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Can US employees of a US company who have been transfered to the UK co


Guest kstorch
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Jon, I gather the authority for your position is that Code Sec. 410(B)(3) allows a plan to exclude "nonresident aliens" receiving no US source income. But how do you conclude that employees who are U.S. citizens residing in the UK become "nonresident aliens" for this purpose? The regs say that the exclusion applies to "nonresident aliens" within the meaning of Code Section 7701(B)(1)(B). Reg. Sec. 1.410(B)-6©(1). That section defines the term to mean an individual who is "neither a citizen of the United States, nor a resident of the United States." So, if the transferred employees are U.S. citizens, the mere fact that they reside in the UK and receive no US source income does not make them excludible under Code Sec. 410(B)(3). Of course, the employer may wish to amend the plan to exclude nonresident U.S. citizens, but such employees cannot be excluded from consideration under the minimum coverage requirements of Code Section 410(B).

Phil Koehler

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Phil, although I'm aware of the non-resident alien exclusion for 410(B) purposes, my primary comment went to the definition of "compensation". If the transferred employee receives no U.S. compensation, then there is nothing to defer from. Perhaps they still count as a "participant" with a zero contribution. But my sense of the original question was whether or not the UK employee could contribute to a US 401(k), and I believe the answer to that is "no", unless there is US source income. I'd be interested in any cites to the contrary.

Jon C. Chambers

Schultz Collins Lawson Chambers, Inc.

Investment Consultants

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It would seem to me that if the UK division employees are not eligible to participate in the 401(k) plan and a U.S. citizen goes to work for such division, and is paid solely by the UK division then he/she would be ineligible to participate. As Jon says if there is no U.S. income, how could this person participate?

In one of my former positions, we had U.S. employees that we sent to the UK to work for our parent company. We paid a portion of their salary from the U.S. and the other portion was paid by the UK. We allowed 401(k) participation and deferrals from the U.S. salary only. Right or wrong, that’s what we were advised to do.

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The question that started this thread was whether it was possible for a U.S. qualified plan to continue to cover U.S. expatriate employees living abroad. The answer to that question is clearly yes and, in fact, unless the direct employment relationship has been severed (which generally doesn't occur merely due to a transfer to a foreign branch office of a U.S. company), this group should be treated as "otherwise nonexcludible" for 410(B) purposes.

Covering U.S. expatriates and third-country nationals ("TCNs") under a U.S. qualified plan can be an attractive option, since it permits the expatriate employee to have uninterrupted coverage as if he had remained in the U.S. On the other hand, coverage under a U.S. qualified plan may have adverse tax consequences under the tax laws of the foreign host country, The superannuation laws and applicable tax treaty provisions could, for example, result in foreign taxation of elective deferrals, employer contributions and/or investment earnings. Also, participation in the U.S. plan may have different consequences depending upon whether the employee is transferred to a foreign branch office or a separately incorporated foreign subsidiary.

Under Code Sec.406, a U.S. parent may treat U.S. expatriate employees (but not TCNs)of a foreign subsidiary as employees of the U.S. parent for purposes of eligibility to participate in the qualified plan of the U.S. parent. See also Code Sec. 407. However, there are significant restrictions that must be satisfied.

Another approach to continued coverage of the expatriate employees is facilitated by operation of Code Sections 414(B) and ©. While these provisions require treatment of all employees of a controlled group of corporations as employed by a single U.S. common parent employer for coverage purposes, Code Sec. 404(a) does not allow the U.S. parent to claim a tax deduction for contributions on behalf of the expatriate employees, since a direct employment relationship does not exist. Generally, a plan amendment will be necessary to allow for their continued participation.

Another approach is for the transfer of the U.S. employee to occur pursuant to a "secondment agreement," under which an individual retains his employee status by continuing to be subject to the direction and control of the prior U.S. employer, even though his services are performed for the benefit of another employer. In some cases the "seconded" employee may have dual employee status.

You cannot settle the issue of whether compensation paid to an expatriate employee is U.S. source income in the abstract. It will depend on the applicable tax treaty provisions, as well as applicable tax laws of the U.S. and foreign country. Simply because an expatriate employee earns no U.S. source income, and therefore derives no tax benefit under U.S. tax law from making elective deferrals, what about the employer contributions, the investment flexibility, the crediting of service for vesting purposes, the treatment of investment earnings as not currently taxable, etc. These are obviously significant tax benefits that an expatriate might well prefer to retain, by continuing to make elective deferrals from the compensation paid in the foreign jurisdiction.

Phil Koehler

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Let me summarize, if I may, my understanding of Phil's last comments in the thread:

1) Expatriates and TCNs can/should continue to participate in the 401(k) plan, unless the plan provides that they don't participate.

2) They may be taxed by the foreign country on their contributions, employer contributions, and investment earnings.

3) The US employer probably can't deduct contributions made for these employees.

If this understanding is correct, why wouldn't you want to exclude expats from the plan, and provide something more appropriate in the country that the expat works in? It seems as if all tax benefits are eliminated.

My initial comment in the thread was not intended to indicate that I believed that the transferred employee had terminated employment. It was merely to indicate that they can't continue to contribute to the 401(k) while they are out of the country. In my experience, this is the policy adopted by most employers. But participants continue to accrue vesting service and continue to benefit from tax deferred investment earnings on the money already in the plan. While it's true that they don't receive matching contributions, the employer can make up for that by setting up a local plan.

Finally, it seems that the sponsor considering these issues needs help from someone more qualified than me.[Edited by Jon Chambers on 08-11-2000 at 01:39 PM]

Jon C. Chambers

Schultz Collins Lawson Chambers, Inc.

Investment Consultants

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Whether or not it make sense to continue to cover U.S. expatriate employees under the U.S. parent's qualified plan depends on the relevant facts and circumstances, tax treaty provisions and the tax laws of the U.S. and the foreign country. Sometimes it makes business sense to do this where the U.S. expatriate either suffers no significant adverse tax consequences under the foreign tax jurisdicition, or the employer prefers to compensate the employee for such consequences, with a gross-up bonus, or whatever. One reason is that covering U.S. expatriates and TCNs under the foreign benefit plans in the host country requires compliance with that country's laws regarding plan design, coverage, funding, vesting and taxation. Since each country's laws will vary, this could require establishment and maintenance of multiple plans. Also, since a funded foreign plan will be treated as a nonqualified plan for U.S. tax purposes, an employee may be subject to current U.S. taxation under Code Sec. 402(B) for contributions and benefit accruals under the plan depending on the plan design, funding arrangement and applicable tax treaty provisions.

Jon, your arguments imply that the Code imposes a special minimum coverage requirement just for 401(k) plans, i.e. the employee's deferrals must obtain the pre-tax treatment allowable under Code Sec. 402(e)(3). You assert that this requires U.S. source income, in the absence of which, an employee, therefore, cannot be covered. There is nothing in Code Sec. 410(B) that supports such an analysis. For many practical reasons, the U.S. employer and the expatriate employee may want to amend the plan to exclude him, but this is much different than asserting a statutory basis for automatically kicking such employees out of the U.S. plan as soon as they become expatriates.[Edited by PJK on 08-11-2000 at 02:09 PM]

Phil Koehler

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I think Jon is thinking about the problem that arises when you want to cover nonresident aliens working outside the U.S. in a DC plan. The problem is (or maybe *was* since I have not looked at this issue in a few years) that the section 415 definition of compensation only includes income includible in U.S. gross income. Nonresident aliens working outside the U.S. have no U.S. source income and thus have $0 section 415 compensation. No 415 compensation means $0 annual additions are permitted.

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See 1.415-2(d)(2)(i)--items includible as compensation are "the employee's wages, salaries . . . and other amounts received . . . for personal services . . . TO THE EXTENT THAT THE AMOUNTS ARE INCLUDIBLE IN GROSS INCOME." Foreign-source earnings of a non-resident alien are not includible in gross income.

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Some miscellaneous comments:

1. If you want to include expats, make certain that the plan document deals with their participation. (On the other hand, if the company has a document that automatically includes everyone in the controlled group, the expats may be in the plan whether you want them to be or not.)

2. There may be treaty provisions that protect the expats.

3. Many corporations have programs to protect employees from the higher taxes that go with many foreign assignments. Depending on how the "hypothetical tax calculation" is done, expats may have an economic incentive to want to make 401(k) contributions, even though common sense would indicate that they should be excluded from the 401(k) program.

4. Most expats will end up being HCEs because of all of the moving allowances.

5. This is a very dangerous area to practice in without coordinating with someone who does expatriate tax work.

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Harry O, if you reread this thread, you'll see that we aren't talking about "nonresident aliens." We don't need a strained interpretation of the 415 regs to exclude them because "nonresident aliens" are statutorily excludible under Code Sec. 410(B)(3)©. We're talking about nonresident citizens or U.S. nationals living abroad. What is the authority for your position that the compensation paid by a U.S. parent company to its U.S. expatriate employees employed in a foreign branch office or by the parent's foreign sub is not "includible in gross income" for purposes of determining Code Section 415 compensation. Please consider the purposes of Code Sections 406 and 407 in your reply.

Phil Koehler

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PJK - I know the thread did not start out discussing nonresident aliens. I just suggested that perhaps Jon was thinking of the section 415 problem that applies to nonresident aliens when he suggested that expats might have a problem participating because they don't have US source income.

Kirk - The section 415 regulations provide that compensation only counts "to the extent included in gross income." So the next step is to figure out if compensation income earned by a nonresident for services performed outside the U.S. is "includible in gross income." The answer is no. See section 872(a): "In the case of a nonresident alien individual, except where the context clearly indicates otherwise, gross income includes only --

(1) gross income derived from sources within the United States . . . "(not our case since the services are performed outside the U.S.), "and

(2) gross income which is effectively connected with the conduct of a trade or business within the United States" (again not our case since the services are performed outside the U.S.).

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Harry O:

My rejoinder is the same as PJK; I was focusing upon US employees that are transferred abroad, not nonresident alients. I have no trouble with the conclusion that nonresident aliens with no US source income can't participate.

My question to you remains where in the Section 415 regulations does it state that a US citizen (not a nonresident alien) who is transferred abroad cannot continue to participate in a tax-qualified retirement plan?

Kirk Maldonado

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Kirk,

My answer is I never said that a *US citizen* working abroad could not participate in a US qualified plan. Where do you think I made such a statement in my prior posts?

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Harry O:

I think it was your statement "The problem is (or maybe *was* since I have not looked at this issue in a few years) that the section 415 definition of compensation only includes income includible in U.S. gross income."

Because the thread was originally about US employees transferred abroad, I interpreted that statement as meaning that even US employees transferred abroad couldn't participate (because of the Section 415 limitations).

It is true that the next sentence in your message referred to nonresident aliens, but I didn't interpret it as limiting your prior sentence on Section 415; I thought it was merely being illustrative. However, after rereading it, I can see that the sentence I quoted above may have been taken out of context.

Kirk Maldonado

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PJK -

Re-read my posts. I never said that a US citizen working abroad could not participate in a US qualified plan.

Jon made that statement and referred to a lack of US source income as the reason. I simply said that perhaps Jon was confusing the issue -- *nonresidents* can't participate in a DC plan because they don't have US source income (a prerequisite for eligible 415 compensation). That is not a "strained reading" of section 415 but is clearly the law.

Your reference to the 410(B) rules is irrelevant. If the plan document doesn't exclude nonresidents from participating they are in the plan as a technical matter regardless of whether section 410(B) would allow you to disregard them for coverage testing purposes. NRAs can only be excluded if you draft your plan to exclude them, they are not excluded automatically by virtue of section 410(B).

Finally, the next employer I meet that uses sections 406 and 407 to cover expats will be the first. Congress could repeal these sections tomorrow and no one would notice.

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Many thanks to Harry O, who accurately relates the problem I was initially trying to address, before we went off on a 410(B) coverage tangent. My recollection of work I did years ago on this topic is that without 415 eligible comp, a nonresident clearly is NOT permitted to make any annual additions. And my understanding is that "US source income" is required for 415 eligible comp, hence my short-cut reference back to "reportable on a W-2" (I recognize that that reference is imprecise, but I find it useful). I'll leave it up to Kirk, Phil and Harry to determine whether nonresident US citizens can have US source income while domiciled and working exclusively in another country.

Jon C. Chambers

Schultz Collins Lawson Chambers, Inc.

Investment Consultants

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Harry O, the "law" is actually what Congress (and the courts) say it is. Treasury regs cannot supercede statutory prescriptions. Since Code Sections 406 and 407 are specficially designed to treat U.S. citizens employed by a foreign affiliate as employed by an "American employer" for purposes of continuing their coverage under a qualified plan of the U.S. parent company, any interpretation of Sec. 415 regs that is inconsistent with such statutory prescriptions is clearly "strained."

As a general rule, the source of income is determined by the situs of the services rendered, not by the location of the payor, the residence of the employee, the place of contracting or the place of payment. Regs. 1.861-4(a)(1). Thus, Code Sections 406 and 407 are pivotal. Code Section 406(a) provides that for purposes of satisfying 401(a) (which certainly includes the requirements of Code Section 415), U.S. citizens working for a foreign affiliate of a U.S. domestic corporation may be treated as employed by the U.S. domestic corporation, if certain requirements are satisfied. Thus, the compensation paid to such employees is treated as compensation paid by the U.S. domestic corporation.

The authority you cite to the contrary is Reg. Sec. 1.415-2(d)(2)(i). The only reference to the exclusion of foreign source compensation is in the second sentence, which is limited to "nonresident aliens." Just as a matter of construction, why do the regs expressly exclude foreign source earnings of a nonresident alien from "gross income" for Sec. 415 purposes, but do not expressly exclude the foreign source compensation of resident aliens or nonresident citizens (the group we're trying to discuss)? Under general principles of construction, if all foreign source earnings were excludible from "gross income" for Sec. 415 purposes, the regulation would logically not have limited its application to just "nonresident aliens." Thus, the authority you cite could be read as supporting the inclusion of foreign source earnings for persons other than "nonresident aliens." This interpretation not only follows general rules of construction, it is not at odds with other sections of the Code.[Edited by PJK on 08-15-2000 at 02:25 PM]

Phil Koehler

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PJK-

Lets take a deep breath and start from the top . . .

I don't believe we disagree on the question that started all this -- US citizens or resident aliens working abroad can participate in a US tax qualified plan. Re-read my posts. I never said otherwise.

What I did say was that *nonresident aliens* can't participate in a US tax qualified DC plan unless they have US source wage income. I'm not sure after going through your posts whether you agree or disagree with this point.

I also believe that 406 and 407 are useless -- kind of like the SLOB rules. No one uses them to keep US expats in their plans. These sections could disappear tomorrow and no one would notice.

Finally, the section 410(B) excludible employee rules are completely inapplicable to the original question.

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Harry O, if you're asked "Can US employees of a US company who have been transferred to the UK continue to participate in the US 401(k) Plan?" how is any discussion of the treatment of "nonresident aliens" relevant to answering this question? Some respondents to this thread initially confused U.S. citizens working abroad with "nonresident aliens," and the discussion has turned into a training project from there. It seems to me that your comments about the treatment of foreign source income of "nonresident aliens" doesn't respond to the call of the question.[Edited by PJK on 08-16-2000 at 01:12 PM]

Phil Koehler

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I'm the late commentator. I agree with everything Phil said. The exact corporate set-up and its relationship to the parent/affiliate is material. Also, as Phil mentioned, which I cannot over-emphasize based upon my experience, someone better know the controlling tax treaties. The U.K. treaty is the one that has the broadest familiarity in the U.S. and that treaty has some amazing twists and loopholes for the two countries' citizens. For example, pension distribution tax rate is affected by where the money was earned (and taxed) and where the person retires. If all the income is paid in the U.K., I was told by international tax lawyers that the income does not count for U.S. domestic retirement plans even though the person may get creditted for hours of service outside the U.S. for all purposes of the plan.

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