Changes to Approved Retirement Funds (ARFs) for non-Irish residents

Background

The Approved Retirement Fund regime was introduced in Ireland in 1999. Income from Approved Retirement Funds (“ARFs”) for non-Irish residents was historically treated by Irish Revenue as pension income for the purpose of the Double Taxation Agreements (“DTAs”) that Ireland had in place.

The OECD model for DTAs directed that pensions were taxable in the country where an individual was deemed resident under the DTA.

What this meant was that no PAYE deductions were made in Ireland, and all taxing rights rested with the country where the individual was resident.

Income from an ARF is different to pension income in that there is greater flexibility provided to taxpayers in relation to how and when they take ARF distributions - this created challenges to the DTA model for pension taxation. 

Individuals who move abroad for their retirement typically suffer foreign tax on their ARF distributions in the same way as other pension income. In the past, as no PAYE was withheld in Ireland, there was no double taxation of this income. However, it was also possible for some individuals to become non-Irish resident on a temporary basis, encash their ARF in full (subject to the foreign tax regime) and return to Ireland without incurring Irish tax on return.

One way to prevent individuals benefiting from ‘temporary non-resident’ would be to introduce anti-avoidance such that any individual who returned within 5 years would suffer Irish tax on their return.

This change was not legislated for and instead, to protect the Irish tax base, Revenue updated their guidance under the Revenue Pension manual which imposed obligations on Qualifying Fund Managers (“QFMs”) of ARFs to withhold tax on ARF distributions where the individual was resident in another country with which Ireland had a DTA.

The update to the Revenue Pensions Manual seeks to resolve the position where the DTA does not have a specific protocol dealing with ARF distributions.

Currently 3 DTAs - Germany, Pakistan and the Netherlands - have protocols dealing with ARF distributions so these provisions override Revenue practice. For interest, all of these DTAs give sole taxing rights on ARF distributions to Ireland.

Summary of the update

The update provides a number of confirmations around the treatment of ARFs for non-Irish residents:

• Distributions from an ARF should be broken down between the underlying income, capital gains or capital which it represents. 
• Income and Gains arising during a period of non-residence need to be identified separately to income and gains that arise whilst Irish resident for tax purposes. 
• The mixed fund principle should be applied to ARF distributions i.e. the distribution of income and gains is deemed to happen first; then capital if the income and gains are fully exhausted.
• The appropriate articles in the DTA should then be applied. Where there is no capital article in the DTA, any Irish tax charge that relates to a withdrawal of capital is not limited by the DTA. 
• As distributions from ARFs or AMRFs are not deemed to be pension payments, PAYE Exclusion Orders are not issued in respect of such distributions.

What does this mean in practice?

A non-Irish resident ARF holder will require their Qualifying Fund Manager (QFM) to split any ARF distribution between the income, capital gain and capital parts. 

These components will suffer tax in Ireland at source under the PAYE system, but based on the Revenue Pension Manual update, the tax paid can be reclaimed as follows:

• Income or Capital Gains - tax paid in Ireland which relates to the withdrawal of income or capital gains which arose when the ARF holder was non-Irish resident can be reclaimed in line with the relevant DTA.
  
  These reflect gains in the underlying assets held within the ARF. “Income” needs to be split between dividends, interest, rent and other income for the purposes of the majority of DTAs.
• Capital - this reflects the balance of the ARF withdrawal based on the mixed fund approach. A non-Irish resident taxpayer may be in position to claim a refund of PAYE if there is a “capital” article in the relevant DTA.

Revenue’s Pension Manual update notes that where the DTA contains a capital article, a distribution from an ARF consisting of capital will generally be taxable in the country of residence (but that the text of DTAs are not standard with regard to capital articles).

The challenge that arises is that relatively few DTAs that Ireland has ratified includes a “capital” article, so in reality a limited number only of non-Irish resident ARF holders may be able to reclaim PAYE on the “capital” element of an ARF distribution.  

The responsibility for the reclaim of tax is likely to be for the individual ARF holder to resolve.

Does this resolve the issue?

There are some clarifications around points of detail that are required, however beyond that we would see a number of key challenges in operating the regime as outlined.

The first is administrative - each distribution from an ARF now needs to get split between dividend income, interest income, rental income and other income, capital gains and capital - and then by periods of Irish residence / non-residence, and this split needs to get tracked over time. The DTA for the country of residence is then considered to identify which country has taxing right across each of these elements. 

As can be seen, the record keeping effort that is required to operate an ARF correctly for a non-Irish resident policyholder is very onerous, certainly when compared to an ARF for an Irish resident. Most QFMs will not readily be in a position to provide the splits required and to track this through time.

Complicating the administrative position further is that a distribution from an ARF (i.e. the taking of an income) is the taxable event in Ireland. The country of residence may or may not consider that this is the taxable event for DTA purposes. This mismatch has the potential to create complications.

Adding to this, a further significant issue is that the Revenue Pensions Manual update reflects the position of Irish Revenue only. This is all predicated on Irish Revenue having adopted the position that distributions from ARFs are not payments of pension.

The challenge that can arise is where the country of residence does not adopt this position - and where that country assesses a distribution from an ARF as equivalent to a pension income. The challenge again is one of a mismatch between the Irish approach and the approach by the country of residence. 

In the worst case scenario, this would lead to an ARF distribution being taxed at source by the Irish authorities, with Ireland offering only very limited relief under the income, (capital) gains or capital article (if any) of a DTA - however the country of residence would assess the ARF distribution to tax in full by asserting it’s taxing rights under the pension article of the relevant DTA.

This could potentially result in no credit being available for any tax payable in the country of residence - and creating the potential for double taxation to arise, all of which is contrary to the objective of a DTA. 

Implications for global mobility programme pension benefits

As we see greater international mobility and as pension regimes become more flexible (for example the ARF regime in Ireland, Pension Drawdown in the UK), Revenue Authorities have become increasingly mindful of the cost of supporting the build-up of pension benefits through the provision of tax reliefs - versus the potential loss of tax income where pension benefits are drawn down in a lower tax regime. 

There can be heightened objections where drawdown of pension income is not taxed in the country where the fund was accumulated and is not taxed in the country of residence where the fund is being drawn down.  As an example, in 2018 the Finnish Parliament voted to denounce the Portugal-Finland DTA as a result of this situation arising - driven by the fact that no tax was applied to pension incomes of Finns who had moved residence to Portugal under that country’s Non Habitual Residence regime.

Looking closer to home, there are anomalous situations that exist across a range of DTAs. For example, a US 401(k) plan is not deemed a “pension” for the purposes of the Ireland / US DTA leading to uncertainty around the taxation treatment. A similar issue exists in the UK in relation to Canadian pension plans - however  in the UK / US DTA a 401(k) is defined as a pension, providing clarity.

Up to now, and as pension benefits are being accumulated, the issues have been largely in the background - albeit with exceptions, such as US assignees to Ireland who accumulate pension benefits, only to find that they are largely incompatible with the US taxation system and create unwelcome reporting obligations on their return to the US as well as proving tax inefficient. 

The significant challenge that now emerges is around the drawdown of benefits. Many of the issues are not new - but the frequency with which they are emerging is only now increasing as the internationally mobile population of workers matures and turns towards the drawdown of their pension benefits. 

For example, the US resident who worked for a period in Ireland, and who has suffered the administration and taxation challenges on an annual basis arising out of the Irish pension fund that they accumulated will now find that they are unable to access the ARF regime, due to the inability of a non-Irish resident to take out a policy with an Irish insurer. As such, the only option available may be to purchase an annuity.

Similarly there is now a growing number of employees who are returning to Ireland and seeking to draw down pension benefits accumulated overseas - with at times very negative outcomes arising. Again, challenges are prone to arise with US 401(k) benefits, and given Ireland’s close ties with the US this is an unhelpful result for increasing numbers of mobile employees. 

Final thoughts

The Revenue Pensions Manual update brings a form of clarify around Revenue’s view of the taxation of Approved Retirement Funds for non-Irish residents, however it heralds the introduction of what is a potentially highly complex administrative regime - and there will be jurisdictions that deliver very different outcomes to retirees drawing an income from their ARF, depending on the specific articles in the DTAs that are in place.

More widely, it is an example of a Revenue Authority seeking to play catch up on how pension funds were being accumulated and drawn down, in a world that has seen significant growth in international mobility over the last decade. This latest clarification may offer a call to action to review pension policies that apply to internationally mobile employees to ensure that they remain fit for purpose in 2020.