Dutch pension fund not an exempt labor organization.

The District Court for the District of Columbia has held in Stichting Pensioenfonds Voor De Gezondheid, Geestelijke En Maatschappelijke Belangen (12/9/96), that a Dutch multi-employer pension fund was not a tax-exempt labor organization under Sec. 501(c)(5), and thus was not entitled to a refund of the $8.5 million U.S. income taxes it paid in 1993. In reaching that conclusion, the court specifically rejected the Second Circuit's decision in Morganbesser, 984 F2d 560 (1993).

The Health Worker's Fund, a Dutch multi-employer pension plan for health care workers, collects pension fund contributions, manages Its investments and pays benefits to enticed participants. The Fund's investments include common stocks of U.S. companies and mutual funds, which are held by U.S. banks and other financial institutions acting as the Fund's custodians. For the 1993 tax year, these custodians withheld and paid to the U.S. Treasury more than $8.5 million in U.S. income taxes on dividends paid on stocks and mutual funds held for the Fund. The Fund brought an action in Federal district court seeking a refund of those taxes, on the grounds that the Fund was an exempt labor organization under Sec. 501(c)(5).

The district court first noted that Sec. 501(c)(5) does not define the term "labor organization," and that the legislative history provides no additional help. Thus, the court turned to Regs. Sec. 1.501, which states:

The organizations contemplated by section 501(c)(5) as entitled to exemption from income taxation are those that:

(1) have no net earnings inuring to the benefit of any member, and

(2) have as their objects the betterment of conditions of those engaged in such pursuits, the improvement of the grade of their products, and the development of a higher degree of efficiency in their respective occupations.

The court found that although the Fund, in providing retirement benefits, has as its object the betterment of conditions of the employees, it did not have as its object the improvement of the grade of their products and the development of a higher degree-of efficiency. Therefore, the regulation, on its face, excluded the Fund from classification as a tax-exempt labor organization

The Fund had relied chiefly on Morganbesser, in which the Second Circuit held that a local union's pension trust qualified as a tax-exempt labor organization. The D.C. district court was not persuaded by any of the authorities relied on by the Morganbesser court, and thus declined to follow the Second Circuit's decision.

Although not noted in the district court's opinion, the Service had earlier announced its nonacquiescence to Morganbesser, revoked one of the primary authorities on which the Morganbesser court had relied (GCM 35862), and issued Prop. Regs. Sec. 1.501(c)(5)-1(b), stating that "an organization is not an organization described in section 501(c)(5) if the principal activity of the organization is to receive, hold, invest, disburse, or otherwise manage funds associated with savings or investment plans or programs, including pension or other retirement savings plans or programs."

Many foreign pension trusts own U.S. investment property such as stocks, bonds and real estate. Sec. 1441(a), which applies to foreign trusts, and Sec. 1442(a), which applies to foreign corporations, require the payer to deduct and withhold at the C source a tax equal to 30% on certain items of income, such as interest, dividends and rent. Tax treaties between the U.S. and other countries often reduce or eliminate withholding requirements for certain types of income. However, most treaties do not exempt dividend income from the withholding requirement, nor do they generally exempt income paid to a foreign pension trust.

Some foreign organizations have relied on Morganbesser for the proposition that their pension trusts are exempt from the withholding requirements of Sec. 1441 as Sec. 501(c)(5) organizations. In light of both IRS and court developments since the Morganbesser decision, such a position may no longer tee supportable.

From Peter I. Elinsky, CPA, LL.M., and Denis L. Yurkovic, J.D., Washington, D.C.