As part of WTax’s commitment to continually boost withholding tax recovery opportunities for institutional investors, WTax will be releasing a series of articles to explore some common withholding tax relief-associated challenges faced by 81-100 Group Trusts. Given the distinctive and complex nature of Revenue Ruling 81-100 Group Trusts, this article series aims to explain the implications of their structure on withholding tax recoveries and will provide suggestions regarding how to manage these unique challenges. It will also present updates on prevalent markets where these structures are currently facing difficulties.
As the opening segment of the article series, the below provides a brief overview of 81-100 Group Trusts, offering a broad understanding of how they are structured and an introduction to the challenges related to withholding tax relief that they may encounter. These will be explored in greater detail in upcoming pieces as the article series unfolds.
The use of pooling vehicles by pension plans to invest plan assets has become an increasingly popular choice for many pension and retirement plans. This is unsurprising since utilising a pooling vehicle to execute and oversee investments enables participating pension plans to capitalise on economies of scale, decrease overall expenses, bolster risk management efforts, and gain exposure to a broader range of diverse and innovative investment opportunities than they could achieve independently. The grouping of pension assets represents a strategic investment approach, addressing the complexities of the current financial landscape to deliver significant financial and administrative advantages to pension plans and maximise returns for beneficiaries.
Collective Investment Trusts (CITs), or Group Trusts as they are commonly referred to in the United States (U.S.), have been around for many years but have become a more popular investment vehicle for pension plans given the many benefits that they offer. However, despite the unquestionable investment and operational efficiencies that these structures can offer to retirement plans, they do present specific challenges, particularly in the realm of withholding tax recoveries.
What is an 81-100 Group Trust?
An 81-100 Group Trust (herein after “Group Trust”) is a U.S.-domiciled pooled investment vehicle organised as a CIT and is comprised of the assets of separate qualifying pension and retirement plans which are pooled together for investment purposes. This means that each participating plan of the Group Trust operates independently and maintains its own provisions, however, investments for each plan are consolidated within the Group Trust alongside the assets of other retirement plans.
By complying with the IRS Revenue Ruling 81-100, the Group Trust can benefit from an exemption from U.S. Federal Income Tax and is treated as a qualified tax-exempt pension fund for U.S. tax purposes. The tax exemption ensures that the investment of pension-related money and the returns thereon are not eroded when investing through the Group Trust rather than being invested directly.
Revenue Ruling 81-100 requires, among other things, that the trust assets must be held for the exclusive benefit of participants and their beneficiaries and that participation in the trust must be restricted to certain qualified investors.
According to Revenue Ruling 81-100, participation in a Group Trust must be limited to the following plans (eligible investors), as provided for in certain sections of the Internal Revenue Code:
- Employer’s pension and profit-sharing trusts exempt under Section 401(a)/501(a)
- Individual Retirement accounts under Section 408(e)
- Government Plans under Section 457(b)
- Custodial accounts under Section 403(b)(7)
- Retirement income accounts under Section 403(b)(9)
- Governmental retiree benefit plans under Section 401(a)(24)
- Puerto Rican plans described in Section 1022(i)(1) of the Employee Retirement Income Security Act of 1974 (ERISA)
Typical Structure of an 81-100 Group Trust
The creation of a Group Trust involves the establishment of a master pension trust in accordance with ERISA, by a bank or trust company. This master trust, designed to qualify as an 81-100 Group Trust, encompasses all the necessary provisions mandated by the Department of Labor and the IRS, including reporting, disclosure, participation, vesting, funding, fiduciary responsibility, and administration. The Group Trust is established and governed by a Declaration of Trust which creates a framework of operational and legal terms and conditions pertaining to the trust and the funds established and maintained under it.
Within the Group Trust, a trustee can establish multiple funds, each representing a unique investment strategy to meet the objectives of qualified retirement plans. Descriptions of the individual funds established under the Declaration of Trust are set out in a document often referred to as a separate fund statement and/or investment guidelines and are normally included as part of or accompanying the Declaration of Trust.
Group Trusts are therefore typically structured with tiers that involves a single upper-tier (referred to as “Master Trust” or “Group Trust Arrangement” or “Umbrella”) and multiple lower-tier vehicles (referred to as “trusts” or “funds” or “sub-funds” or “pools”) offering diverse investment strategies for participant plans. Participating pension plans will invest in the lower-level vehicles according to the investment strategy they desire. Each lower-tier vehicle will in turn hold its assets and securities separate from other funds established under the Group Trust arrangement.
The structure of an 81-100 Group Trust can be summarised as follows:
The Benefits of Investing Through an 81-100 Group Trust
When the assets of the pension fund are placed into one or more Group Trust structures (or other investment vehicles) and are invested through the trust rather than directly, the execution of the pension fund’s investment strategy is delegated to the asset manager, thereby reducing various cost and administrative burdens for the pension plan trustees and placing investment decisions in the hands of expert investment advisors. Investing in a Group Trust specifically eliminates the risk of the pension plan forfeiting its tax-exempt status in the United States.
Moreover, given the structure of the Group Trust, the pension fund is able to maintain its pro rata ownership in the assets contributed to the trust. This allows the pension fund to enjoy the same tax benefits and asset ownership without incurring the costs and operational efforts associated with directly investing the fund’s assets.
Barriers to Treaty Access
Although the advantages of participating in 81-100 Group Trust arrangements are evident for various operational and cost-related reasons, as mentioned earlier in this article, these structures often encounter challenges in obtaining withholding tax relief from foreign governments on dividend income arising from investments.
These challenges encompass a spectrum of issues, including uncertainties regarding the appropriate entity to submit the reclaim and be treated as the beneficial owner, debates on whether a group trust should be classified as a pension fund according to the definitions outlined in double tax treaties, and considerations related to the inclusion of Puerto Rican domiciled plans in Group Trusts.
Many of these challenges related to withholding tax relief on foreign investments were not initially envisaged, however, as Group Trusts became increasingly popular and foreign tax authorities started to clarify and streamline their treatment of these investment vehicles, more and more challenges seem to have arisen. This is a thorn in the side for many Group Trust managers who are playing catch-up to ensure that withholding tax leakage does not reduce the appeal and returns of Group Trusts overall.
As we delve deeper into our article series, we invite readers to stay tuned for the upcoming segment, where we will explore these challenges in respect of the various investment markets and provide some valuable insight on how to navigate these challenges from a withholding tax relief perspective. Be on the lookout for the second instalment titled: Barriers to Treaty Access for 81-100 Group Trusts which will be released on 31 January 2024.
In the meantime, WTax’s regional specialists remain keen and available for all your withholding tax recovery needs.