October 2, 2014 | Benedict Francis and Robert Rothery of KPMG's Washington National Tax provide an update on current and pending income tax treaties and international social security agreements, also know as totalization agreements, both of which have important implications for global mobility professionals.
Ben: Hi, I’m Ben Francis and I’m joined today by Bob Rothery. Today we’re going to be talking about two types of international agreements that are important in the context of international assignments. The first type is income tax treaties and the second is international social security agreements, also known as totalization agreements. Both of these types of agreements are important in that they foster trade and business between the two countries concerned, and they also can help to reduce the cost of international assignments.
Bob: Absolutely, that’s so much the case in the world of global mobility. Both kinds of agreements help us to often determine which country has the right to tax a certain amount of income and, in the case of treaties, if both countries have the right to tax the income, then we have foreign tax credit provisions that allow us to prevent double taxation.
All these issues are really important so that in the context of an assignment, it helps us to have control over the costs of both tax and compliance, and much of the time there’s cost mitigation as well –because of the agreements the cost is lower than it otherwise would be.
Ben: Well, there are important differences between these two types of agreements. Income tax treaties generally do not cover social security taxes; that is the role of totalization agreements. Totalization agreements have three main benefits. First of all, they ensure that an individual on an international assignment will not pay double social security tax—they will not have to pay social security tax both in their home country and also in the host country. The agreement has the effect of assigning to only one of those two countries the right to impose social security tax, so that reduces the cost of the international assignment.
Second, they provide assurances to the individual assignees that they will have no break in coverage, they will have continuity of coverage, and that they will pay social security tax in one country and then can immediately switch over to paying social security tax in the other country. SO they have no break in the insurance and other related benefits that they’re entitled to under social security.
And finally, when they become eligible for benefits under one of those two social security programs, whether that might be at retirement or disability, or whatever it is that causes them to become able to receive benefits, they will receive full credit, as it were, for the payments that they have made into the systems of both countries.
So, if during somebody’s working career, they paid social security tax in two separate countries—the United States and Japan, for example—when they come to retire, they will receive what is known as a totalized benefit that takes into account the full amount of tax they have paid into both of those two countries thus enhancing in many cases the benefit that they will ultimately receive.
Bob: Absolutely, and for all of these reasons, it’s really considered to be an advantage when we have a totalization agreement with a country that we’re going to be sending a worker to—both from the standpoint of lowering the cost or preventing double social security tax, and also the peace of mind that the worker will have knowing that they’re not going to have an interruption in their service credits for their ultimate credit that they’re going to be earning under their social security system in the years to come.
Unfortunately, although we continue to get new totalization agreements from time to time, there hasn’t been any movement on tax treaties in quite a while.
The problem with that is that although the president is mandated to negotiate the tax treaties, that’s under the Constitution with the “Advice and Consent of the Senate.” And what that means in practical terms is that it’s the Senate’s responsibility to ratify the treaty. Treaties have to be ratified by both countries before they can be entered into force, and since we’ve had very little movement of anything in the Senate these past few years, all of the treaties that have been pending have been bottled up.
You can see on your screen that there’s a list of five countries’ treaties, as well as a sixth treaty, Poland, that was recently advanced to the Senate by president Obama.
So it is quite a problem that we have with this backlog of treaties in the Senate. Hopefully after the November elections, perhaps the lame-duck Senate will feel comfortable with taking up the backlog of treaties, or perhaps with the new Congress in January we’ll see some action.
Ben: Well, it’s true there really is quite a significant backlog right now in terms of income tax treaties that have been agreed by the two countries but have not been ratified by the United States Senate and therefore have not yet entered into effect. Senator Levin, in June of this year, put forward a proposal, a unanimous consent proposal, the proposed effect of which would be to break this backlog and have those treaties come up for ratification by vote in the senate. Senator Rand Paul objected to this and blocked that proposal. Senator Levin responded that there’s now been a historically long gap—three years, I believe—since the last income tax treaty came into effect. So that really is a significant time lag during which no new income tax treaties have come into effect. And many business organizations think that that is regrettable; they like to see new treaties coming into effect, they like to see older treaties being updated to reflect new business realities.
So, so much for the backlog with income tax treaties. Better news, however, with regard to totalization agreements.
Bob: We do have a new agreement with the country of Slovakia that entered into effect on the first of May of this year.
Ben: And that has some important provisions. Because this is the 1st agreement that exists between those two countries, it includes a transitional rule which will apply to individuals that are already working in one of those two countries. So the fact that somebody’s assignment has already started as of May 1st 2014 will not cause them to lose the benefit of the five-year certificate of coverage rule whereby they can work in the host country and not have to pay social security tax in that country. The agreement also contains a provision whereby individuals can be assigned by third country other than the united states or Slovakia. If those individuals are sent to one of those two countries on assignment, they could also be covered by the agreement. SO that’s an important rule that increases flexibility and allows assignees to move to one of those two countries and still get the benefit of that agreement.
Bob: Absolutely. We also have a new agreement with Switzerland that entered into force on August 1 of this year. We already had an agreement with Switzerland that had entered into force back in 1980, so this new agreement just takes into account changes in the law of both countries that have occurred since that time—notably, the 0.9-percent Additional Medicare Tax is covered by this totalization agreement. I believe this is the first one that explicitly encompasses that tax. It doesn’t encompass the 3.8 percent net investment income tax—some people had hoped that it might—but since that isn’t part of the FICA law in the US, it’s not encompassed by the social security totalization agreement.
Since the Switzerland agreement is a replacement of an old agreement, it doesn’t need that transitional rule that we have in the Slovakia agreement, but it does have that third-country rule that I mentioned is in the Slovakia agreement. And how that would work is, for example, if we have a worker from the united states who’s working, say, in Argentina, where we don’t have a totalization agreement, and continues to be subject to FICA while working in Argentina, if that worker moved directly from Argentina to Switzerland, he would be able to have a certificate of coverage under the US-Switzerland agreement. Under the wording of the old agreement, that wouldn’t have been possible.
Ben: Well, new developments in the area of totalization agreements are generally welcomed, and the new agreement with Slovakia brought to 25 the total number of agreements to which the United States is a party, and most people welcome that development and welcome the continued expansion of that network of international social security agreements and the benefits that they bring.
We will continue to monitor the situation with income tax treaties and hope that the elections possibly might bring a breakthrough in that regard. Most business organizations as I said would welcome a remedy to that backlog situation and would like to see new income tax treaties come into effect.
So we’ll continue to monitor that situation—in the meanwhile, Bob, thank you very much for joining us today.
Bob: Thank you, Ben.
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