WASHINGTON - Holland's second largest largest pension fund could collect an $8.5 million tax refund from the U.S. government if a federal appeals court rules it qualifies as a tax-free labor organization.
The U.S. Court of Appeals for the District of Columbia Circuit accepted the appeal from the Dutch pension fund earlier this month after a lower court rejected as "unpersuasive" its claim that it did not have to pay U.S. income taxes because it is a labor organization.
The lower court ruling against the pension fund was made by Judge Charles R. Richey of the U.S. District Court for the District of Columbia.
A favorable ruling by the appeals court could open the door for several other Dutch and British union pension funds to collect millions of dollars in refunds on taxes they have paid on U.S. investments.
The case involves the 62 billion guilder ($35.7 billion) Stichting Pensioenfonds voor de Gezondheid Geestelijke en Maatschappelijke Belangen, a Zeist, Holland, health care industry pension plan.
"The Dutch case is just the very teeniest bit of the iceberg," said Michael A. Thrasher at the Washington law firm of Groom and Nordberg and former assistant chief counsel in the employee benefits and exempt organizations department of the Internal Revenue Service.
Mr. Thrasher said the IRS had more than $150 million in tax refund claims from pension funds over this issue pending when he left the agency a year ago.
The amount at stake now could be much higher, according to a source familiar with the matter who asked not to be identified.
"The IRS is holding in abeyance a number of audits of foreign taxpayers that have this issue," said the source.
PGGM sought a refund for taxes it paid in 1993 on earnings from investments in U.S. stocks that year. A four-year-old agreement between the United States and the Netherlands exempts Dutch pension funds from paying taxes on U.S. investments after 1993.
Foreign pension funds generally are taxed at a 30% rate on dividends earned from investments in U.S. stocks, unless their home countries have a reciprocal agreement with the United States or the funds qualify as tax-exempt labor organizations. Because of other reasons, most foreign pension funds usually end up paying 15% in taxes, experts say.
The tax does not apply to profits from the sale of U.S. stocks held by foreign pension funds, or interest on U.S. bonds held by them.
Tax laws have exempted labor organizations from paying income taxes since 1909. While the U.S. tax code does not define labor organizations, tax rules define them as those that have no net earnings benefiting any member, work to improve the conditions of people employed in the same profession, and engage in "the improvement of the grade of their products and the development of a higher degree of efficiency in their respective conditions."
At a minimum, the entity must be "controlled by an organization (such as a labor union) carrying on such activities."
The Dutch fund did not show how it helped workers improve the quality of their products or enhance their productivity, Judge Richey ruled last month.
The fund also failed to meet the definition because it does not have the authority to represent workers in benefits issues because half of its trustees are employer representatives, which is common in the Netherlands.
The judge also concluded seven of the 15 IRS rulings issued on qualifications for tax-exempt labor organizations rested on whether they were controlled and funded by labor unions. Because PGGM does not represent workers on benefits matters, but exists solely to manage retirement funds and pay pensions, it cannot pass for a labor organization, the judge said in his decision.
The ruling also said that letting pension funds with tenuous connections to labor groups receive tax-exempt status even if they fail to meet the requirements of federal pension law would undermine the law. The judge made this point, even though the Dutch pension fund is expected to comply with Dutch pension laws, not U.S. pension law.
Nonetheless, K. Peter Schmidt, partner at the Washington law firm of Arnold & Porter, who is representing the Dutch pension fund and who won a similar case involving a U.S. union pension fund some years ago, is hopeful the fund will win on appeal.
"While no one can predict such things accurately, I would handicap our chances in this case as better than many appellate cases because it is a meritorious case," Mr. Schmidt said.
The U.S. Treasury drafted a rule in December 1995 that would tighten the definition of labor organizations to specifically exclude retirement plans and those providing health care benefits, but it has not been adopted. Even if the proposal were adopted, it would not affect the Dutch pension fund whose case precedes that, Mr. Schmidt said.
Two other foreign pension funds - the Merchant Navy Officers Pension Fund Trustees Ltd. and the Merchant Navy Ratings Pension Fund, both of the United Kingdom - applied similar logic to ask the IRS for refunds on taxes paid on U.S. investments during the late 1980s, according to Michael McNulty, partner in the London office of Whitman Breed Abbott & Morgan.
The IRS granted their requests in March 1991 and refunded approximately $7 million to the two funds for taxes they paid between 1985 and 1989 on dividend income from U.S. stocks. Because the IRS recognized them as labor organizations, they have not paid any U.S. taxes since then, Mr. McNulty said. But still in dispute is approximately $2 million in interest on the back taxes, said Mr. McNulty, who has refund claims for about half a dozen other U.K. funds he would not name still pending with the IRS.
The IRS also has pending claims from several Dutch pension funds, Mr. McNulty said.
Dutch and British union funds believe they qualify for a tax refund because they closely fit the IRS' definition of labor organizations, while other European and Asian pension funds do not, Mr. McNulty said.
"I have not come across any possibility that any others would qualify," he said.
In 1993, the 2nd U.S. Circuit Court of Appeals ruled in a matter involving a U.S. union pension fund that retirement plans that do little more than manage money for unionized workers still can come under the umbrella of labor organizations if connected to groups such as labor unions.
The International Union of Operating Engineers, Local 478, Hamden, Conn., applied for tax-exempt status as a labor organization only after it flunked the traditional IRS test pension funds must complete to receive tax deductions for employer contributions and tax-deferral on pensions for covered workers until retirement.