District Court Rules in Favor of 401(k) Plan Recordkeeper in Lawsuit Over Foreign Tax Credits | Practical Law

District Court Rules in Favor of 401(k) Plan Recordkeeper in Lawsuit Over Foreign Tax Credits | Practical Law

In a case involving novel issues around foreign tax credits (FTCs) in the ERISA setting, a federal district court held that a 401(k) plan's recordkeeper did not have an obligation under the Employee Retirement Income Security Act of 1974 (ERISA) to provide plans with rebates for the foreign tax credits (FTCs) that the recordkeeper received.

District Court Rules in Favor of 401(k) Plan Recordkeeper in Lawsuit Over Foreign Tax Credits

by Practical Law Employee Benefits & Executive Compensation
Published on 17 May 2022 • USA (National/Federal)
In a case involving novel issues around foreign tax credits (FTCs) in the ERISA setting, a federal district court held that a 401(k) plan's recordkeeper did not have an obligation under the Employee Retirement Income Security Act of 1974 (ERISA) to provide plans with rebates for the foreign tax credits (FTCs) that the recordkeeper received.
The US District Court for the Southern District of Florida has held that a 401(k) plan's recordkeeper did not have an obligation under ERISA to provide plans with rebates for the foreign tax credits (FTCs) that the recordkeeper received (Romano v. John Hancock Life Ins. Co., (S.D. Fla. May 9, 2022)).

401(k) Plan Recordkeeper's Use of Foreign Tax Credits

The plaintiffs are the trustees for a 401(k) plan they established. They entered into a group variable annuity contract (contract) and a recordkeeping agreement with John Hancock to provide administrative and recordkeeping services to the plan and a platform of investment options for the plan.
The contract provided the plaintiffs with access to John Hancock separate accounts, which were used as the plan's funding mechanism. John Hancock was the owner of the assets held in the separate accounts. The separate accounts:
  • Were divided into sub-accounts.
  • Each sub-account allowed for investment in a pre-specified mutual fund.
Some of the sub-accounts available under the contract used mutual funds that invest in foreign securities, and the plaintiffs selected some of those mutual funds. Investments in foreign securities may be taxed by the foreign country on income related to those investments, but US taxpayers who pay foreign taxes on income that is also subject to US taxes may, in certain circumstances, receive an FTC.
The foreign taxes paid by John Hancock that were factored into the determination of the FTCs at issue involve foreign taxes paid by mutual funds. During certain years at issue in the case, John Hancock, which owned the mutual fund shares held in separate accounts, qualified for offsetting FTCs.
The plaintiffs filed suit in federal district court, alleging that John Hancock:
In January 2022, the court granted the plaintiffs' motion to certify a class who owned contracts from the insurance company (Romano v. John Hancock Life Ins. Co., (S.D. Fla. Jan. 14, 2022)). John Hancock moved for summary judgment.

Court Grants Recordkeeper's Summary Judgment Motion

The district court held that John Hancock did not violate a fiduciary duty of loyalty under ERISA or engage in a prohibited transaction under ERISA by engaging in FTC transactions authorized by the federal tax code.
The court held that John Hancock had no obligation under ERISA to provide its customers with rebates for the FTCs it used because it was not an ERISA fiduciary to the plan and the FTCs were not plan assets. According to the court, a plan service provider is not an ERISA fiduciary absent actual control of a retirement plan's assets, and John Hancock did not control any assets in the plan. Furthermore, the contract between the parties disclaimed any fiduciary role by John Hancock. However, even if John Hancock were an ERISA fiduciary, the court found that it did not:
  • Breach a duty of loyalty under ERISA Section 404(a)(1)(A) (29 U.S.C. § 1104(a)(1)(A)) by using the FTCs because it provided recordkeeping services as required by the contract with the plaintiffs, and there was nothing disloyal about using FTCs that are not transferable and no other party could use.
  • Engage in a prohibited transaction under ERISA Section 406(b)(1) (29 U.S.C. § 1106(b)(1)), which prohibits a plan fiduciary from dealing with plan assets in its own interest. The FTCs in this case were not ERISA plan assets, and the mutual funds in the plan made an election under the Internal Revenue Code (Code) that required John Hancock to report its share of foreign taxes paid by the mutual funds as income on its own tax return. The Code allowed John Hancock to claim a related deduction or credit subject to certain limitations. The court concluded that this arrangement was not a transaction involving the plan or a party dealing with the plan under ERISA Section 406.
The court also observed that when the plaintiffs replaced John Hancock with another recordkeeper for their 401(k) plan, the new service provider also did not provide rebates or credits for FTCs, but there was no evidence that the plaintiffs have filed an action against the new recordkeeper.

Practical Implications

In a footnote to the decision, the district court noted that the plaintiffs' theory about FTCs in an ERISA setting was a novel one. As ERISA litigation in the retirement plan space continues to evolve, the decision may be of interest to 401(k) plan sponsors and retirement plan service providers.