Where are your pension payments taxed if you retire abroad? The UK’s First-tier Tribunal (FTT) had to grapple with this question in Masters. The case concerned payments from a UK self-invested personal pension (SIPP) to an individual who had become tax resident in Portugal. HMRC sought to tax these payments, but the FTT decided that they had no right to do so. Because the payments from the SIPP were “pensions and other similar remuneration paid…in consideration of past employment”, the double tax treaty (DTT) between Portugal and the UK allocated the exclusive right to tax those payments to Portugal. 

What was the background to the payments? 

The taxpayer had built up a pension entitlement under his employer’s defined benefit scheme and, in 2016, when the taxpayer was still resident in the UK, the cash equivalent of this entitlement was transferred to his personal SIPP. A SIPP is a self-invested personal pension plan which is a type of personal pension arrangement that allows an individual greater investment choice than a conventional personal pension scheme.

After the taxpayer had become resident in Portugal, he received significant payments from the SIPP. In Portugal, he did not have to pay tax on these payments because he benefitted from an exemption under the Portuguese Non-Habitual Resident (NHR) regime. HMRC sought to impose tax in the UK and the FTT had to decide whether they had the right to do so. 

Who can tax the payments under the applicable DTT?

The decision turned on the interpretation of Article 17(1) of the DTT between Portugal and the UK, but it is of wider relevance, given that the relevant wording tracks Article 18 of the OECD’s Model Tax Convention, which also forms the basis of many other treaties.

The crucial question was whether the payments constituted “pensions and other similar remuneration […] paid in consideration of past employment”. If so, then under the DTT, the exclusive right to tax them belonged to Portugal; if not, Article 17(1) was inapplicable and Article 20 would have to be considered.

It was common ground between the parties that the payments were “pensions and other similar remuneration”. But what does “in consideration of past employment” mean? The FTT stated it is not to be read as a reference to “consideration” as that term is defined for the purposes of English contract law, but it points to the need for a sufficient causal connection. 

The FTT considered that, as a matter of principle, payments from a SIPP could have such a sufficient causal connection with a past employment, but this would depend on the facts:

• The connection would clearly be present for a SIPP that was funded out of employer contributions and salary sacrifice payments made during the employment. 
• In contrast, where an employee decides to use some of their take-home pay to invest in a SIPP, the causal link would be broken “because the salary has become the property of the employee before it is contributed to the pension”. 
• Equally, the FTT considered that the causal link would likely be too weak  “where the period of pensionable service and the value of the capital transfer from an occupational pension scheme to a SIPP is proportionately low compared to the period of time that the capital transfer is held in a SIPP, or the value of the subsequent contributions that the employee makes to it.”

Here, the only contribution to the SIPP was the cash equivalent of the taxpayer’s entitlement under his employer’s pension scheme, and it was in the SIPP for only four years before the payments were made. In these circumstances, there was a sufficient causal link for the payments from the SIPP to be “in consideration of past employment” for the purposes of Article 17(1) of the DTT. Consequently, the exclusive taxing right belonged to Portugal and no UK tax could be charged on the payments. 

Does it matter that no Portuguese tax was due?

That Portugal did not, in fact, make use of its exclusive right to tax the payments is irrelevant to the application of Article 17(1) of the DTT. 

It would, however, have mattered if the payments had not been sufficiently connected with the taxpayer’s past employment and therefore outside the scope of Article 17(1) of the DTT. In that case, the crucial question would have become whether Article 20 of the DTT excluded UK taxing rights on the basis that the taxpayer was “subject to tax in respect” of the payments in Portugal (which is different from the equivalent provision in the OECD’s Model Tax Convention).

The FTT considered that being “subject to tax” in this context required “actual and effective taxation” – which was missing here, given the exemption under the Portuguese NHR regime. So, had the case turned on Article 20 of the DTT, the FTT would have decided it in favour of HMRC.