to give back 100% of the pension in one payment. The fund would remain as now, allowing the 25% tax free lump sum payment, and/or issuing standard pension monthly payments until death.

The compliance of UK pension schemes with the new pension legislation is highly variable. Having worked only in the USA (unless you include two summers working for British Steel on the Redcar blast furnace and one for ICI) I'm amazed at the restrictions UK pension companies impose with a straight face. It should be possible to move your pension to one that offers more flexible withdrawals where you have the cash drawdown options. But I've heard that pension companies often ignore such requests, resort to"computer says non" responses or charge very high fees. FYI with all its failings I prefer the liberal US system where you can move money between defined contribution plans with a simple phone call. I moved money from a company 401k plan to an IRA with one phone call and an single form at zero cost.


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It's a mixed bag, nun.

I hired in about 28 years ago. There were two schemes on offer, one with higher monthly deductions, and one with less. They were the standard British pension schemes (defined benefit) where there is a pension department with the funds going into a pension trust. The trust is standalone. The trust hires a group of investment consultants to invest the funds. When you retired, you were paid by funds from the trust.

About 8 years ago the scheme was split (I'm fuzzy on this since I had already retired and didn't really care about what was happening for those still employed). New hires were offered the chance to join the existing scheme, or they could opt for various other types of pensions. The new hires who opted into the existing scheme went from a defined benefit pension to a defined contribution pension. I seem to remember there were also stakeholder/SIPP type offerings which were under limited company control.

Today, you have the remnants of the old scheme (defined benefit, and now defined contribution) combined with those new to the company on the new type schemes.

The restrictions in my previous post apply to the old scheme (those under the trust). New employees now have the options similar to what you are discussing is the norm in the States. I always stay out of conversations on this site when newly arrived US people talk of pensions from an UK employer. These days, it could be one of many 'types' of pensions, and each scheme seems to have small variations as to how the scheme is controlled.

For the scheme I'm familiar with, it's a transition period. Those who hired in 30 - 40 years ago are being held to the scheme rules in the previous post (financial expediency, I presume, to keep the trust fully funded). But, you have some new hires who now control their own pensions and in reality (I assume) the company doesn't really want to know about it. If I remember correctly, it was around 1975-80 when US company schemes started to change to the (new then) IRA type schemes and away from the old defined benefit schemes. Today, are there any defined benefit schemes left in the US? They are rapidly fading in the UK.

The new legislation (take the money and run upon retirement) appears to only actively apply to schemes where, instead of going into a standalone perpetual trust, the funds were required to be changed to an annuity (variable according to the economy at the time)upon retirement, so completely different to the traditional defined benefit pensions. With the current economy appearing destined to remain tight, the requirement to have an annuity became a penalty , and the Chancellor proposed the new 'take the money and run' option to appease those unhappy with the situation.

For someone such as yourself who is knowledgeable and proactive on investing, the US system works well. For those less inclined to be involved in investing, the old system worked well. The problem today is for those who are reticent to become involved, but are in the new US type schemes. Then Osborne throws in the wobbly 'go buy a new Roller' instead option.

Sorry for the rambling. DR:TL     

I can see the old defined benefit schemes having restrictions and it's often best to stay in those even when the company offers a lumps sum buy out. I don't think that the defined contribution self investing approach is better than a well run traditional pension scheme, however, many of those traditional pensions have been very poorly managed. I've recently bought into a US defined benefit pension scheme and it will be a good deal if I live long enough. However, I have kept money self invested in US IRAs to give me some flexibility.

But beyond all that what is you opinion about HMRC's application of the saving clause, does it completely ignore it?

But beyond all that what is you opinion about HMRC's application of the saving clause, does it completely ignore it?

I doubt very few outside HMRC know the precise answer to that question.

HMRC deal with civilised countries all over the world where what an Article in a treaty says is what it means. I suspect this is HMRCs approach to all situations, unless the unique US-centric saving clause could be used for a specific purpose, a tool, when attempting to nail a particular individual where the saving clause would be of value. I personally doubt, because one strange sect in the middle of the North American continent decides to wield 'Old Testament' wrath against those who dare leave its shores, that HMRC would take any other approach than 'what a treaty says is what the treaty means'. I doubt they ever think about the saving clause in normal circumstances. But again, I know nothing.

The reply you received from HMRC, as shown in the other thread, appears to confirm this. What I don't understand is your last sentence in that post:
"Also I know of situations where a UK Government pension paid to a US/UK dual citizen resident in the UK is also not taxed by HMRC."

http://talk.uk-yankee.com/index.php?topic=86988.90
   

Yes sorry I got my UKs and USs mixed up that sentence should read

"Also I know of situations where a UK Government pension paid to a US/UK dual citizen resident in the US is also not taxed by HMRC."

This (and the no UK tax status of US Government pensions paid to US citizens living in the UK) leads me to the conclusion that HMRC ignores the saving clause. It would obviously be irrelevant for CBT, but the "residence" bits would seem to be sensible to apply.

The following may be of interest to RW in connection with the US taxation of lump sum pension payments made from US pension funds to UK residents.

At the time of the issue of the 2001 UK US Double Tax treaty, the US Treasury released a detailed Technical Explanation. The following related to Article 17(2).

“Paragraph 2 is intended to deal with a particular type of double non-taxation that arose under the prior Convention because the United Kingdom does not tax lump-sum distributions from pension funds. Under the prior Convention, a lump-sum payment was treated in the same way as any other pension, and was taxable only in the country of residence of the beneficial owner. Accordingly, a person who anticipated receiving a lump-sum distribution from a US pension scheme with respect to employment in the United States could avoid US withholding tax on the distribution by establishing residence in the United Kingdom for the year in which he received the distribution.  The person would not be subject to tax in either the United States or the United Kingdom with respect to the lump-sum distribution, resulting in a significant windfall.

Paragraph 2 prevents this unanticipated benefit by providing that, notwithstanding the exclusive residence-country taxation of paragraph 1, any lump-sum payment derived by a resident  of a Contracting State from a pension scheme established in the other Contracting State shall be taxable in that State.”

I am aware of this, but it does not really tell us anything about whether or not the US is allowed to tax a lump sum paid from a UK pension, received by a UK resident US taxpayer. Does it?