How Tax Treaties Impact Pension, Social Security & Public Service

How Tax Treaties Impact Pension, Social Security & Public Earnings

Tax Treaties Impact Pension, Social Security & Public Earnings

When it comes to the United States entering into international tax agreements with foreign countries, three (3) of the most common and important provisions of the tax treatiess for individuals, include taxation of Pension Income (Private and Public); Social Security Income, and Public/Government earnings. In a common tax situation, a resident of one country resides in the other country (aka contracting state) and receives income which may be taxed differently in the resident country then it would have been taxed in the country of source. The tax treaty serves to bring some continuity to the tax rules, noting the Saving Clause‘s omnipresent impact on how certain provisions of the tax treaty applies to residents and citizens of either of the two countries who are parties to the agreement. While many international income tax treaties have vert similar in their verbiage — they are not always identical to one another. Thus, it is important that taxpayers evaluate each specific treaty that impacts their tax situation — and not just presume that just because one tax treaty provides a tax rule (residence vs source) that all other tax treaties will come to the same tax conclusion. Taxpayers are able to make a treaty election with the Internal Revenue Service by filing an IRS Form 8833.  Let’s review of the basics on How Tax Treaties Impact Pension, Social Security & Public Earnings from the the model treaty:

Pension

• • • 1. a) Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that Contracting State.

      • b) Notwithstanding subparagraph (a) of this paragraph, the amount of any such pension or remuneration arising in a Contracting State that, when received, would be exempt from taxation in that Contracting State if the beneficial owner were a resident thereof shall be exempt from taxation in the Contracting State of which the beneficial owner is a resident.

    • 2. a) Where an individual who is a resident of a Contracting State is a member or beneficiary of, or participant in, a pension fund established in the other Contracting State, income earned by the pension fund may not be taxed as income of that individual, unless, and then only to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund established in that other Contracting State in a transfer that qualifies as a tax-deferred transfer under the laws of that other Contracting State). In such case, the provisions of paragraph 1 of this Article shall apply.

      • b) Where a citizen of the United States who is a resident of __________ is a member or beneficiary of, or participant in, a pension fund established in __________, the United States may not tax the income earned by the pension fund as income of the individual unless, and then only to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund established in __________ in a transfer that qualifies as a tax-deferred transfer under the laws of __________). In such case, the provisions of paragraph 1 of this Article, which generally is subject to paragraph 4 of Article 1 (General Scope), shall apply.”

What does this Mean?

The general proposition involving pensions is that a pension that is owned by a resident of one of the countries will be taxed in the country they reside. Thus, the general proposition begins with pension is taxable in this country of residence.

Then comes the exceptions:

• • • If the type of pension is the type of pension that would otherwise be exempt from tax in the source country (such as Roth IRAs) will also be exempt in the country of residence.

    • The next exception provides an exception to tax for items such as rollovers and other transfers of pensions within the same country that the pension is located.

    • If the Individual is a US citizen who resides in a foreign country and receives pension that was established in their country Comedy in the United States cannot tax the income unless it was paid to or for the benefit of the individual and not transferred to another pension plan in that country.

Social Security

• • • Notwithstanding the provisions of paragraph 1 of this Article, payments made by a Contracting State under provisions of the social security or similar legislation of that Contracting State to a resident of the other Contracting State or to a citizen of the United States shall be taxable only in the first-mentioned Contracting State.

What does this Mean?

It means that despite any information otherwise provided in this article, when a payment of social security is being made, it will only be taxable in the country of source. This makes logical tax sense, since Social Security as a government funded program, and therefore foreign countries (including the United States in a reciprocal situation) should not have the opportunity tests tax another countries Government controlled income source.

Government Renumeration (or Public)

• • • Notwithstanding the provisions of Articles 14 (Income from Employment), 15 (Directors’ Fees), 16 (Entertainers and Sportsmen) and 20 (Students and Trainees):

      • a) salaries, wages and other remuneration, other than a pension, paid to an individual in respect of services rendered to a Contracting State or a political subdivision or local authority thereof shall, subject to the provisions of subparagraph (b) of this paragraph, be taxable only in that Contracting State;

      • b) such remuneration, however, shall be taxable only in the other Contracting State if the services are rendered in that Contracting State and the individual is a resident of that Contracting State who

        • : i) is a national of that Contracting State; or

        • ii) did not become a resident of that Contracting State solely for the purpose of rendering the services.

What does this Mean?

It means that when a person receives salary, wages or similar remuneration by providing services to one of the parties is to the tax treaty, that only the country that provided the source of income has the opportunity attacks that income — but exceptions apply.

• For example, the income would only be taxable in the country of residence and not the country of source, if the services were provided by a national of the other country who either performed the services in that other country or did not become a resident of that other country solely for the purpose of rendering the services.

Saving Clause

• • • Except to the extent provided in paragraph 5 of this Article, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens. Notwithstanding the other provisions of this Convention, a former citizen or former long-term resident of a Contracting State may be taxed in accordance with the laws of that Contracting State.

    • 5. The provisions of paragraph 4 of this Article shall not affect:

      • a) the benefits conferred by a Contracting State under paragraph 3 of Article 7 (Business Profits), paragraph 2 of Article 9 (Associated Enterprises), paragraph 7 of Article 13 (Gains), subparagraph (b) of paragraph 1, paragraphs 2, 3 and 6 of Article 17 (Pensions, Social Security, Annuities, Alimony and Child Support), paragraph 3 of 3 Article 18 (Pension Funds), and Articles 23 (Relief From Double Taxation), 24 (Non-Discrimination) and 25 (Mutual Agreement Procedure); and

      • b) the benefits conferred by a Contracting State under paragraph 1 of Article 18 (Pension Funds), and Articles 19 (Government Service), 20 (Students and Trainees) and 27 (Members of Diplomatic Missions and Consular Posts), upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that Contracting State.

What does this Mean?

We have detailed information in other articles we have written specifically about the saving clause, but let’s go to the basics:

• • • Tax treaties provide certain ways different types of categories of income will be taxed as according to the tax treaty; but

    • The saving clause precludes certain residents and citizens from relying on the tax treaty and leaves it up to the contracting parties to determine the outcome of a certain tax situation; and

    • Despite the saving clause, there are certain exceptions to the saving clause which provides that the tax treaty will trump the saving clause — and therefore if an article is exempt from the saving clause, then the tax treaty position will be the primary position.

    • Some of the exceptions to the saving clause requires that the Taxpayer is neither a citizen nor permanent resident in the contracting state — such as pension and government service.

    • At the end of the day, often times items such as Social Security and other public/government service will be exempt from the savings clause only if the person is neither a citizen nor resident.

    • Stated another way, the United States for example was still tax citizens and permanent residence on their worldwide income — 

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