ARTICLE 18

Pensions, Etc.

This Article deals with the taxation of private (i.e., non-government service) pensions and annuities, social security benefits, alimony and child support payments and with the tax treatment of contributions to pension plans.

Paragraph 1

Paragraph 1 provides that distributions from pensions and other similar remuneration derived by a resident of a Contracting State in consideration of past employment are taxable only in the State of residence of the beneficiary. The phrase “pensions and other similar remuneration” is intended to encompass payments made by private retirement plans and arrangements in consideration of past employment. In general, the phrase is intended to include both periodic and lump-sum distributions. However, paragraph 3 provides special rules with respect to certain lump-sum distributions.

In the United States, the plans encompassed by Paragraph 1 include: qualified plans under section 401(a), individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), individual retirement accounts, individual retirement annuities, section 408(p) accounts, and Roth IRAs under section 408A), non-discriminatory section 457 plans, section 403(a) qualified annuity plans, and section 403(b) plans. The competent authorities may agree that distributions from other plans that generally meet similar criteria to those applicable to other plans established under their respective laws also qualify for the benefits of Paragraph 1. In the United States, these criteria are as follows:

(a) The plan must be written; (b) In the case of an employer-maintained plan, the plan must be non-discriminatory insofar as it (alone or in combination with other comparable plans) must cover a wide range of employees, including rank and file employees, and actually provide significant benefits for the entire range of covered employees;

(c) In the case of an employer-maintained plan the plan must contain provisions that severely limit the employees’ ability to use plan assets for purposes other than retirement, and in all cases be subject to tax provisions that discourage participants from using the assets for purposes other than retirement; and

(d) The plan must provide for payment of a reasonable level of benefits at death, a stated

age, or an event related to work status, and otherwise require minimum distributions under rules designed to ensure that any death benefits provided to the participants’ survivors are merely incidental to the retirement benefits provided to the participants.

In addition, certain distribution requirements must be met before distributions from these plans would fall under paragraph 1. To qualify as a pension distribution or similar remuneration from a U.S. plan the employee must have been either employed by the same employer for five years or be at least 62 years old at the time of the distribution. In addition, the distribution must be made either

(A) on account of death or disability, (B) as part of a series of substantially equal payments over the employee’s life expectancy (or over the joint life expectancy of the employee and a beneficiary), or

(C) after the employee attained the age of 55.

Finally, the distribution must be made either after separation from service or on or after attainment of age 65. A distribution from a pension plan solely due to termination of the pension plan is not a distribution falling under paragraph 1.

Pensions in respect of government service are not covered by this paragraph. They are covered either by paragraph 2 of this Article, if they are in the form of social security benefits, or by paragraph 2 of Article 19 (Government Service). Thus, Article 19 covers section 457, 401(a) and 403(b) plans established for government employees. If a pension in respect of government service is not covered by Article 19 solely because the service is not “in the discharge of functions of a governmental nature,” the pension is covered by this article.

Paragraph 1 does not include the sentence from the U.S. Model providing that the exclusive residence-based taxation is limited to taxation of amounts that were not previously included in taxable income in the other Contracting State. It is anticipated that any issues of potential double-taxation that arise due to the previous inclusion of a portion of the distribution in taxable income of the individual in the other Contracting State may be addressed by the competent authorities pursuant to the mutual agreement procedure of Article 25 (Mutual Agreement Procedure). However, it is understood that, in the case of a U.S. resident receiving a pension distribution from an Italian pension plan, the United States may tax the entire distribution pursuant to paragraph 1 regardless of the fact that Italy may have previously imposed a tax on the Italian pension plan with respect to earnings and accretions.

Paragraph 2

The treatment of social security benefits is dealt with in paragraph 2. As in the prior Convention, but unlike the U.S. Model, this paragraph provides that payments made by one of the Contracting States under the provisions of its social security or similar legislation to a resident of the other Contracting State will be taxable only in the other Contracting State. This paragraph applies to social security beneficiaries whether they have contributed to the system as private sector or Government employees. The phrase "similar legislation" is intended to refer to United States tier 1 Railroad Retirement benefits.

Paragraph 3

Paragraph 3 provides that, notwithstanding the exclusive residence country taxation of paragraph 1, if a resident of a Contracting State becomes a resident of the other Contracting State, lump-sum payments or severance payments (indemnities) received after such change of residence that are paid with respect to employment exercised in the first-mentioned State while a resident thereof, shall be taxable only in the first-mentioned State. The term “severance payments (indemnities)” includes any payment made in consequence of the termination of any office or employment of a person.

This paragraph is intended to prevent potential abuses of paragraph 1. For example, Italian law requires Italian employers to make certain lump-sum retirement payments to employees upon their retirement. Absent paragraph 3, an employee resident in Italy who anticipates receiving such a payment might establish residence in the United States in order to obtain more favorable U.S. tax treatment under paragraph 1. Similarly, paragraph 3 prevents a U.S. resident who anticipates receiving a lump-sum distribution from a U.S. pension plan with respect to employment in the United States from establishing residence in Italy in order to obtain more favorable Italian tax treatment under paragraph 1.

Paragraph 4

Under paragraph 4, annuities that are derived and beneficially owned by a resident of a Contracting State are taxable only in that State. An annuity, as the term is used in this paragraph, means a stated sum paid periodically at stated times during life or a specified number of years, under an obligation to make the payment in return for adequate and full consideration (other than for services rendered). An annuity received in consideration for services rendered would be treated as deferred compensation and generally taxable in accordance with Article 14 (Independent Personal Services) or Article 15 (Dependent Personal Services).

Paragraph 5

Paragraph 4 provides rules for the taxation of alimony and child support payments made by a resident of one Contracting State to a resident of the other State and defines the terms “alimony” and “child support”. The general rule is that such payments are taxable only in the country of residence of the recipient. However, if the payer is not entitled to a deduction in his country of residence, the amount will not be taxable to the recipient in either State. Thus, for example, since under present law alimony is deductible by the payer in each country, it is taxable to the recipient only in his country of residence, and since child support is not deductible by the payer in either country, it will not be taxable to the recipient in either country. The United States does not tax child support payments to the recipient; in the absence of the Convention, Italy would generally do so.

The reference to “entitled to” a deduction means permitted to claim a deduction under statutory rules. For example, a U.S. taxpayer who did not claim a deduction for alimony because he claimed the zero bracket amount or because he had a loss from other activities is nevertheless

“entitled to” such a deduction if it is allowed by the Code.

Paragraph 6

Paragraph 6 deals with cross-border pension contributions in order to remove barriers to the flow of personal services between the Contracting States that could otherwise result from a failure of the two Contracting States' laws regarding the deductibility of pension contributions to mesh properly. Many countries allow deductions or exclusions to their residents for contributions, made by them or on their behalf, to resident pension plans, but do not allow deductions or exclusions for payments made to plans resident in another country, even if the structure and legal requirements of such plans in the two countries are similar.

Subparagraph 6(a) allows for the deductibility (or excludibility) in one State of contributions to a plan in the other State if certain conditions are satisfied. Subparagraph 6(a) also provides that contributions to the plan will be deductible for purposes of computing the employer's taxable income in the State where the individual renders services to the extent allowable in that State for contributions to plans established and recognized under that State's laws.

The benefits of this paragraph are allowed to an individual who is present in one of the Contracting States to perform either dependent or independent personal services. The individual, however, must be a visitor to the host country. Subparagraph 6(d) provides that the individual can receive the benefits of this paragraph only if he was contributing to the plan in his home country, or to a plan that was replaced by the plan to which he is contributing, before coming to the host country. The allowance of a successor plan would apply if, for example, the employer has been taken over by another corporation that replaces the existing plan with its own plan, rolling membership in the old plan over into the new plan.

In addition, the host-country competent authority must determine that the recognized plan to which a contribution is made in the home country of the individual generally corresponds to the plan in the host country. It is understood that United States plans eligible for the benefits of paragraph 6 include qualified plans under section 401(a), individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), individual retirement accounts, individual retirement annuities, section 408(p) accounts, and Roth IRAs under section 408A), section 403(a) qualified annuity plans, and section 403(b) plans. Paragraph 15 of Article 1 of the Protocol provides that, in the case of Italy, the pension plans eligible for the benefits of paragraph 6 include a “fondi pensione”.

Finally, the benefits under this paragraph are limited to the benefits that the host country accords under its law, to the host country plan most similar to the home country plan, even if the home country would have afforded greater benefits under its law. Thus, for example, if the host country has a cap on contributions equal to, say, five percent of the remuneration, and the home country has a seven percent cap, the deduction is limited to five percent, even though if the individual had remained in his home country he would have been allowed to take the larger deduction. Where the United States is the host country, the exclusion of employee contributions from the employee’s income under this paragraph is limited to elective contributions not in

excess of the amount specified in section 402(g). Deduction of employer contributions is subject to the limitations of sections 415 and 404. The section 404 limitation on deductions would be calculated as if the individual were the only employee covered by the plan.

Relationship to Other Articles

Paragraphs 1, 2, 3 and 4 of Article 18 are subject to the saving clause of paragraph 4 of Article 1 (Personal Scope). Thus, a U.S. citizen who is resident in Italy, and receives either a pension, social security, annuity or alimony payment from the United States, may be subject to U.S. tax on the payment, notwithstanding the rules in those three paragraphs that give the State of residence of the recipient the exclusive taxing right. However, as explained with respect to Article 2 above, and as in the prior Convention, paragraph 2 of Article 1 of the Protocol provides that the saving clause does not override the exclusive residence country taxation provided in paragraph 2 of Article 18 of the Convention for individuals who are citizens of the residence State even if they are citizens of both States. Thus, if the United States makes a social security payment to a resident of Italy who is a citizen of both the United States and Italy, only Italy can tax that payment.

Paragraphs 5 and 6 are excepted from the saving clause by virtue of paragraph 3(a) of Article 1. Thus, the United States will allow U.S. citizens and residents the benefits of paragraphs 5 and 6.