Freedom of movement

Mike Morrison discusses the impact European law can have on the UK

I started my career with Provident Life (which later became Winterthur) in July 1990 and one of my first jobs was to deal with the implications of the Barber case. This was the European Court case of Barber v Guardian Royal Exchange, which decided that pensions were in effect pay and therefore pension schemes could not discriminate between men and women.

This was the first time that I had really noticed the effect of European law on domestic pensions law, an area which has subsequently become a personal area of interest and which, over the years, has had an increasing influence on the legal structure of UK pension schemes.

Where European law has had its greatest effect is in the area of preventing discrimination of one sort or another and in facilitating mobility.

At the heart of European law are the four 'fundamental freedoms', the free movement of goods, the free movement of persons, the free movement of services and the free movement of capital and any provision of local law that infringes these freedoms is likely to be challenged.

Let's look at a couple of areas where there has been, or will potentially be, an effect on UK pensions.

It has been the practice of some European Union Member States to levy more tax on the investments of foreign pension funds than of their own funds. Commonly the practice has been to levy withholding taxes on dividend and/or interest payments to foreign pension funds, while effectively exempting their domestic pension funds from any corporation and/or income tax on their investments.

It has been held by the European Courts of Justice (ECJ) that such a practice is a restriction of the free movement of capital under Article 56 of the European Commission (EC) Treaty and this has been confirmed in two cases where the ECJ ruled that higher taxation of outbound dividends than of domestic dividends is not in conformity the Treaty (Denkavit, Case C-170/05 of 14 December 2006 and Amurta, Case C-379/05 of 8 November 2007). Since then, a number of the offending countries have agreed to change their domestic legislation.

A similar problem exists more directly with paying contributions into pension schemes and, on 27 November 2008, the EC formally requested the United Kingdom to amend its legislation.

Their concern is that UK legislation, in certain circumstances, does not allow tax relief on pension contributions paid to pension funds established outside the United Kingdom. The view of the Commission is that the UK should specifically allow tax relief for all pension contributions paid by resident taxpayers to pension funds established in other EU Member States and that the denial of tax relief particularly affects cross-border workers who move to the UK while continuing with a pension fund established in their state of origin.

The Commission's request takes the form of a 'reasoned opinion' and if no satisfactory answer is received within two months, the Commission may decide to refer the matter to the European Court of Justice.

The point in question is that UK income tax rules often deny workers established in the UK the right to tax relief on any pension contributions they pay to pension funds established elsewhere in the EU (or the European Economic Area) from their UK taxable income. In reality the UK legislation denies such deductibility if an overseas pensions fund does not jump through some hoops and provide certain information to the UK tax authorities.

To receive tax relief on contributions to a pension scheme while in the UK an individual must qualify as a 'relevant migrant member'.

This means that the individual:

- Must have been non-resident in the UK at the time of joining a qualifying overseas pension scheme (QROPS), and must come to the UK as an existing member of the overseas scheme.

- Must now be resident in the UK.

- Must notify the scheme manager that he/she intends to claim 'migrant member relief'.

- Must have earnings chargeable in the UK.

- Was eligible for tax relief on contributions to the overseas scheme in the country in which he/she was resident at any time in the ten years prior to coming to the UK.

The qualifying overseas pension scheme must:

- confirm to HMRC that it is an overseas pension scheme, providing supporting evidence if required.

- Undertake to notify HMRC if it ceases to be an overseas pension scheme.

- Undertake to provide HMRC with the name and address of the relevant migrant member who has had a benefit crystallisation in the tax year concerned.

- The amount, date and nature of the benefit crystallisation must also be indicated. This information must be provided by no later than 31 January following the tax year in which the benefit crystallisation took place.

- Notify the member claiming migrant member relief that it has undertaken to comply with HMRC's benefit crystallisation event information requirements.

It is argued that the information requirements constitute an extra cost to the business, particularly for foreign pension providers that do not wish to enter the UK market but merely provide services to existing scheme members who have exercised their right of free movement.

This additional burden means that the UK legislation currently is not compatible with Articles 39, 43 and 49 of the EC Treaty ('the fundamental freedoms') and needs to be corrected. We are not the only country in this situation and the last few years have seen cases bringing various countries into line e.g. Commission v Belgium (C-522/04) and Commission v Denmark (C-150/04), both in 2007. Prior to this there is a line of cases that indicate that there is little scope for Member States to apply different rules to foreign pension funds. (c.f Wielockx, C-80/94 Safir C- 1 18/96, Danner Case C-136/00and SkandiaC-422/01). Indeed this is not the first time that the UK has been questioned on this subject, yet we still appear not to have found a suitable solution.

It will be interesting to see what happens next. It might also be relevant in the world of QROPS where European schemes face similar reporting requirements and perhaps similar issues.