Provident funds are very common in many different jurisdictions, and is an important part of any offshore disclosure application. We have been referred numerous cases from clients who after initially retaining an attorney or CPA, soon realized that their representative does not understand how provident funds interact with IRS tax law.
- 1 A Basic Summary of Foreign Provident Funds
- 2 U.S. Tax & Reporting Basics
- 3 Employment Provident Funds – The Basics
- 4 Different types of Provident Funds
- 5 U.S. Taxation of a Provident Fund
- 6 Provident Funds – Employer Contributions
- 7 Provident Funds – Employee Contributions
- 8 Provident Funds – Accrued Earnings
- 9 Reporting of a Provident Fund
- 10 FBAR (FinCEN 114)
- 11 Form 8938
- 12 Is my Foreign Provident Fund a PFIC?
- 13 Why Care if Your Provident Fund is considered a PFIC?
- 14 Never Reported the Provident Fund?
- 15 Golding & Golding: About Our International Tax Law Firm
A Basic Summary of Foreign Provident Funds
Provident funds are a type of retirement planning/Social Security/government subsidy. It goes by many different names: in India it is a Public Provident Fund, in Singapore it is a Central Provident Fund, in Hong Kong it is a Mandatory Provident Fund, and in Malaysia it is an Employees’ Provident Fund.
The idea behind a “Provident Fund” is that money is invested for the long-term. It usually grows tax-free (aka 401K) and cannot be touched until a certain age in which the person may begin taking distributions (unless they relinquish their foreign citizenship/permanent residence status).
U.S. Tax & Reporting Basics
For U.S. Persons (aka U.S. Citizen, Legal Permanent Resident, Foreign National who meets the Substantial Presence Test), there may be significant Tax and Reporting responsibilities.
That is because while a person with a provident fund may not be receiving the benefit of the fund yet, they may still have a tax and reporting requirement.
Some of the key questions we deal with on a near daily basis include the following:
- FBAR Flings
- FATCA Form 8938
- U.S. Tax on Accrued/Undistributed Earnings
- Form 8621
- Form 3520
Employment Provident Funds – The Basics
A Provident Fund earned from employment is somewhat similar to a 401(k) except that in many countries, such as Singapore, the Provident fund is mandatory. In these countries, the Provident fund is like a hybrid 401(k) and Social Security, wherein both the employer and employee contribute a certain amount of money annually to the fund. And, like a 401(k) in the U.S., the contributions by the employer (Under Foreign Tax laws) are generally not considered “currently” taxable income to the employee. In addition, the Employee’s contributions may be deducted from their tax current income.
While Provident Funds are not utilized in the United States, the majority of Asian countries have some form of Provident Fund which is geared toward retirement. While each provident fund may be somewhat different, they are all alike in the sense that they are used for the purpose of generating a nest egg for an individual in order to prepare for retirement.
One of the biggest issues and questions we receive is whether a Provident Fund is taxed in the United States before the earnings within the fund are distributed. Unfortunately, the majority of the time (while there may be a concrete answer by the IRS, although there are usually IRS Memos and PLRs floating around) the Earnings are going to be taxable in the United States at the time the earnings are being accrued, even if they are not distributed.
Different types of Provident Funds
There are many different types of provident funds, depending on which country you work in. Some of the more common types of funds include:
- CPF – Central Provident Fund (Singapore)
- CPF – Central Provident Fund (South Africa)
- EPF – Employees Provident Fund (Malaysia)
- EPF – Employees Provident Fund (Nepal)
- TPF – Thailand Provident Fund (Thailand)
- MPF – Mandatory Provident Fund (Hong Kong)
U.S. Taxation of a Provident Fund
Even though the Provident Fund may receive tax-deferred treatment in its country of origin, it does not mean the United States recognizes that tax-deferred treatment as well.
Example: David is a Permanent Resident of Singapore and therefore is required to contribute to his CPF. The Singapore CPF is one of the largest Provident Funds in the world with extremely high contribution rates. David is a Highly Compensated Employee (“HCE”), with a salary upwards of $400,000. As such, David has a large portion of his salary diverted into CPF through employer contributions. In addition, David contributes a significant portion of his own salary into the CPF.
David is also a US citizen and has to report the CPF each year to the United States.
What about the CPF Tax Liability (Contributions, Deductions and accrued Growth) to David?
Provident Funds – Employer Contributions
Since the mid-1990s, the IRS has taken the position that employer contributions to the CPF on behalf of the employee are not deductible by the employee and must be considered to be income. For example, if an employer was to contribute $30,000 of David’s salary into the CPF, that $30,000 is to be considered income by David, and David would therefore have to pay U.S. tax on the employer contribution portion to the Provident Fund now — as opposed to the U.S. recognizing tax-deferred treatment in which that income which was diverted into the CPF would not currently be taxed, such as when a U.S. Employer contributes to an employee 401K plan .
Provident Funds – Employee Contributions
Moreover, unlike a 401(k) in which an employee can contribute to the 401(k) and receive tax-deferred treatment on the contributions — (since a 401(k) is tax-deferred and the recipient does is not taxed until the money is distributed) –David does not receive a tax-deferred benefit.
In other words, if David decides to contribute $25,000 of his pretax salary towards the CPF, he still needs to report the the contributed amount as part of his current income (aka he cannot “deduct” the pretax contributions from his overall current tax liability)
Provident Funds – Accrued Earnings
This is a very complex issue.
The reality is, because the United States does not recognize tax-deferred status on a CPF (employer or employee contributions), and there is no tax treaty with many of the countries which utilize Provident Funds as a retirement vehicle – the going theme is that the non-distributed accrued earnings are presently taxable.
In other words, if David’s CPF earned $7,000 in dividends and interest — even though David cannot access the money now, he would still have to pay tax on the non-distributed earnings. The theory is that because the United States does not recognize tax-deferred treatment of either the employer or employee contributions to the fund, then by default the accrued but not distributed earnings should be taxed (and not receive tax-deferred treatment either).
It should be noted, that once David pays tax on the non-distributed earnings, it will increase his basis in so far as he will not be paying double-tax in the future, on the same income.
Example: Let’s say David was properly paying U.S. tax on all of his employer contributions, employee contributions and accrued earnings, to the tune of $500,000. Once David begins to withdraw his money, David will not be taxed on the first $500,000 – or whichever amount David has already paid taxed on. In addition, future distributions based may be taxed as a hybrid, to ensure that the portion of the distribution which is “principal” is not taxed, versus the portion that is income generated on the principal – which has not yet been taxed.
In other words, it is not as it David is being double taxed (save for the fact that many provident funds are not taxed at distribution), but rather, David is being taxed now while the earnings accumulate – as opposed to later when the earnings are distributed (as to the portion of the distributions which is considered to have been already taxed).
Reporting of a Provident Fund
A Provident Fund must be reported on an FBAR, along with other forms if it meets the minimum threshold requirements.
Even though a Provident Fund is a retirement fund, and despite the fact that under many FATCA IGA (intergovernmental agreements) that the United States has entered into, a Foreign Financial institution may not have to report the Provident fund (excluded from the reporting) to the United States – you, as an individual still have a reporting requirement..
Therefore, each year when it is time for you to complete a tax return, there are a number of different forms you may have to file, depending on the facts and circumstances of your Provident Fund.
Two of the more common forms a person has the file are below:
FBAR (FinCEN 114)
We start off with the FBAR, because it is one of the IRS International Reporting forms that receives the most amount of press. The FBAR is used to Report Foreign Bank and Financial Accounts on an annual basis.
The form has a relatively low threshold requirement of $10,000. In other words, if you have an annual aggregate total of foreign accounts (including life insurance or retirement funds) that on any day of the year exceeds $10,000, then you are required to report this form. It does not matter if the money is in one account or spread over numerous accounts. And, it does not matter if the account is in your home country of citizenship or if you opened the account before relocating to the United States.
The US government does not look into the semantics that deeply; rather, if you meet the threshold requirement then you have to file the form. Starting in 2017 (to report 2016 maximum balance), the due date coincides with your tax return filing date (including extension).
When it comes to the FBAR, one of the main concerns are the FBAR Penalties.
A penalty for failing to file FBARs. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
Form 8938 is a byproduct of FATCA (Foreign Account Tax Compliance Act). It is a form that is required to be filed with the tax return each year when a person meets the threshold requirements for filing. Unlike the FBAR, which is an electronic form which is submitted directly to the Department of Treasury (The FBAR is not submitted with your tax return), Form 8938 is part of your tax return.
Form 8938 requires you to provide extensive information regarding foreign accounts and specified foreign assets. For example, with the FBAR, reporting is limited to accounts and insurance policies (although those terms can have a very broad meaning). Conversely, with form 8938, the person must report Income — along with assets and accounts.
Therefore, if you were to own stock of a foreign company, that would be considered a Specified Foreign Asset that would need to be reported on a Form 8938 — but would not be reported on an FBAR.
Moreover, with the FBAR, a person is required to report the maximum balance in the account, but is not required to report any income that is generated from the accounts. The 8938 is more depth than that. Rather, with form 8938, a person must report the account balance along with the annual income that is generated from form 8938 accounts or assets.
Additionally, the income must be broken down by type of income earned (such as royalties, dividends, interest, capital gains) and/or whether the income was earned through a custodial or deposit account and/or it was earned through one of the specified foreign assets.
Form 8938 Penalties
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
Is my Foreign Provident Fund a PFIC?
This is another very common and scary question we receive. If you have not been introduced to the term PFIC, it stands for “Passive Foreign Investment Company.” At Golding & Golding we have written numerous articles on this concept, and it always boils down to the following: if your foreign provident fund is considered to be a PFIC, then you may be in for some serious tax consequences.
With that said, it should be noted that under most circumstances as long as the Employer contributions exceed the Employee contributions, chances are the fun is not going to be a PFIC.
But, once the fund has accumulated more employee contributions that employer contributions, then the fund may become more of a Grantor Trust (at least to the portion of the employee contributions) vs. a Non-Exempt Employee Trust, and then the fund must be split for tax purposes –and the employee contributions will be considered to be a PFIC and a form 3520 or form 8621 may be required.
Why Care if Your Provident Fund is considered a PFIC?
Because with most provident funds you cannot access the money until you reach a certain age. During all the while, the fund continues to grow and get larger. Meanwhile, you have not received any distributions that and therefore by time you receive the first distribution, it will probably be considered to be an excess distribution.
PFIC excess distributions are taxed at an extraordinarily high tax rate, and depending how long the fund has been growing and how long the fund’s been in existence from the initial contribution, through the time of withdrawal — the tax liability can reach upwards of 75% to 100% of the value of the distribution.
* For an example of Excess Distributions, you can click here.
**If your Provident Fund invests in Foreign Mutual Funds, it may be considered a PFIC.
Never Reported the Provident Fund?
If you have never reported the Provident Fund, and/or the prior employer contributions or employee contributions to the United States government you can be considered out of compliance and subject to extreme high fines and penalties. With that said, you may be able to get back into compliance relatively safely by entering one of the approved IRS offshore voluntary disclosure programs.
A summary of the different programs are provided below:
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance.