UK: Pensions Directive - Cross-Border Aspects

(UK Pensions - Pensions Directive)
Last Updated: 12 October 2004
Article by Rosalind Knowles and Jayne Hidderley

This article deals with the impact of the Pensions Directive on UK schemes with cross-border aspects.

Focus on UK schemes

Member states have until 23 September 2005 in which to implement the Pensions Directive into their local laws.

The Directive sets:

  • minimum standards for the provision, funding and regulation of pension schemes that will have to be met in each member state; and
  • for the first time a common legal regime for operating pan-European or cross-border pension schemes – this means a multinational employer can operate a single pension scheme in one member state to cover all its employees within the EU.

This new regime for cross-border schemes will apply to UK schemes with cross-border elements, for example, overseas employers with UK pension schemes and "posted workers" or existing dual membership schemes (for example, UK/Irish employees).

The UK government has consulted on how it might implement the Directive and proposals for cross-border schemes are contained in Part 7 of the Pensions Bill.

What does the Directive say:

  • Funding rules
  • Registration/social and labour laws
  • Investment rules

Funding rules

This is likely to be the most significant aspect of the Directive for UK schemes. Member states must ensure all schemes have sufficient assets to cover their actuarially-calculated liabilities. Deficiencies may be allowed for a short time but the home member state authorities must require the scheme to adopt a recovery plan (to be made available to members). If there is cross-border activity there is a requirement for full funding at all times.

What does this mean - issues

  • "Full funding at all times" for cross-border schemes is particularly onerous and practically impossible to guarantee for a UK scheme, particularly if the scheme invests in assets such as equities. As worded it does not seem likely that the ECJ would interpret this generously – the best that could be hoped is that any underfunding would have to be addressed in a very short timescale.
  • Existing cross-border arrangements will need to watch that they are not caught by the provisions of the Pensions Bill (for example, overseas banks with UK pension schemes and "posted workers" or existing dual membership schemes, for example, UK/Irish employees) and the requirement that these be "fully funded". The government has been advised of this and it is hoped it will amend the draft legislation; we are monitoring the government’s response.
  • It is currently still unclear how the UK’s Pension Protection Fund would apply to a UK based pan-European scheme; if the government intends that only the obligations due to the UK members are covered then assets could be ring fenced but this may reduce the attractiveness of having any cross-border element.
  • Schemes with an existing "cross-border" element will need to monitor the development of the Pensions Bill closely and review whether they can continue existing arrangements, if they have to meet the requirement to be "fully funded at all times".

Registration/social and labour laws

A scheme that complies with the Directive’s requirements is permitted to register in one member state and automatically be recognised in other member states. The scheme will need to comply with the social and labour laws of each member state.

What does this mean - issues

  • This means that a cross-border scheme will need to have separate sections, each of which complies with the social and labour laws of the jurisdiction in which the members are employed.
  • There is no guidance within the Directive as to what constitutes social/labour laws and there are obviously major variations between member states.
  • The Directive does not cover how to address the differing compliance requirements between member states, for example what proportion of the governing board (for example trustees) of the scheme must be elected by the scheme membership. Employers could deal with this by "ratcheting up", adopting a governing board which complies with all the relevant requirements, for example 50% member representation would satisfy both UK and Dutch law – but employers may still need to ensure they comply with the detail of the legislation.

Investment rules

There is a three-tier system of investment rules applying to cross-border schemes:

  • All plans including cross-border, are subject to common minimum standards, including the "prudent person" rule and the requirement that investment shall be in "the best interests of the members and beneficiaries". The generic restrictions on investments in derivatives, unlisted assets, sponsoring employers, and borrowing for investment purposes, also apply to cross-border schemes.
  • Member states can impose additional restrictions to any plans located in their territories, but only within limits. Plans are allowed to invest up to 70% of their assets in shares and bonds traded on regulated markets, and up to 30% in foreign currencies and investing in risk capital markets.
  • Where there is cross-border activity the host member state could require a particular set of investment restrictions to apply - essentially these are similar to the above rules on traded shares and bonds and foreign currencies, together with a 5% limit on investments in one undertaking.

What does this mean - issues

  • The requirement for assets to be "predominantly invested on regulated markets" does not currently exist for UK schemes; it is hoped that "look through" provisions will be included in the legislation to prevent the introduction of new restrictions on open ended investment companies (OEICs), unit trusts and similar types of investment vehicles. We are monitoring the government’s response to this.
  • A cross-border pension scheme may be subject to different investment rules depending on where the plan, and the participating employers, are located. It could be possible to ring fence these different sections to meet the different rules for different host member states. The Directive leaves it to the home member state to determine how ring fencing would be achieved and whether it is necessary. However, ring fencing may dilute the advantages of a cross-border scheme.
  • If the scheme is a new scheme or a defined contribution scheme there is the possibility of pooling assets across borders. This would allow a more aggressive overall investment strategy. For existing defined benefit schemes this is much more difficult as trustees would be unlikely to agree to share surpluses or merge with schemes which are in deficit.

What the Directive does not say

The Directive does not cover tax at all. The current tax barriers are one of the main obstacles to establishing cross-border schemes.

  • Tax treatment has still not been harmonised across Europe. Pension scheme contributions are often only granted tax relief when they are made to a pension scheme in the same country but not when the contributions are made to a scheme in another country from that in which the tax relief is claimed.
  • The European Commission is currently taking infringement proceedings against a number of member states (including the UK) and has referred Denmark and Spain to the ECJ for failing to provide the same tax treatment to schemes based in other member states as they provide within their own country. The Commission has also been supported by the ECJ in its decisions in the Danner and Skandia cases. A number of member states have already told the Commission that they will amend their tax legislation and it is likely that in 2005 there will be significant progress towards tax harmonisation.

Tax Changes introduced by the Finance Act

The Finance Act 2004 includes details of the government’s pensions tax simplification. Changes are due to take place with effect from 6 April 2006.

  • Eligibility: the Act has relaxed the eligibility requirements for registered schemes (schemes which register for the new simplified tax regime). Employers can include non-UK employees in UK registered schemes and overseas schemes can apply to become UK registered schemes.
  • Transfers: these can be made freely between registered schemes and "recognised overseas schemes" - these include schemes established in the EU, or in other countries provided certain requirements are met (for example generally the scheme must be recognised for tax purposes in the country where it is established). These changes may mean it is possible for employers to merge their UK and overseas pension arrangements.

Employers will need to consider carefully whether it is appropriate to include non-UK employees in UK registered schemes (or to register non-UK schemes in the UK). In particular, it will be necessary to consider the tax or regulatory requirements in the country where the employee is working.

Correspondingly approved schemes – at present overseas employees who remain in their overseas scheme whilst seconded to work in the UK may claim ‘corresponding approval’. The Act removes this and replaces it with ‘migrant member relief’. Subject to certain conditions, this can apply to a wider description of schemes than was possible before and is intended to offer greater flexibility. It should also enable more secondees to the UK to remain in membership of their overseas scheme. Alternatively, individuals would be able to claim relief under the terms of a double taxation treaty,


The UK government still needs to address the anomalies in the draft legislation to ensure cross-border schemes are a practical alternative for multinational employers. Most of the elements to establish a cross-border scheme are now in place or, at least, once the Directive is fully implemented throughout the EU, they will be. The main obstacle still remains doing this tax-efficiently. However, it does appear that the Commission is committed to the removal of these tax obstacles within the EU.

This article is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts at Linklaters.

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