Executive Summary

On February 29, 2016, the Organisation for Economic Co-operation and Development (the OECD) published a discussion draft, Treaty Residence of Pension Funds (Discussion Draft), proposing certain changes to the OECD Model Tax Convention (OECD Model Treaty) and its Commentary. According to the Discussion Draft, the changes are intended to remove any doubt that a "recognised pension fund" should be considered a resident of the State in which it is constituted, regardless of whether that pension fund benefits from a limited or complete exemption from taxation in that State. The OECD has requested comments on the proposed changes and invited comments on a specific set of questions, described below. Comments are due by April 1, 2016. Given the relatively short comment period, all interested parties will need to quickly consider the proposed definition of "recognized pension fund" and consider whether to submit comments. The Discussion Draft and comments received will be discussed by Working Party 1 at its next meeting, when the Working Party will be asked to finalize the changes proposed in the Discussion Draft.

Discussion

Background

The current version of the OECD Model Treaty generally defines "resident of a Contracting State" as any person who, under the laws of that State, is liable to tax therein by reason of the person's residence or other similar criterion. The definition does not explicitly refer to a pension fund. The current Commentary to Article 4 (Residence) of the OECD Model Treaty acknowledges, however, that many countries view pension funds as residents for purposes of determining whether treaty benefits apply, notwithstanding that they are exempt from tax. The current commentary also notes, however, that, pensions funds would not be regarded as residents in some other countries unless they were expressly covered by the treaty.

In its final report on BEPS Action 6, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, released on October 5, 2015 (the Report), the OECD indicated that forthcoming changes to the OECD Model Treaty would ensure that a "recognised pension fund" is considered to be a resident of the State in which it is constituted, regardless of whether it benefits from a limited or complete exemption from taxation in that State.

The Report identified certain elements that the definition of "recognised pension fund" would likely include, among them that a pension fund be regulated by the State in which it is established. Finally, the Report noted that the Commentary would be revised to elaborate on these elements.

Discussion Draft

Consistent with the Report, the Discussion Draft proposes changes to Articles 3 (General Definition) and 4 (Residence). In Article 3, the Discussion Draft proposes adding a new definition of "recognised pension fund" that would provide:

(j) the term "recognised pension fund" of a State means an entity or arrangement established in that State that is treated as a separate person under the taxation laws of that State and:

(i) that is constituted and operated exclusively to administer or provide retirement or similar benefits to individuals and that is regulated as such by that State or one of its political subdivisions or local authorities; or
(ii) that is constituted and operated exclusively to invest funds for the benefit of entities or arrangements referred to in subdivision i).

The proposed Commentary to Article 3 explains that a pension fund meeting this definition would be considered to be a resident of the State in which it is established.

In Article 4, the Discussion Draft proposes the addition of an explicit reference to a "recognised pension fund" in the definition of "resident of a Contracting State."

The Discussion Draft also recommends corresponding changes to the Commentary, including explanations of certain elements in the new definition of a "recognised pension fund." In particular, the proposed Commentary to Article 3 provides:

— There is considerable diversity in the legal and organizational characteristics of pension funds and the reference to "arrangement" is intended to accommodate those diverse forms. It is necessary, however, for the entity or arrangement to be treated as a separate person under the tax laws of the State in which it is constituted.

— In order to qualify as a "recognized pension fund," an entity or arrangement must be constituted and operated exclusively to administer or provide retirement or similar benefits to individuals. For example, a pension paid upon retirement from active employment would be an example of a "retirement benefit," as well as one or more payments made at or after retirement to a self-employed person, even if the payments are not made in the form of regular pension payments. Examples of other "similar benefits" would include payments made as a result of the death or invalidity of an individual.

— The pension fund must be regulated, a requirement that is intended to restrict the definition of a "recognised pension fund" to an entity or arrangement that is subject to some conditions imposed by the State in which it is established (or one of the State's political subdivisions or local authorities). The proposed Commentary notes that the entity or arrangement must be recognized by law as a vehicle constituted to finance retirement benefits for individuals and be subject to conditions intended to ensure that it is used solely for that purpose. As a result, an unregulated private company, even if established to provide retirement benefits, would not qualify.

— Subparagraph (ii) of the definition proposed in Article 3(1)(j) is intended to cover entities that pension funds (within the scope of subparagraph (i) of the definition) use to invest indirectly. Examples would include a wholly owned arrangement or entity, resident in the same State as the pension fund, that is used by pension funds to pool assets for investment purposes.

As noted above, the Discussion Draft invites interested parties to send comments to the OECD on the proposed changes by April 1, 2016. Regarding the proposed definition of "recognised pension fund," the Discussion Draft also identifies the following questions on which comments are specifically requested:

— Does the phrase, "that is treated as a separate person under the taxation laws of that State," deal adequately with pension funds established in your State? If not, what other formulation would ensure that pension funds, the income of which is not otherwise attributed to another person for tax purposes, are treated as residents?

— Is the word "exclusively" in subparagraph (i) of proposed Article 3(1)(j) too restrictive given the normal operations of a pension fund? If yes, please describe the operations that might not be covered, taking into account the fact that the subparagraph refers not only to "retirement benefits" but also to "similar benefits."

— Are there examples of "benefits" that are typically granted by pension funds that would not be covered by the phrase "similar benefits"? If yes, please describe these benefits.

— Is the word "exclusively" in subparagraph (ii) of proposed Article 3(1)(j) too restrictive given the normal operations of an intermediary that invests on behalf of pension funds and, in particular, the possibility that these operations would include activities that are not related to the investment of funds and the possibility that non-resident pension funds would be investing through such an intermediary? If yes, please describe the operations that might not be covered.

Implications

The proposed changes described in the Discussion Draft are intended to eliminate any ambiguity regarding whether a recognized pension fund established in a Contracting State should be treated as a resident of that State under the OECD Model Treaty. Modifying Articles 3 and 4 to clarify when pension funds are considered residents would be helpful given the disparate views among countries about whether pension funds should be considered to be residents for treaty purposes. Nevertheless, the proposed changes and proposed commentary may require some refinement to ensure that all pension funds that are intended to be covered by the definition are in fact covered.

Pension funds should evaluate the proposed changes and consider submitting comments to the OECD, particularly if it would not constitute a "recognised pension fund" under the proposed definition. Comments are due by April 1, 2016.

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