Eleventh Circuit Holds Defined Contribution Plans Are Not Entitled to the Benefit from Foreign Tax Credits

In Romano v. John Hancock Life Ins. Co. (USA), No. 22-12366, 2024 WL 4614701 (11th Cir. Oct. 30, 2024), a matter of first impression, the Eleventh Circuit considered whether ERISA’s fiduciary duties required the value of certain foreign tax credits received by John Hancock, an insurance company that provided investment and recordkeeping services to 401(k) retirement plans, to be passed through to the benefit of the plans. The Court determined that John Hancock was not an ERISA fiduciary with regard to the foreign tax credits and that the retirement plans are not entitled to the value of the foreign tax credits. “To rule otherwise would provide them a windfall.”

John Hancock provides investment and recordkeeping services to the Romano Law, PL 401(k) Plan (the “Romano Law Plan”), for which the Plaintiffs act as trustees. Plaintiffs contracted with John Hancock to enter into a “Signature” platform group variable annuity contract, which made a menu of investment options available for the Romano Law Plan and its participants. The parties also executed a recordkeeping agreement, requiring John Hancock to provide administrative and recordkeeping services. John Hancock enters into two standardized form contracts—a group annuity contract and a recordkeeping agreement—with each retirement plan that signs up for the Signature platform. John Hancock selects a group of mutual funds for the platform and then each retirement plan chooses a subset of those funds. The individual participants then determine which specific funds to invest in. Notably, none of the plans or the participants invested directly in the mutual funds. The group annuity contract allowed the plans to make contributions into John Hancock separate accounts, which were divided into sub-accounts that corresponded to the mutual funds and other investment options available under the contracts with the plans. The plans’ assets, including the Romano Law Plan’s assets, were allocated among those sub-accounts, which were established, administered, owned, and managed by John Hancock. John Hancock was the legal and taxable owner of the assets in the separate accounts. John Hancock did “not assume any fiduciary responsibility of the Contractholder, Plan Administrator, Plan Sponsor or any other Fiduciary of the Plan.” The recordkeeping agreement explained that John Hancock would not have any discretionary authority or responsibility for the management or control of the separate accounts’ assets. John Hancock received fees for their services, including an “Annual Maintenance Charge” of 0.60% of the assets in each sub-account. John Hancock agreed to use revenue-sharing fees and credits as an offset to reduce the Annual Maintenance Charge charged to the plans.

John Hancock did not disclose that it received and retained foreign tax credits from the mutual fund shares owned in the separate accounts. From 2013 through 2019, John Hancock received more than $130 million in foreign tax credits from the various plans’ investments and used these credits to reduce its overall U.S. tax liability by tens of millions of dollars. The Internal Revenue Code permits certain regulated investment companies to pass through tax credits to their shareholders and because John Hancock is the legal and taxable owner of the shares of the mutual funds, it receives the passed-through foreign tax credits from such mutual funds.

According to Plaintiffs and the class of similarly situated plans, John Hancock should be required to pass through the benefits of the foreign tax credits to the plans since the plan assets are reduced by the amount of the foreign taxes paid with the assets of the sub-accounts. John Hancock argues that because it is the taxable owner of the mutual fund shares, only it is required to gross-up its taxable income to include the foreign taxes paid by a mutual fund.

The district court “concluded that John Hancock was not an ERISA fiduciary for the conduct underlying the Romanos’ claims, did not breach any ERISA fiduciary duties, or engage in ERISA prohibited transactions. The district court also ruled that the Romanos and the class failed to establish loss causation and therefore lacked Article III standing.” The Eleventh Circuit disagreed with the district court on standing but affirmed its summary judgment order on the merits.

First, the court found that Plaintiffs satisfied the injury-in-fact, causation, and redressability requirements of standing at the summary judgment phase. They allege that they paid for the benefit that was ultimately retained by John Hancock in purported breach of its ERISA fiduciary duties. They also allege that the group annuity contract required John Hancock to use certain revenue-sharing fees and credits as an offset to reduce the Annual Maintenance Charge, and this includes application of the foreign tax credits. “The Romanos and the class were not required to succeed on their ERISA claims in order to have Article III standing. To rule otherwise would allow a merits decision to swallow the antecedent matter of standing.”

Second, Plaintiffs asserted that John Hancock breached its duties under 29 U.S.C. § 1104(a)(1)(A) and engaged in prohibited transactions under 29 U.S.C. § 1106(b)(1). The court concluded that the foreign tax credits are not plan assets under ERISA, since the Plaintiffs and the class did not have a “beneficial ownership interest” in them. The court explained that “the tax credits were inalienable and were ‘owned’ by John Hancock as the legal and taxable owner of the shares of the mutual funds in the separate accounts.” Further, the language in the group annuity contract with respect to revenue sharing credits did not obligate John Hancock to apply the foreign tax credits to offset the Annual Maintenance Charge. Foreign tax credits do not fit within the contract’s listing of revenue sources. “Because the Romano Law Plan does not have a beneficial ownership interest in the foreign tax credits, those credits were not plan assets under ERISA. John Hancock therefore had no fiduciary obligations to the Romano Law Plan based on its discretionary authority over such credits.”

The court also rejected the Plaintiffs’ argument that John Hancock was an ERISA fiduciary because the retention of the foreign tax credits arose from its exercise of discretionary authority over the management and administration of the separate accounts. The court explained that John Hancock did not have control over the factors that gave rise to the foreign tax credits. The plan and its participants chose which investment vehicles and mutual funds to invest in, including certain mutual funds that invested in foreign securities. John Hancock did not advise them with respect to their choices. The company simply held the assets and allocated them as instructed by the Plaintiffs and plan participants. The mutual funds make the decision as to whether it is required to include the foreign taxes as grossed-up income on its U.S. taxes returns.

Because the court concluded that John Hancock was not an ERISA fiduciary with regard to its application and retention of the foreign tax credits, and because fiduciary status is a prerequisite for the ERISA breach of fiduciary duty claims, the claims fail as a matter of law.