Article 18 deals with cross-border — U.S. Income Tax Treaty

barriers to the flow of personal services between the Contracting States that could otherwise result from discontinuities in the laws of the Contracting States regarding the deductibility of pension contributions. Such discontinuities may arise where 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.

Paragraph 1

Paragraph 1 provides that, if a resident of a Contracting State participates in a pension fund established in the other Contracting State, the State of residence will not tax the income of the pension fund with respect to that resident until a distribution is made from the pension fund. Thus, for example, if a U.S. citizen contributes to a U.S. qualified plan while working in the United States and then establishes residence in the other Contracting State, paragraph 1 prevents the other Contracting State from taxing currently the plan’s earnings and accretions with respect to that individual. When the resident receives a distribution from the pension fund, that distribution may be subject to tax in the State of residence, subject to paragraph 1 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support).

Paragraph 2

Paragraph 2 provides certain benefits with respect to cross-border contributions to a pension fund, subject to the limitations of paragraphs 3 and 4 of the Article. It is irrelevant for purposes of paragraph 2 whether the participant establishes residence in the State where the individual renders services (the “host State”).

2006 U.S. Model Technical Explanation

Subparagraph (a) of paragraph 2 allows an individual who exercises employment or selfemployment in a Contracting State to deduct or exclude from income in that Contracting State contributions made by or on behalf of the individual during the period of employment or selfemployment to a pension fund established in the other Contracting State. Thus, for example, if a participant in a U.S. qualified plan goes to work in the other Contracting State, the participant may deduct or exclude from income in the other Contracting State contributions to the U.S. qualified plan made while the participant works in the other Contracting State. Subparagraph (a), however, applies only to the extent of the relief allowed by the host State ( e.g. , the other Contracting State in the example) for contributions to a pension fund established in that State.

Subparagraph (b) of paragraph 2 provides that, in the case of employment, accrued benefits and contributions by or on behalf of the individual’s employer, during the period of employment in the host State, will not be treated as taxable income to the employee in that State. Subparagraph (b) also allows the employer a deduction in computing its taxable income in the host State for contributions to the plan. For example, if a participant in a U.S. qualified plan goes to work in the other Contracting State, the participant’s employer may deduct from its taxable income in the other Contracting State contributions to the U.S. qualified plan for the benefit of the employee while the employee renders services in the other Contracting State.

As in the case of subparagraph (a), subparagraph (b) applies only to the extent of the relief allowed by the host State for contributions to pension funds established in that State. Therefore, where the United States is the host State, the exclusion of employee contributions from the employee’s income under this paragraph is limited to contributions not in excess of the amount specified in section 402(g) for elective contributions. Deduction of employer contributions is subject to the limitations of sections 415 and 404. The section 404 limitation on deductions is calculated as if the individual were the only employee covered by the plan.

Paragraph 3

Paragraph 3 limits the availability of benefits under paragraph 2. Under subparagraph (a) of paragraph 3, paragraph 2 does not apply to contributions to a pension fund unless the participant already was contributing to the fund, or his employer already was contributing to the fund with respect to that individual, before the individual began exercising employment in the host State. This condition would be met if either the employee or the employer was contributing to a fund that was replaced by the fund to which he is contributing. The rule regarding successor funds would apply if, for example, the employer has been taken over by a company that replaces the existing fund with its own fund, rolling membership in the old fund over into the new fund.

In addition, under subparagraph (b) of paragraph 3, the competent authority of the host State must determine that the recognized plan to which a contribution is made in the other Contracting State generally corresponds to the plan in the host State. For this purpose the U.S. pension funds eligible for the benefits of paragraph 2 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),

2006 U.S. Model Technical Explanation

section 403(a) qualified annuity plans, section 403(b) plans, section 457(b) plans and the Thrift Savings Plan (section 7701(j)).

Paragraph 4

Paragraph 4 generally provides U.S. tax treatment for certain contributions by or on behalf of U.S. citizens resident in the other Contracting State to pension funds established in the other Contracting State that is comparable to the treatment that would be provided for contributions to U.S. funds. Under subparagraph (a), a U.S. citizen resident in the other Contracting State may exclude or deduct for U.S. tax purposes certain contributions to a pension fund established in the other Contracting State. Qualifying contributions generally include contributions made during the period the U.S. citizen exercises an employment in the other Contracting State if expenses of the employment are borne by an employer or permanent establishment in that other Contracting State. Similarly, with respect to the U.S. citizen’s participation in the pension fund in the other Contracting State, accrued benefits and contributions during that period generally are not treated as taxable income in the United States.

The U.S. tax benefit allowed by paragraph 4, however, is limited under subparagraph (b) to the lesser of the amount of relief allowed for contributions and benefits under a pension fund established in the other Contracting State and the amount of relief that would be allowed for contributions and benefits under a generally corresponding pension fund established in the United States.

Subparagraph (c) provides that the benefits an individual obtains under paragraph 4 are counted when determining that individual’s eligibility for benefits under a pension fund established in the United States. Thus, for example, contributions to a pension fund in the other Contracting State may be counted in determining whether the individual has exceeded the annual limitation on contributions to an individual retirement account.

Under subparagraph (d), paragraph 4 does not apply to pension contributions and benefits unless the competent authority of the United States has agreed that the pension fund established in the other Contracting State generally corresponds to a pension fund established in the United States. The notes provide that certain pension funds have been determined to "generally correspond" to funds in the other country. Since paragraph 4 applies only with respect to employees, however, the relevant plans are those that correspond to employer plans in the United States.

Relationship to other Articles

Paragraphs 1 and 4 of Article 18 are excepted from the saving clause of paragraph 4 of Article 1 by virtue of paragraph 5(a) of Article 1. Thus, the United States will allow U.S. citizens and residents the benefits of paragraphs 1 and 4. Paragraph 2 is excepted from the saving clause by subparagraph 5(b) of Article 1 with respect only to persons who are not admitted for permanent residence or citizens. Accordingly, a person who becomes a U.S.

2006 U.S. Model Technical Explanation

permanent resident or citizen will no longer receive a deduction for contributions to a pension fund established in the other Contracting State.