Cross-border pension provision with reference to the USA, for example

It is generally known that the global mobility of employees and capital investors or even cross-border family ties are not always privileged for tax purposes. All the more reason, therefore, to ensure that international situations are coordinated in advance so as to achieve balanced overall taxation. In this context, it is important to classify specific asset structures and investment forms appropriately and to work towards a coherent tax treatment in the tax jurisdictions concerned.

This applies in particular to obtaining a benefit from U.S. pension plans. Since many German employees are transferred or seconded to a U.S. company or family members resident in the U.S. also subscribe to such pension plans, their cross-border treatment may also be relevant for German tax law. U.S. retirement plans are often offered by U.S. companies in the form of deferred compensation/wage conversion for more senior employees and form part of a new salary package offered by the employer. This can be advantageous to the employee in several ways. On the one hand, the U.S. offers tax advantages for certain pension models such as selected fund savings plans, and on the other hand, these pension plans often offer good interest rates for long terms.

According to the basic concept of pension plans, the employee waives payment of part of his income and has the contributions paid into the pension plan. In the USA, the tax incentive is that the contributions constitute deductible business expenses for the employer (virtually as wages) and tax-deductible expenses for the employee. Furthermore, the income on the paid-in capital, for example at the level of the fund/investment assets, is not subject to taxation. However, scheduled payouts are then taxed (downstream) as normal income.

To qualify for this preferential treatment, retirement savings plans must meet a number of requirements. For example, as special assets, the savings plans may only be held and managed by a dedicated insurance trust. Failure to comply with the eligibility requirements will result in adverse tax consequences. However, the beneficiary may be granted the right to also restructure the investment forms (so-called rollover). Widely used forms of these retirement plans are the so-called 401 (k) plans or Individual Retirement Accounts, or IRAs for short. As a result, these pension plans always lead to the concept of deferred taxation that has been established in Germany.

It now appears questionable how these pension plans or payments from them are taxed in Germany, for example if the beneficiary has moved back to Germany. Particularly when determining the tax consequences in cross-border situations, the exact constellation of the individual case is important. For this reason, the possible different tax consequences will be illustrated on the basis of two examples. An appeal is currently pending before the Federal Fiscal Court (BFH X R 29/18) on the question of the taxation of a payment from a pension plan; the Cologne Fiscal Court had issued a ruling favorable to the taxpayer in the proceedings at first instance.

A German national worked for an American employer from 2005 to 2011 and had also moved his place of residence to the USA for this purpose. The US employer allowed participation in a 401 (k) plan. During the savings phase, the plaintiff did not have to pay tax on the converted salary in the USA. After returning to Germany in 2011, the plaintiff had the retirement benefit paid out as planned. The tax office now took the view that the period of contribution payments would have to be treated as a German tax-exempt accumulation phase, with the result that the entire benefit paid out would be subject to German pension taxation. However, the taxpayer was able to prevail with his legal opinion before the Cologne Fiscal Court that only the surplus from the payout minus his contributions would be subject to German pension taxation. The taxpayer thus obtained a double tax advantage. On the one hand, his contributions during his stay in the U.S. were exempt, and on the other hand, only the surplus was now subject to pension taxation in Germany. The outcome of the appeal proceedings will show whether the plaintiff will retain this advantage.

However, serious negative legal or tax consequences can also quickly arise if asset planning is lacking or inadequate. The following example illustrates this:

A U.S. citizen had subscribed to two IRAs with his employer during his service and made contributions to them. Since he still received income from other sources, the payout benefit was not drawn down during his lifetime. He named his two children as beneficiaries of one IRA each, one child being a resident of Germany. The U.S. citizen died and bequeathed half of his assets to each of his two children. When an IRA was called, the child living in Germany discovered that U.S. withholding tax was to be withheld first. However, the German tax authorities wanted to subject the entire payout amount to German pension taxation without crediting the withholding. Since no survivor exemption applies to the German taxpayer as a child of the decedent, German inheritance tax is also to apply to the gross payout amount.

This unfavorable tax situation could have been improved by the child receiving other assets in the course of the inheritance instead of the benefit from the IRA. The testator could then at least have avoided the triggered double burden of income tax and inheritance tax.

The legal and tax treatment of certain types of assets may be complicated enough in itself, as shown above. However, when it comes to handling cross-border investments, a certain degree of professionalism and experience is also required in terms of how to establish contact and deal with foreign asset managers or banks, for example. Experience shows that in an inheritance case, it is important right from the start of the asset settlement process to demonstrate to the foreign parties involved your own competence in dealing with the legal tax issues. PSP is frequently active in cross-border issues of asset succession and the inflow and outflow of private clients, and will be happy to advise you in this regard.