The Taxation of Foreign Pension and Annuity Distributions
International Tax Gap Series
A foreign pension or annuity distribution is a payment from a pension plan or retirement annuity received from a source outside the United States. You might receive it from a:
trust established by a foreign employer
foreign government or one of its agencies (including a foreign social security pension)
foreign insurance company
foreign trust or other foreign entity designated to pay the annuity
Just as with domestic pensions or annuities, the taxable amount generally is the Gross Distribution minus the Cost (investment in the contract). Income received from foreign pensions or annuities may be fully or partly taxable, even if you do not receive a Form 1099 or other similar document reporting the amount of the income.
General Rule: Treaties—Pension/Annuity Articles
As a general rule, the pension/annuity articles of most tax treaties allow the country of residence (as determined by the residency article) to tax the pension or annuity under its domestic laws. This is true unless a treaty provision specifically amends that treatment. Some treaties, for example, provide that the country of residence may not tax amounts that would not have been taxable by the other country if you were a resident of that country. In some cases, government pensions/annuities or social security payments may be taxable by the government making the payments. There also may be special rules for lump-sum distributions. You need to look at each treaty carefully.
If you live in a foreign country and receive a pension/annuity paid by a U.S. payor, you may claim an exemption from withholding of U.S. Federal Income Tax (FIT) under a tax treaty by completing Form W-8BEN and delivering it to the U.S. payor. You must report your U.S. Taxpayer Identification Number (TIN) on Form W-8BEN for it to be valid for treaty purposes.
If you live in the USA and receive a pension/annuity paid by a payor from a foreign country, you must claim your desired treaty withholding exemption on the form, and in the manner specified by the foreign government. If the foreign government, and/or the foreign withholding agent, refuses to honor the treaty claim, make the treaty claim on your income tax return, or other prescribed form, filed with the foreign country. Additionally, you may be able to claim a Foreign Tax Credit on your U.S. federal individual income tax return for any foreign income tax withheld from your foreign pension or annuity.
Tax Treaty Residency Issues
When deciding whether a tax treaty applies, identify your tax residency (Article 4 under most treaties). Then find out if the relevant treaties have articles which deal with pensions, annuities, government payments or social security payments. Remember each tax treaty is unique -- just because one treaty allows a certain treatment does not mean another treaty will allow the same treatment.
Your residency determines how treaty articles on pensions and annuities will be applied. Use the domestic laws of each country to identify your residency, IRC 7701(b) in the case of the USA (Green Card Test and/or Substantial Presence Test). If, after applying the domestic law of each country, you are a resident of both countries, apply the Tiebreaker Rules:
In which country do you have a Permanent Home available to you?
With which country do you have closer personal and economic relations?
In which country do you have an Habitual Abode?
Of which country are you a National?
If none of the above tiebreaker rules works, then residency will be decided by the Competent Authorities of each country upon request by the taxpayer. Refer to Revenue Procedure 2006-54 for Procedures for Requesting Competent Authority Assistance Under Tax Treaties.
Some treaties have special rules, e.g., the USA-Canada and the USA-UK treaties have special rules for taxpayers who have U.S. green cards. You must read the residency article from beginning to end to find any special rules. You must also read all the Protocols of the treaty to see if the residency rules have been amended by a later Protocol. If you are a U.S. citizen, you also may need to refer to the so-called “saving clause” (typically found in Article 1) for special rules that allow the United States to tax in some cases as if the treaty had not entered into force.
Foreign Social Security Pensions
Most income tax treaties have special rules for social security payments. In many cases, foreign social security payments are taxable by the country making the payments. Unless specified otherwise in an income tax treaty, foreign social security pensions are generally taxed as if they were foreign pensions or foreign annuities. Unless a tax treaty allows it (see, e.g., the USA-Canada treaty), they are not eligible for exclusion from taxable income the way a U.S. social security pension might be.
Foreign Employer Contributions
If you worked abroad, your Cost might include amounts contributed by your employer that were not includible in your gross income. This applies to contributions made either:
before 1963 by your employer for that work,
after 1962 by your employer for that work if you performed the services under a plan that existed on March 12, 1962, or
after 1996 by your employer on your behalf if you were a foreign missionary (a duly ordained, commissioned, or licensed minister of a church or a lay person).
Foreign Contributions while a Nonresident Alien
Your contributions and your employer's contributions are not part of your Cost if the contribution was based on compensation for services performed outside the United States while you were a nonresident alien and not subject to income tax under the laws of the United States or any foreign country (but only if the contribution would have been taxable if paid as cash compensation when the services were performed).
Publication 575, Pension and Annuity Income
Publication 939, General Rule for Pensions and Annuities
Publication 590, Individual Retirement Arrangements (IRA’s)
Publication 519, U.S. Tax Guide for Aliens
Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities
Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad
Internal Revenue Code (IRC) Section 72 and the related Regulations
IRC 1441 and the related Regulations
IRC 3405 and the related Regulations
The International Tax Gap Series