FATCA: Why the Isle of Man is a Magnet for International Pension Plans

 As the dust settles on the US introduced Foreign Account Tax Compliance Act (FATCA) regime, we can now consider just how the new legislation affects IPPs.

Employers with IPPs based in any jurisdiction should be looking at this topic as a matter of urgency, and engaging the services of their employee benefit consultants, accountants or lawyers to determine what course of action is required to secure the future of their IPPs.

IPPs are normally established by multinational employers to provide benefits for mobile, expatriate and globally based employees where the use of a domestic plan is either not possible or is uneconomic. IPPs are normally domiciled in jurisdictions that have the right tax legislation and oversight regulation in place to administer such plans.

One of the most popular homes for such plans is the Isle of Man, a self-governing UK crown dependency situated in the Irish Sea between Great Britain and Ireland, because it is one of the largest and most respected International Finance Centres as evidenced by reports issued by the International Monetary Fund and the Organisation for Economic Co-operation and Development. The Island has also been commended for its position on tax transparency and compliance and was the first jurisdiction to sign up to both the US and UK FATCA and has long been praised by the OECD for its compliance and action to combat tax evasion.

Through FATCA, the US introduces another layer of tax revenue protection by applying the legislation to Foreign Financial Institutions (FFIs). FFIs include banks, fund managers, brokers, custodians, trustees and credit unions to name but a few. FFIs effectively become reporting agents on behalf of the IRS. When you couple this with the reporting requirements which already exist for US individuals, it produces a much more robust regime.

Most countries around the world have entered into Intergovernmental Agreements (IGAs) with the US. IGAs take the form of a model agreement, either a ‘Model 1’ or ‘Model 2’. Model 1 agreements result in FFIs reporting to their local Government, whereas Model 2 agreements result in FFIs reporting directly to the IRS, something which is considered much less attractive by sponsoring employers of IPPs.

Both types of model agreement can provide for IPPs to potentially be exempt from reporting under FATCA. Each country agreement can have specific exemption criteria which must be met for an IPP to be exempt. Below we look at the model agreements which have been signed by four key jurisdictions where IPPs are domiciled, the Isle of Man, Jersey and Guernsey (Channel Islands) and Bermuda.

The three islands located in close longitude all signed Model 1 agreements with the US. The key requirements an IPP must be able to meet under a Model 1 agreement to be exempt under FATCA (termed ‘Broad Participation Retirement Fund’ under Annex II of the agreements) are as follows:

1. The plan is established to provide retirement, disability, or death benefits, or any combination thereof to employees in relation to past service with the employer.

2. The IPP does not have a single beneficiary with a right to more than five percent of the plan’s assets;

3. The IPP is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities; and

4. One of the following conditions is satisfied by the IPP:

• The fund is generally exempt from tax on investment income under the laws of the country due to its status as a retirement or pension plan;

• The fund receives at least 50 percent of its total contributions (other than transfers of assets from other) from the sponsoring employers;

• Distributions or withdrawals from the fund are allowed only upon the occurrence of specified events related to retirement, disability, or death (for transfers), or penalties apply to distributions or withdrawals made before such specified events; or

• Contributions by employees to the fund are limited by reference to earned income of the employee or may not exceed $50,000 annually, applying the rules set forth for account aggregation and currency translation.

It is relatively straight forward for an IPP to meet the requirements of 1 and 4a above, they are very much matter of fact, and all three islands should be in a position to tick these boxes. Point 2 is a test that applies on a plan by plan basis, and our experience shows us that most IPPs will not have a single member who owns more than five per cent of the fund. The difficult part to interpret is point 3.

The Isle of Man is quite unique amongst the four jurisdictions considered here in the fact that it has a dedicated pensions regulator in the form of the Insurance and Pensions Authority (IPA). The IPA was established in 1986 as the Insurance Authority, and in 1997 was renamed to the IPA when its supervisory remit was extended to include pensions. Since 2001 any IPPs domiciling on the island have benefitted from the additional security that a true regulator offers. Isle of Man schemes are therefore in a good position in relation to the first part of point 3.

Point 3, however, has two parts, the second being that plans must report to their local tax office on an annual basis. The Isle of Man has the relevant practice in place and is able to meet this requirement. The combination of regulation and reporting means that the Isle of Man fully meets the requirements of point 3.

Another historic player in the IPP space is Bermuda, also a British Overseas Territory, albeit with a much warmer climate than the other islands previously referred to! Bermuda, however, has taken a very different approach to FATCA, by signing a Model 2 agreement. So far very few countries have taken this direction.

After analysis of the Bermuda agreement, it is evident that the only types of plan domiciled in Bermuda that could potentially be exempt are those for local residents. This means that any other type of plan, including an IPP would not be capable of being exempt. In addition, because Bermuda has signed a Model 2 agreement, any reporting is to be made directly to the IRS as opposed to via a local tax office. Any IPP based in Bermuda has therefore been left out in the cold by the Bermudan Government, and already IPPs are starting to emigrate due to the significant costs and risks that have been introduced by choosing the Model 2 agreement.

The following table gives a summary of the differences between the four key players in the IPP market:

As can be seen from the table, the Isle of Man has a very compelling IPP proposition, with a dedicated regulator ensuring schemes and those providing services suitably experienced and qualified. In addition, plans are domiciled in an environment where sponsoring employers can be happy that not only current FATCA exemptions can be met, but also those laid out by the Common Reporting Standard (CRS) blueprint.

If a plan has been established as a discretionary trust without seeking formal tax approval of the plan as a retirement benefits scheme (as is often the case for plans established in the Channel Islands), then further care is required. If an IPP is operating on this basis, there is currently no route to an exemption under FATCA, and employers need to carefully consider the implications of this.

Employers with IPPs based in any jurisdiction should seek advice to determine what course of action is required to secure the future of their IPPs.

Multinational employers looking for a mature, regulated, compliant FATCA jurisdiction, which also has an eye on the introduction of the new OECD Common Reporting Standard (the future of global automatic exchange of information), should give serious consideration to the Isle of Man as a place for domicile. The island is a ‘one stop shop’ for pension services, with everything needed to operate IPPs available from locally based providers.