International mobility continues to increase, yet pensions do not seem to be a big concern. Employees typically continue to contribute to their state pension (social security) and occupational (company) pension where possible, but how are pensions taxed in different countries and why does double taxation often occur? This article covers the international tax challenges of occupational pensions.
How are occupational pensions taxed?
Where occupational pension plans meet certain conditions under the country's tax rules, favourable taxation is often available. These conditions typically relate to the pensionable base, the retirement age and the maximum contribution rate.
When discussing the taxation of pensions, it is good to distinguish three parts: (1) contributions to the pension plan, (2) returns on investment, and (3) distribution of pension benefits. Favourable tax treatment can mean tax-free employer contributions, tax-deductible employee contributions, tax-exempt returns on investment, and/or tax-exempt benefits. A favourable tax treatment typically applies to one or two of these parts, but some countries exempt all three parts (e.g. Bulgaria).
If an occupational pension plan does not meet the conditions for favourable tax treatment, the employer's contributions are generally considered to be taxable income and the employee's contributions are not deductible for income tax purposes. Additionally, the return on investment in these funds is most likely also taxed.
Most countries allow for an exemption of the pension contribution, if the plan meets the conditions stipulated in the country's tax law. The return on investment is mostly exempt as well. For these countries, the pension benefits will generally be taxed upon receipt.
Some countries tax the contributions, but exempt the returns on investment and the pension benefits (e.g. Czech Republic and Hungary). Other countries tax the contributions and the benefits, but exempt the returns on investment (e.g. Belgium and France). Other variations exist as well. The OECD published a report on the tax treatment of pension funds in 2015.1
Luxembourg allows for a deduction of employee contributions in a qualifying pension plan. The employer's contributions are subject to 20% tax, payable by the employer. The return on investment and future benefits are exempt from taxation.
International pension challenges
When employees move internationally, temporarily or permanently, they become subject to a different tax system. Because each country has its own set of rules, the pension plan from country A may not be entitled to a favourable tax treatment in country B. This can result in double taxation, where both the contributions as well as the benefits are taxed.
Each scenario has its own challenges. Someone moving permanently may want to consolidate his/her pension and transfer all funds to the pension plan in the new country. European rules impose minimum requirements on the preservation of pension rights. Nevertheless, countries can still impose restrictions and/or conditions. For example, the tax authorities may want assurances that the pension capital is not paid out too soon after the transfer. The administrative burden surrounding such a transfer of pension capital often discourages people from doing it. This is why for many countries this is, in practice, not a real option.
In cases of temporary assignments, the employee will most likely continue to participate in the home country's occupational pension plan. Oftentimes, however, the rules of the home country pension plan do not match the conditions for qualifying pension plans in the host country. As a result, the employer's contributions are considered taxable income and the employee's contributions are not deductible in the host country.
Some countries allow for so-called corresponding approval (e.g. the UK and the Netherlands). If the host country's tax authorities grant this corresponding approval, the contributions to the home country pension plan receive the same favourable tax treatment as contributions to a qualifying pension plan in the host country. Such approval is generally subject to anti-abuse provisions and limited in time (e.g. five years).
Most tax treaties allow taxation of occupational pension benefits in the country of residence. Very few tax treaties allow for taxation of occupational pension benefits in the country where the pension was (partially) built up. This means that if the pension contributions were taxed in the host country and the pension benefits will be taxed in the home country, double taxation occurs. Not many countries have provisions that provide relief from double taxation in these situations. Even when there are such provisions to provide relief from double taxation, the formalities are quite complex and require specialist tax advice. Companies usually only provide tax support with a specialist tax provider during the years of assignment. This is why double taxation is not mitigated in most of these international situations, even when it is possible.
Double taxation often arises when people temporarily move to a different country. Some countries have unilaterally taken steps to prevent it. Luxembourg could learn from these countries and, in doing so, further increase its attractiveness to internationally mobile employees. At the same time, employers who temporarily assign people abroad leave money with the tax authorities by not using double taxation relief when the employee retires.
By carefully planning and knowing how to claim relief from double taxation, tax savings can be realised. A specialist tax adviser and (pension) insurance specialist are recommended in these situations.
1 The tax treatment of funded private pension plans in OECD and EU countries OECD 29/10/2015
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.