Main story: Retiring to France
David Anderson and Graeme Perry of solicitors and chartered tax advisors Sykes Anderson highlight a hidden ‘stealth tax’ on UK personal pension schemes, and examine the implications for people resident in France
Q: I have a personal pension scheme and am about to retire. Looking at the poor annuity rates I have decided that the best option is for my personal pension to go into drawdown and for me to take the money out according to HMRC’s rules. Does this sound sensible?
A: Yes, this is a fairly normal procedure and many IFAs will recommend it.
Q: What happens if I die during the drawdown period?
A: There is a particularly nasty sting in the tail here. If you die during the drawdown period then the amount left in your pension scheme will be subject to what is know as a ‘Special lump sum death benefits charge’ at the date of your death. This is governed by section 206 of the Finance Act 2004 and amounts to an income tax charge of 35% on the sum left in your pension. The section also allows for the Treasury to alter the rate of 35%.
Q: I was not aware of that. Does that mean that even though the pension arrangements are that the fund is to pass to my wife, she will only receive the balance of the fund, net of 35% UK income tax?
A: Yes. This is often not spelt out to people taking out pensions and is a stealth tax which is not properly understood by many people.
Q: How does the UK Revenue make sure it receives the 35% income tax charge on my death?
A: Under the legislation it is the pension scheme administrator who is liable to pay the charge so the pension fund trustees pay this money over to the Revenue on your death. Your surviving heirs will receive the pension fund after 35% has been deducted in income tax.
Q: It seems bizarre that I pay 35% income tax on my death. I would have thought that if anything my estate should be paying inheritance tax?
A: It does not work like this. The specific provision in the Finance Act classifies the money as subject to income tax, even though it is clearly a capital sum in the pension fund. In fact the section in the legislation specifically states that the lump sum death benefit is not to be viewed as income even though income tax is payable on it. This is a bizarre way to draft legislation. Essentially the UK Revenue is clawing back the income tax relief it gave you when you made the contributions to your fund. It makes you wonder whether having a pension is sensible as the only reason for tying your money up with a pension fund is to get the tax relief. Without this no one would have a pension.
Q: Does it make any difference if I move to, say, France?
A: The legislation is widely drafted and provides that the scheme administrator must pay the charge whether or not they or the recipient of the lump sum is resident, ordinarily resident or domiciled in the United Kingdom. The legislation specifically makes the pension scheme administrator the taxable person. Although not specifically stated the legislation must be subject to any double tax treaty as international treaties have priority over both UK and French internal law.
The UK-France Double Tax Treaty of 1968 does preclude, in relation to certain forms of income, a charge to income tax in the UK on French residents but it is not clear how this unique 35% charge fits in with the Treaty. There is the possibility of challenging the legislation as the rules set out in the Treaty take priority over domestic law, however no such challenge has taken place as of yet.
Q: Why doesn’t the UK France Double Tax Treaty protect my surviving spouse from this 35% tax charge if it protects the income I receive during my lifetime from UK tax? How can the treaty sometimes exempt pension money from UK income tax and sometimes not?
A: The Treaty certainly covers income tax of this kind and provides in Article 18 that any pension and other “similar remuneration” paid in consideration of past employment to a resident of France shall be taxable only in France. In this case the literal reading of the treaty is that “similar remuneration” i.e. the lump sum is being paid to the surviving spouse who is French resident though in consideration of the past employment of the deceased spouse previously in receipt of the pension which was exempt from UK tax. As you can see the literal reading of the treaty covers the situation and the 35% UK tax should not be payable. In our view any pension fund which has suffered such tax in respect of a deceased pensioner in France should be reimbursed by the UK Revenue.
Q: What would be the position if I moved to Monaco?
A: There is no double tax treaty between the UK and Monaco, and accordingly the pension fund would be taxed as though you were resident in the UK and the 35% tax would be payable. In addition, whilst you are alive and in receipt of the pension you will pay UK income tax on the money arising in the pension fund, before it is paid to you in Monaco. The contrary is the position with regard to France, because the UK France Double Tax treaty provides that France not the UK has the right to tax income from pensions.
So if you are French resident then during the period you are alive and in receipt of a pension the UK pension fund trustees have to pay you gross (i.e. without deducting UK income tax) and you are then taxed in France, normally at a much lower rate. Somewhat counter intuitively you are from a pension’s point of view better off retiring in France than Monaco.
Q: I have a fairly substantial fund. Are there any other routes I could take in order to avoid the 35% tax?
A: Yes, you could consider moving abroad and transferring your pension to a pension provider in that country. Under UK Pensions legislation it would only be possible to transfer into a scheme approved by the UK Revenue, known as Qualified Registered Overseas Pension Schemes (QROPS). A list of QROPS is published on a regular basis by the Revenue and there are a number of such schemes in France amongst other countries. There is no approved QROPS in Monaco. The effect of this is in broad terms to remove your pension fund from the UK tax net. In order to be approved the foreign QROPS must contain similar restrictions on say investment and benefits as in the UK.
Q: I do not want to go through the upheaval of any move abroad. Are there any other ways in which I can avoid this charge and make my pension arrangements more flexible?
A: Yes, there are specialist schemes in which you can export your pension fund to, say, the Channel Islands whilst continuing to remain UK resident. These require a detailed analysis of your position and are only suitable for larger funds because of the costs involved. These arrangements also allow you for instance to avoid having to take an annuity at age 75.
Please note that tax law and pension law are complex subjects and you should not take any action or refrain from taking any action without professional advice on the facts of your particular case. Please note that this article does not constitute financial advice.
David Anderson solicitor and chartered tax adviser,
Graeme Perry trainee solicitor
Sykes Anderson LLP
31 Bury Street
London EC3A 5JJ
Telephone 020 7398 4700