We apologise for the confusing replies we haved posted on the forum. Our double taxation policy team has reviewed the thread and has provided the following correct and final response:
The way in which payments from a US pension are taxed depends on the frequency of the withdrawals/payments from that pension:
Lump Sum Payments
There is no legislative definition of a lump sum but HMRC regards these as being any non-periodic payment of a pension, that is, any non-regular payment that decreases the value of the remaining pension pot after such payment is made. For example, the first (IRA) withdrawal is taken in year 1, the next withdrawal was made in year 5, and another withdrawal in year 7, such payments will not be regarded as periodic and will be treated as lump sums under the UK/USA Double Taxation Agreement (DTA). Whereas any amount withdrawn in set, periodic, frequent intervals, that is weekly, monthly, annually and so on would not be a lump sum, but rather periodic payments.
Article 17(2) of the UK/USA DTA provides the US with the right to tax any lump sum payment which is made from a US sourced pension scheme, including IRAs. However, the UK is also permitted to tax the same lump sum payment(s), which is in accordance with Article 1(4) of the DTA, both Article 17(2) and Article 1(4) are outlined below and, when read from the perspective of a UK resident, state:
Article 17(2) - Notwithstanding the provisions of paragraph 1 of this Article, a lump-sum payment derived from a pension scheme established in a Contracting State [USA] and beneficially owned by a resident of the other Contracting State [UK] shall be taxable only in the first-mentioned State [USA].
Article 1(4) - Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State [UK and/or USA] may tax its residents, and by reason of citizenship may tax its citizens, as if this Convention had not come into effect.
A UK resident, Article 1(4) above permits the UK to tax any US sourced lump sum payment received, as if Article 17(2) of the DTA was not in force or applicable, Article 1(4) effectively ‘overrides’ the provision at Article 17(2), and the consequence is that both the UK and USA can tax any lump sum payment received from a US sourced pension scheme.
In these situations, double taxation will occur since both the UK and the USA can tax the same income. However, that double taxation will be eliminated in accordance with Article 24(4)(a) of the DTA which requires the UK, as the country of residence, to provide Foreign Tax Credit Relief (FTCR) to offset the US tax correctly paid against the UK tax charged on the same the IRA withdrawal.
Uk/USA Double Taxation Agreement - 2002
Periodic, frequent, payments or withdrawals, that is weekly, monthly, annually and so on, then those payments would have been taxable within the UK and ‘maybe’ exempt from US tax. This is in accordance with Article 17(1)(a) of the DTA which, again from the perspective of a UK resident, states:
‘Pensions and other similar remuneration beneficially owned by a resident of a Contracting State [UK]shall be taxable only in that State [UK].’
As a result, these periodic payments are fully taxable in the UK and should be declared to HMRC on the foreign income pages (SA106) of a Self Aassessment return. If US tax has also been paid on those payments, then it is important to note that no UK tax relief can be claimed to offset that US tax charge against any UK tax due. Instead, you must approach the US Internal Revenue Service (IRS) to claim US tax relief and the type of US tax relief available will differ depending on whether or not you are a US citizen.
If you are not a US citizen, then periodic pension payments will be fully exempt from US tax and you should claim a full repayment from the US IRS. However, if you are a US Citizen, you will only be permitted to claim the US version of FTCR, which will offset the UK tax paid against a US tax charge. This is because the US taxes its citizens worldwide income, regardless of where they are resident. So, if you are a US citizen, then Article 1(4), as outlineD above, would kick in again and, this time, allow the US to tax any periodic payment received, despite Article 17(1) providing the UK with the sole right to tax. Again, Article 1(4) effectively ‘overrides’ Article 17(1), and the consequence is that both the UK and USA can tax any periodic payments received.
In these situations, double taxation will occur since both the UK and the USA can tax the same income. However, this time, it is for the US to eliminate that double taxation, since they are the ones invoking Article 1(4). This is in accordance with Article 24(1)(a) of the DTA, which states:
‘In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a resident or citizen of the United States as a credit against the United States tax on income:
a. the income tax paid or accrued to the United Kingdom by or on behalf of such citizen or resident.’
In summary, both periodic and lump sum payments from traditional IRAs are taxable in the UK and need to be declared on the on the foreign income pages (SA106) of a Self Assessment return, the only difference is that periodic payments are taxable in the UK, so any US tax paid on those payments should be refunded by the IRS or, if you are a US Citizen, you should claim the US version of FTCR and offset the UK tax paid against the US tax charge. Whereas ’non-periodic’ or lump sum payments are taxable in both the UK and USA, in this situation, the UK should provide FTCR to offset the US tax correctly paid against the UK tax charged on that payment.
These are usually exempt from tax in the USA, under US domestic laws. However, it is the taxpayer’s responsibility to check with officials within the USA to confirm/establish that their Roth IRA is/is not exempt from tax in the USA. If the Roth IRA is in fact exempt from US tax, then it will also be exempt from tax within the UK. This is in accordance with Article 17(1)(b) of the UK/USA DTA which, from the perspective of a UK resident, states the following:
‘Notwithstanding sub-paragraph a) of this paragraph, the amount of any such pension or remuneration paid from a pension scheme established in the other Contracting State [USA]that would be exempt from taxation in that other State [USA]if the beneficial owner were a resident thereof shall be exempt from taxation in the first-mentioned State [UK]’.
This position is also re-affirmed in HMRC guidance within the Double Taxation Relief Manual, which is published online under DT19853, and this states:
‘Pensions (Article 17)
Article 17 provides for the taxation of pensions and other similar remuneration only in the state of residence of the beneficial owner. For this purpose, a payment is treated as a pension or other similar remuneration if it is a payment under a pension scheme, as defined at Article 3(1)(o).
DT19853 - Double Taxation Relief Manual: Guidance by country: United States of America: Notes
Contrary to this general rule above, the residence state, under paragraph 1(b), must exempt from tax any amount of such pensions or other similar remuneration that would be exempt from tax in the State in which the pension scheme is established if the recipient were a resident of that State. Thus, for example, a distribution from a US Individual Retirement Arrangement or "IRA" to a UK resident will be exempt from tax in the UK to the same extent that the distribution would be exempt from tax in the US.’
Although Roth IRAs maybe exempt from UK tax, it is highly recommended that the taxpayer declares the amount they received from their Roth IRA within the additional notes section of their UK tax return. This declaration will not lead to that income being taxed but it will ensure it is fully declared to HMRC. We would recommend the taxpayer quotes the amount they have received, converted into pounds from US dollars, and a short statement to explain why they believe that income is exempt from UK tax.
If you have particularly complex questions on double taxation we suggest you seek the advice of an accountant or tax advisor to ensure you have your affairs correctly in order as HMRC does not give tax planning advice.