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International tax issues
In the realm of international finance, US qualified retirement plans often benefit from reduced withholding tax rates or even full withholding tax exemption on non-US dividends or interest, under double tax treaties (DTTs) the United States has with other countries. CITs investing in foreign securities similarly can receive these reduced withholding tax rates and exemptions, providing further cost savings relative to their mutual fund counterparts. CITs are increasingly investing in foreign stocks and bonds, making these international tax advantages more important than ever. However, there are some important considerations for CITs and plan sponsors. CITs have been hitting roadblocks in accessing the intended tax benefits they’re due in some countries.
In our experience, while some countries, like the Netherlands and Finland, recognize and respect a CIT’s structure and extend treaty benefits with minimal fuss, others are more skeptical. Instead, these other tax authorities do not consider the CIT treaty eligible at the entity level, but rather, want to look through to the status of the participating plans investing in the CIT. This issue not only puts these participating plans at a tax disadvantage, but also erodes the retirement savings of countless Americans invested in foreign securities through CITs. In our experience, tax authorities’ skepticism appears to stem from a variety of factors, including the IRS’s expansion of the CIT Rulings in 2014 to permit Puerto Rico-only qualified retirement plans in CITs and the complex “umbrella” and “subtrust” structure of many CITs.
As a result, countries like France, Switzerland, Germany, Denmark and Sweden have imposed stringent documentation requirements or limited the tax benefits available to CITs under the DTTs. For instance, France and Switzerland have made it operationally challenging for CITs to document their participants’ eligibility for tax benefits through certificates of tax residence, often leading to a denial of treaty benefits. Germany has paused its evaluation of claims from CITs due to concerns over their structure, while Denmark and Sweden have taken a narrow view of what constitutes a qualifying pension fund, limiting the tax benefits for US retirement plans’ indirect investments.
In response to these challenges, the IRS, industry groups and tax advisors have been actively engaging with foreign tax authorities to seek clarity and solutions for the tax relief disruptions faced by CITs and their qualified retirement plan investors. Discussions are ongoing, with hopes for positive developments soon. Potential solutions may include recognizing these trusts as entitled to treaty benefits or adopting a “look-through” approach with simplified documentation requirements.
Despite the uncertainty, there are actions that CITs can take to limit the impact of these challenges. These include applying for a standard reduced tax rate under applicable DTTs (e.g., 15% for dividends), where possible; excluding Puerto Rican retirement plans from certain arrangements; and obtaining separate taxpayer identification numbers for different levels of tiered trusts. Trusts with fewer investors are also increasingly seeking direct documentation from their participants to strengthen their claims for tax relief.
As the situation evolves, the financial industry remains hopeful for resolutions that will ensure CITs and their participating US retirement plans can fully benefit from international tax treaties, thereby safeguarding the retirement savings of millions of Americans.