INTM163160 - Pensions - Lump Sums
Source: gov.uk (2025-03-11)


INTM163160 – Pensions - lump sums

Double Taxation Agreements: Pensions: Lump sums

For most of the UK’s Double Taxation Agreements (DTAs), whether a payment from a pension scheme is a lump sum will not have a material effect since lump sums and non-lump sums will be treated the same way in the relevant DTA. However, a small number of the UK’s DTAs include a specific provision that creates a different taxing right for lump sum payments. This will be an issue where either:

· The pensions article includes “or similar remuneration” and has a specific provision that applies to lump sums, or

· The pensions article does not include the words “or similar remuneration”.

Where the pensions article of a DTA does not apply to lump sums, such payments will fall within the “Other Income” Article, which may give the same result if both articles provide for the income to be taxed only in the State of residence, though a different outcome is also possible depending on the terms of the DTA.

An example of a specific provision that applies to lump sums can be found in Article 17 of the 2013 UK/Norway DTA:

1. Subject to the provisions of paragraph 2 of Article 18, pensions, including payments under a social security system, arising in a Contracting State and paid to a resident of the other Contracting State, may be taxed in the first-mentioned State.

2. Notwithstanding the provisions of paragraph 1, a lump sum payment derived from a pension scheme established in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in the first-mentioned State

The UK’s policy intention for paragraph 2 was to ensure that people who have paid into a UK registered pension scheme while employed in the UK, but then moved to another country before taking their pension, were still able to benefit from the 25% tax-free lump sum to which a UK resident would be entitled (as a Pension Commencement Lump Sum (PCLS)). However, since 2015 the rules regarding pensions have been relaxed and the above provision now applies more widely than originally intended.

What is a Lump Sum?

For the purposes of a DTA, the term “lump sum” means any non-periodic, irregular or abnormal payment of a pension. Determining whether a payment is a periodic payment or a lump sum will, in most cases, be straightforward. For example, many occupational pensions and annuities will provide for a set, monthly payment of broadly similar amounts for a set period, or until the pensioner’s death. These pensions may also allow for a lump sum to be taken, usually on commencement of the pension, and that lump sum will clearly be identifiable as a lump sum under the UK’s DTAs.

It would generally be safe to assume that a payment that represents 50% or more of the total value of the pension fund available to the individual will be a lump sum. However, this would not be the case where, for example, the payment is the penultimate payment of a regular amount of a pension (that is, the total fund started at, say, £100,000 and a monthly payment of £2,000 is received for 50 months. In the penultimate month, £2,000 represents half of the remaining funds but it would still be a periodic payment when considering the position as a whole).

Similarly, in most cases a payment of 20% or more of the fund is likely to be a lump sum – though this may not always be the case where the whole pension was distributed in 5 payments with some regularity and, as such, those five payments are more akin to periodic payments. In all cases, regard must be had to the facts and circumstances surrounding the actual payment.

A common feature at the beginning of a pension, or immediately before a lump sum, is that the pension fund and/or the recipient may request a nominal test payment – perhaps to ensure the correct tax is withheld or that the correct bank details have been used. Where that test payment is clearly linked to another payment, it would be reasonable to treat both payments in the same way. That is, if the following payments are all clearly periodic payments, then the test payment should be treated the same way, but if the test payment preceded a lump sum then it would similarly be taxed as a lump sum.

Difficulties may arise where a person has complete control over their pension payments and generally takes a proportion of their pension as and when they need it. In all cases the nature of the payment will be based upon the facts and circumstances, and the considerations to be taken into account include:

· Whether the payment has some regularity to it, both in terms of payment dates and amounts paid. For example, a payment of broadly the same amount on a weekly, monthly, quarterly or annual basis is likely to be a periodic payment;

· Whether the payment is significantly different to the usual payments made, whether it falls on a regular date or not.

· Whether the payment has a material effect on the available pension “pot”. That is, a periodic payment is likely to be relatively consistent, after taking into account things like inflation and growth of the fund. Whereas a lump sum payment is likely to reduce the value of periodic payments, or the number of such payments, that can be made after the lump sum has been taken.

· Whether there are any indicators the principal purpose, or one of the principal purposes of the lump sum payment is to obtain a benefit under the DTA (if the relevant DTA has such a test, which is usually in the “Entitlement to Benefits” Article). If you consider the principal purpose test to be relevant to a particular case, please contact xxx@xxx.xx (mailto:xxx@xxx.xx)for further guidance.

Where all, or the majority of payments from a pension fund are ad hoc payments of irregular amounts, it is likely that each will be a lump sum for the purposes of a DTA. However, it may be necessary in these cases to consider a longer period of time to establish the nature of the irregularity. For example, where a person draws from their pension as and when they need it, you may see that a pattern emerges year-by-year that, say, £20,000 is taken annually. In such cases it is more likely that the payments can be treated as periodic payments rather than lump sums. If in a particular year, say, £50,000 is taken this would then demonstrate some irregularity and the additional £30,000 would be treated as a lump sum.

The UK/US DTA

It should be noted that the US regards the lump-sum provision in paragraph 2 of Article 17 of the UK/US DTA to be an anti-avoidance measure. For payments arising in the US, regard must therefore be had for US domestic law.

A particular feature of the UK/US DTA is that, although paragraph 2 of Article 17 gives exclusive taxation rights over lump sum payments to the State in which the payment arises, this is in effect overridden by paragraph 4 of Article 1. The effect of paragraph 4 of Article 1 is that the DTA will not prevent either State from taxing its own residents unless the provision is specifically listed in paragraph 5 of Article 1. This means that although the State in which the pension lump sum arises will be able to tax that payment under Article 17, the State in which the recipient is resident will also be able to tax the payment under Article 1. Relief from double taxation will be available under the treaty in the usual way.

There is a second limb to paragraph 4 of Article 1, which is that the treaty does not prevent a State from taxing its citizens “by reason of citizenship” except where specifically listed. Because the UK does not tax “by reason of citizenship” (it taxes by reason of source or by reason of residence), this limb currently only has effect for the US, which is why the elimination of double taxation article deals only with the US citizenship tax in respect of paragraph 4 of Article 1. This means that while paragraph 4 of Article 1 allows the US to tax some residents of the UK, because of the interaction with UK domestic law the UK would not tax a US resident under this provision even if they were a UK citizen.