The QROPS regime and EU law

From a tax perspective, and at its most basic level, a private pension represents a mechanism by which the imposition of income tax may be deferred until a later date. The array of products is vast and someone wishing to make provision for their retirement may seek assistance from an army of advisers willing to navigate the path to a suitable product. Naturally, the pensions industry in the UK is heavily regulated and each UK pension is registered with HMRC. The fact of that registration offers some comfort, both to the pension holder and to the exchequer, that the particular fund is operated in an appropriate way and is compliant with the law. On this last point, compliance with the law is essentially a question of ensuring that tax is appropriately accounted for as and when income is drawn down.

Provided a pension is registered with HMRC at the time it is opened or transferred into, there is no danger that the underlying legal status of that fund will be altered after the event. All a UK pension holder need worry over is the likely value of the fund at retirement. For most people, this worry is quite sufficient, but for individuals wishing to transfer their pensions abroad, the position is potentially far worse.

The QROPS regime

The qualifying recognised overseas pension scheme (QROPS) system was introduced in FA 2004 as a mechanism by which those with UK pensions could transfer their funds abroad. In this way, the rules sought to comply with the terms of the EU treaty which provides for the free movement of workers and capital. In broad terms, the system permits the transfer of a UK pension to an overseas pension, provided the receiving scheme satisfies the conditions of an ‘overseas pension scheme’ (FA 2004 s 150(7); SI 2006/206) that it is ‘recognised’ (FA 2004 s 150(8); SI 2006/206) and ‘qualifying’ (FA 2004 s 169(2); SI 2006/208). Such a transfer is referred to as a ‘recognised transfer’ (FA 2004 s 169(1)) and is free from tax.

However, where a transfer is made from a UK fund into a non-QROPS, the penalties are huge: an unauthorised payment charge and surcharge of 55% of the value of the fund at transfer (FA 2004 ss 208, 209), plus interest.

The way in which HMRC administers the QROPS system is to require the would-be QROPS fund trustees to submit a form which indicates whether the fund meets the requirements of a QROPS. Much of the information is input in a ‘tick box’ format. Once HMRC is satisfied that the fund meets the requirements (largely based on what the trustees have said in the form), it sends a letter which confirms the same and places the fund’s name on the ‘QROPS list’. This list is published on HMRC’s website.

Such was the case with recognised overseas self-invested international pension (ROSIIP), a fund which appeared on the QROPS list between late 2006 and May 2008 before being removed by HMRC. In the meantime, around 120 individuals transferred their UK pensions into the fund. HMRC was of the view that the initial registration (the form described above) contained errors which undermined ROSIIP’s status as a QROPS. The point was litigated in TMF Trustees v HMRC [2012] EWCA Civ 192, and the fund lost: as a matter of law, ROSIIP is not and never was a QROPS. HMRC then began to issue assessments against those who had transferred into the fund to 55% of the value of their pensions at transfer plus interest. In some instances, this represented more than the total current value of the fund. In all cases, it amounted to a significant and potentially life-changing grab at the pension holders’ provisions for retirement. The pension holders had done nothing wrong. They had relied in good faith on information provided to them by HMRC and were being penalised merely for selecting the wrong fund at the wrong time. Many of those affected challenged HMRC by way of judicial review and the ROSIIP GLO was formed. After a year of litigation, HMRC withdrew from the case, withdrew all of the assessments issued against the ROSIIP investors and notified the court that it would do the same to all pre-October 2008 transfers (the date on which a caveat was added to the QROPS list indicating that its contents could not be relied upon). Consequently, no judgment was delivered, but the issues raised in the ROSIIP GLO go beyond the facts of the case itself and to the heart of HMRC’s interpretation and administration of the QROPS system as a whole.

The cross-border transfer of a pension engages EU rights under the Treaty on the Functioning of the European Union (TFEU) article 63 (concerning free movement of capital). This applies to transfers to other parts of the EU and third countries. Where EU rights are engaged, general principles of EU law apply. These general principles include, in particular, legal certainty and legitimate expectations. The principle of the protection of legitimate expectations, although a general principle in its own right, is considered to stem from the general principle of legal certainty; that is to say, the fundamental premise that those who are subject to the law must be able to know what the law is so they may plan their actions accordingly.

HMRC’s view

HMRC’s position on the QROPS list is that it may not be relied upon as an indicator of the legal status of a fund at any one time; and that if it transpires later that a fund should not have been included on the list, it will be removed and any transactions made in the meantime will be subject to the unauthorised payment charge and surcharge. Since the pension holder has only HMRC and the receiving fund itself as a source of information on the legal status of a particular fund at UK law, how is that investor to know whether or not a fund meets the relevant criteria? HMRC’s answer to this during the ROSIIP GLO was to argue that ultimately it was a matter for the courts to decide, as they had in TMF Trustees.

Such a view is impossible to reconcile with the principle of legal certainty. Even if HMRC’s interpretation of the legislation is correct, in the sense that its administration of the QROPS system accurately reflects the intention of parliament, it is incumbent on the member state and the courts to interpret national rules so as to give effect to the requirements of EU law or, in the context of treaty freedoms, the treaty itself.

The affront to legal certainty would not be so bad if the cross-border system was remotely comparable to the system relevant to the transfer of pensions domestically. It is not. In a purely domestic situation, irrespective of whether or not the UK pension fund properly meets the criteria for ‘registration’ in the legislation, provided it appears on the register at the time of the transfer (FA 2004 s 150(2)), the transfer will be a ‘recognised transfer’ (FA 2004 s 169(1)(a)) and no punitive charges will apply.

Where does this leave us?

HMRC’s interpretation of the law produces a state of complete certainty domestically and utter uncertainty cross-border. This outcome breaches the EU principles referred to above and produces clear discrimination between UK-to-UK and cross-border transfers. In addition, the imposition of the 55% tax at transfer, when viewed through the prism of EU law, must amount to an unlawful exit charge. HMRC’s position is that these charges are ‘compensatory’ in nature and are designed to recoup the tax relief enjoyed on payments made into the fund. This view can withstand no sensible examination. A UK pension holder transferring his pension to another UK pension fund would only attract a tax charge upon drawdown, and even then only on the amount drawn (i.e. subject to the income tax rate applicable to him/her in retirement and with a 25% tax-free lump sum). The 55% charges applied on cross-border transfers are payable on transfer, not drawdown, and do not take into account the 25% exemption or any increases in the value of fund which have accrued from investments made. The effect is that the imposition of these charges would tend to dissuade pension investors from choosing to transfer their pension funds abroad when compared to transferring domestically or leaving the fund where it is.

The QROPS system as a whole has been subject to strong criticism both for the inherent weaknesses of the system itself and the way in which it is administered. HMRC’s approach has been to place the entire burden of ensuring the bona fides of a particular fund on the pension holder. The system contains mechanisms to exonerate the transferring scheme and makes no attempt to penalise bogus funds. The concession made in the ROSIIP GLO mean that those whose transfers were made before HMRC placed a broad caveat on the QROPS list in October 2008 are safe. However, for transfers after this date, HMRC takes no responsibility whatsoever for the front-end administration of the system and has and continues to levy heavy penalties on pension holders who have done nothing more than rely on the information, which HMRC itself (at least at one stage) found sufficient to include a fund on its QROPS list. This leaves us with a question as to whether transfers made after October 2008 are not equally entitled to rely upon the list, in accordance with the EU principles described above. It is, after all, the only information the pension holders have when making their transfers and it seems doubtful that the discrimination described can be remedied by something which makes the situation even less certain.

Irrespective of whether it is an appropriate way to run a regulatory or tax system, HMRC’s administration of the QROPS regime has the effect of making cross-border transactions far less attractive and considerably riskier than keeping funds in the UK. Whether this outcome was intentional may be the subject of debate; however, the question of whether it breaches EU law appears rather more certain than the system itself.