EIM75550 - The taxation of pension income: lump sums from foreign pension schemes

Overview
Taxable amount of the lump sum

Overview

Section 574A ITEPA 2003

From 6 April 2017, certain lump sums are now taxable. These lump sums are paid to, or in respect of, a member of a foreign pension scheme which is not one of the following:

  • a registered pension scheme
  • a relevant non-UK scheme (RNUKS)
  • an employer-financed retirement benefits scheme (EFRBS) established in the UK

These lump sums are called ‘relevant lump sums’. A lump sum will be taxable under section 574A only if the member is UK resident or, if the member has died, they were UK resident immediately before their death. This includes cases where the beneficiary is not themselves resident in the UK.

Most commonly a payment will be a relevant lump sum if it is paid to or in respect of a UK resident member under either an EFRBS or a personal pension arrangement established outside the UK.

Where a third party arrangement is used to provide a relevant lump sum, payment of the lump sum is excluded from being a relevant step under Chapter 2 of Part 7A ITEPA by section 554S (see EIM45610); the charge to tax under Part 9 ITEPA 2003 takes precedence.

If the payment is not taxed in the UK due to the operation of a double taxation agreement, it is a ‘relevant withdrawal’ for the temporary non-residence rules. The term ‘pension scheme’ has the same meaning as in section 150(1) FA 2004 (see PTM021000).

Relevant non-UK scheme (RNUKS)

The term ‘relevant non-UK scheme’ is set by paragraph 1(5) schedule 34 FA 2004. PTM113210 provides guidance on the definition of an RNUKS, but broadly it is a foreign pension scheme that has benefitted from at least one of the following UK tax reliefs:

  • on contributions
  • funds transferred in from a registered pension scheme
  • under section 307 ITEPA 2003

If a lump sum is paid under an RNUKS and the member payment provisions of schedule 34 FA 2004 do not apply to that payment, it will be a relevant lump sum under section 574A(2) ITEPA 2003. See the guidance at PTM113210 for information on the member payment provisions.

Employer-financed retirement benefit scheme (EFRBS)

Chapter 2 Part 6 ITEPA 2003

An EFRBS is a scheme or arrangement for the provision of benefits to or in respect of an employee or former employee, consisting of or including ‘relevant benefits’. For a definition of ‘relevant benefits’ and more information about EFRBS see EIM15000 onwards.

Where a payment is made under an EFRBS to a non-UK resident (other than in respect of a deceased UK resident member), consider whether either Chapter 2 Part 6 or Part 7A ITEPA 2003 (see EIM45000 onwards) will apply.

Taxable amount of the lump sum

Section 574A(3) to (6) ITEPA 2003

The starting point is that 100% of the lump sum payment will be taxable, subject to the 3 steps at section 574A(3) under which a reduction of the taxable amount of the lump sum may be available.

Step 1 provides for a deduction from the lump sum in respect of the commutation of rights to receive pension income on which no liability to tax arises by reason of an exemption in Chapter 17 Part 9 ITEPA 2003. For details of exemptions see EIM75080.

Step 2 provides for a deduction in relation to lump sum rights built up in a pension scheme before 6 April 2017. The deduction is limited to the value of the rights immediately before that date and does not include any investment growth thereafter. The precise application of this step depends on whether or not the scheme was an EFRBS immediately before that date; see Application of step 2 section below.

Step 3 provides for a deduction in respect of a lump sum payable under an overseas pension scheme where an amount would not be liable to Income Tax if it was paid under a registered pension scheme. For a definition of ‘overseas pension scheme’ and the conditions such a scheme must satisfy see PTM112200.

The member is assumed to have all or part of their lifetime allowance available for the purposes of determining whether or not the lump sum could be paid by a registered pension scheme. For information on the taxation of lump sums paid under a registered pension scheme see EIM75420 for payments to members and EIM75620 for payments to beneficiaries following a member’s death.

Application of step 2

Scheme was not an EFRBS immediately before 6 April 2017 (for example, a personal pension scheme)

Following any deduction under step 1, deduct from the remaining lump sum the value immediately before 6 April 2017 of the rights specifically to receive benefits by way of lump sum payments. These are rights which:

  • accrued before 6 April 2017
  • specifically to receive benefits in the form of a lump sum (or lump sums)

The term ‘rights’ includes both actual and prospective rights accrued before 6 April 2017.

The right to receive benefits by way of lump sum payments includes both actual and prospective rights held:

  • unconditionally
  • under a member’s election
  • at the option or direction of the trustee of the fund (where applicable)

The detailed time-test for whether the member had such a right to receive a lump sum payment (whether by explicit provision, by election, by trustee’s option or by discretion) is that the right to receive a lump sum either:

  • could have been exercised at 5 April 2017
  • could have been exercised at that date had the member met the necessary conditions (for example, around age)

For the purposes of this test, it does not matter if:

  • the right is exercised later
  • the lump sum includes growth occurring after 5 April 2017 (the value of the growth is not included in the step 2 deduction)

Scheme was an EFRBS immediately before 6 April 2017

Following any deduction under step 1, a deduction from the remaining lump sum may be available in respect of pre-6 April 2017 ‘reckonable service’ that is ‘foreign service’.

In this context, ‘reckonable service’ is service in respect of which the lump sum rights accrued. This may include rights accrued in the service of one or more employers and rights originally accrued under a different EFRBS.

The definition of ‘foreign service’ for this purpose is given by section 395C ITEPA 2003 (see EIM15325).

A deduction of the full 5 April 2017 value of the pre-6 April 2017 lump sum rights may be deducted where:

  • foreign service makes up at least 75% of the pre-6 April 2017 reckonable service
  • the period of pre-6 April 2017 reckonable service exceeds 10 years, and all of the last 10 years of that period is made up of foreign service
  • the period of pre-6 April 2017 reckonable service exceeds 20 years and at least half of that period, including any 10 of the last 20 years, is made up of foreign service.

Where none of the above criteria are satisfied, a partial reduction is available for the ‘appropriate fraction’ of the value of the pre-6 April 2017 lump sum rights. The appropriate fraction is given by multiplying the value of these rights by the formula:

F ÷ R

Where:

  • ‘F’ is the period of pre-6 April 2017 reckonable foreign service
  • ‘R’ is the period of pre-6 April 2017 reckonable service

Examples

Note that these examples are designed only to illustrate the operation of step 2 of section 574A(3) and do not consider scenarios where a deduction might be available under either step 1 or step 3.

Example 1: scheme was not an EFRBS immediately before 6 April 2017

Tom is UK resident and in November 2017 receives a lump sum payment of £150,000 from his overseas personal pension scheme, to which he has been contributing for several years. This scheme does not meet the conditions to be an overseas pension scheme within the meaning of section 150(7) FA 2004.

At 5 April 2017 the value of Tom’s lump sum rights under the scheme was £130,000 and there has not been any growth on that fund value since that date.

The starting point is that the full amount of the relevant lump sum (£150,000) will be taxable as foreign pension income. However, a deduction is available under step 2 in respect of the value at 5 April 2017 of the rights accrued before 6 April 2017 specifically to receive benefits by way of lump sum payments (£130,000). The taxable amount of the lump sum will therefore be £20,000 (£150,000 − £130,000).

Example 2: scheme was an EFRBS immediately before 6 April 2017

Judy worked in the UK from 6 April 2006 to 5 April 2009. From 6 April 2009 to 5 April 2013, she worked at the same employer’s USA office, during which period she was not UK resident. On 6 April 2013 she returned to live in the UK and resumed working at the UK office until her retirement in November 2017. During the entire period of her employment, the employer made contributions to a Jersey-based pension scheme. This scheme was an EFRBS immediately before 6 April 2017 and remains so. On her retirement, Judy takes her benefits from the scheme in the form of a lump sum payment of £500,000. The value of her pre-6 April 2017 lump sum rights at 5 April 2017 was £400,000.

[Note that the employer contributions to the scheme on or after 6 April 2011 would be a relevant step under Part 7A ITEPA 2003 (see EIM45000 onwards). However, to maintain the simplicity of the example, the tax implications of this are not considered further here.

The starting point is that the full amount of the relevant lump sum (£500,000) will be taxable as foreign pension income. However, a deduction is available under step 2 in respect of the amount of the lump sum that can be attributed to pre-6 April 2017 reckonable service that is foreign service. Assuming that all of Judy’s service counts as reckonable service, we first need to establish if one of the tests has been met for a full reduction to be available, those being:

  • foreign service makes up at least 75% of the pre-6 April 2017 reckonable service
  • the period of pre-6 April 2017 reckonable service exceeds 10 years, and all of the last 10 years of that period is made up of foreign service
  • the period of pre-6 April 2017 reckonable service exceeds 20 years and at least half of that period, including any 10 of the last 20 years, is made up of foreign service

In this case the total period of pre-6 April 2017 reckonable service is 11 years (6 April 2006 to 5 April 2017) and the total period of foreign service is 4 years (6 April 2009 to 5 April 2013).

None of the conditions have been met for a full reduction, but a partial reduction will be available. The amount of the reduction is the appropriate fraction of the value at 5 April 2017 of the pre-6 April 2017 lump sum rights:

£400,000 × 4 ÷ 11 = £145,455

The taxable amount of the lump sum will therefore be £354,545 (£500,000 − £145,455).