CONFERENCE
ON
VOLUNTARY PENSION SYSTEM
ORGANISED BY
SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN
“ACCOUNTING AND TAX IMPLICATIONS / INCENTIVES”
by
SYED SHABBAR ZAIDI, FCA
PARTNER
A.F. FERGUSON & CO.
CHARTERED ACCOUNTANTS
LAHORE, SEPTEMBER 05, 2005
CONTENTS
•
UNDERSTANDING OF THE PROPOSED SYSTEM
•
PENSION FUND – ACCOUNTING
•
ELIGIBILITY TO THE SCHEME
•
TAX INCENTIVES / IMPLICATIONS
•
PRESENT
SCHEMES
•
THE FUTURE- LINKAGES AND MARKETABILITY
TAX
CONSIDERATIONS
FOR
PENSION
2
UNDERSTANDING OF THE PROPOSED SYSTEM
•
The relevant entities, in front, of the proposed scheme are:
– The Participant (Beneficiary / The Eligible Person);
– The Pension Fund; and
– Pension Fund Manager- Asset Management Company or
Life Insurance Company.
•
Entities in background are
– Employers (if any); and
– Trust.
3
UNDERSTANDING OF THE PROPOSED SYSTEM
Three ‘Ps’
•
“Participant” means any person on whose behalf contributions
are made into one or more pension funds and held in one or
more identifiable individual pension accounts managed by one
or more Pension Fund Managers.
•
“Pension Fund” means a fund made up of sub-funds, created
from the contributions paid by the participants and would consist
of all the assets for the time being held or deemed to be held by
sub-funds and includes all income or investment returns thereon
but excludes fees, charges and expenses related to the
management of the investments of sub-funds.
•
“Pension Fund Manager” means an asset management
company or a life insurance company duly authorized by the
Commission to efficaciously manage the contributions made by
or on behalf of participants in pension fund and meet such other
conditions as may be prescribed from time to time by the
Commission.
4
UNDERSTANDING THE SYSTEM
Investment Cum Annuity Scheme
• The scheme envisaged is a combination of a ‘Unit Trust’ for
investment by participant and a Pension (Annuity) scheme
operated through a Life Insurance Company.
• The Pension Fund so formed can invest in the ‘Capital Markets’.
• Tax concessions have been provided for ‘Contributions’
(investments) and ‘Return’ on investment, whereas, ‘Benefits’
arising from investment are deemed to be taxable.
• The system does not in any way relate / refer to ‘Pension’
procedure in practice in the country where such retirement
benefits, by way of pensions, is provided by the employer. Thus
this system does not represent an ‘Employee Benefit’ in strict
sense.
5
UNDERSTANDING THE SCHEME
•
The scheme in the present form effectively reinstates the system
whereby individuals were allowed ‘Tax Credit’ for the investment made
in the shares. Now this credit is available on ‘Contributions’ made to
the Pension Fund which invests the money in various kinds of listed or
unlisted securities. This investment would effectively be kept in an
individual Pension Account.
•
The amount of contribution by an individual participant will be used by
Pension Fund for the acquisition of Units of a Trust Fund which will
consist of three kinds of sub-funds managed by that Fund.
•
The Pension Fund will operate as a unit trust.
•
On achieving the retirement age, the participant’s units would be
redeemed . The proceeds arising on that redemption would be paid 25
percent in cash and remaining could be used (upto the age of seventy
five) for acquiring an Income Payment Plan or a Annuity Scheme of a
Life Insurance Company.
6
UNDERSTANDING THE SCHEME (Cont’d)
• In this manner the participant is effectively having a ‘Tax Credit’
for his investment in the fund.
• The amount so invested can be withdrawn or it may be used for
acquiring an Annuity Policy from an Insurance Company.
• The amount lying in the fund account belongs to the participant
which can be withdrawn at any time. However, it is being
conceived that if such amount is withdrawn, in the manner other
than that laid down in the scheme, then such benefit would
represent taxable sum in the hands of the participant.
• At present, the scheme is not available for person who are
eligible to any approved pension scheme.
7
PENSION FUND - ACCOUNTING
• Pension Fund would effectively be a Unit Trust.
• Each Pension fund will operate three sub-funds, viz
– DEBT FUND
– EQUITY FUND
– MONEY MARKET FUND
• Each fund will place a SEED Money of Rs. 50 million in each
fund
• Participants will acquire the unit in these funds out of the
contribution made by them. There would be a choice of
adoption of any kind of the fund.
8
PENSION FUND - ACCOUNTING
• Each individual’s participant account will be maintained. It will
reflect the value of units invested as determined on time to time
basis.
• On retirement, the investment in the individual account will be
redeemed in the manner laid down in the scheme; the whole
sum would be transfered to ‘Redeemed Deposit Account’. The
amount so available can be used as under:
– 25 percent can be withdrawn in cash
– Remaining 75 percent can be used either for the purchase of
Life Annuity policy or invested in the Income Payment Plan
of the said fund. However, the option for the investment in
the Income Payment Plan is available upto the age of 75
only. After reaching the age of 75 the amount will be used
exclusively for the annuity plan.
9
PENSION FUND – ACCOUNTING (Cont’d)
• In case if the participant intends to redeem its account earlier
than the retirement age prescribed the amount will be paid by
the fund to the participant after deducting tax thereon.
10
BEFORE RETIREMENT
ACCOUNTING FOR
PENSION FUND
(Continued;
Illustration)
GOOD LUCK PENSION FUND
Rupees in million
Seed Money
150
___
150
Rupees in million
Debt sub-fund
Equity sub-fund
Money Market sub-fund
50
50
50
50
Net Asset Value Rs 150 million Unit : 1.5 million units of Rs 10 each
11
ACCOUNTING FOR
PENSION FUND
(Continued:
Illustration)
Mr. A contributes Rs 450,000 to VPS over the period
Allocation
15,000 units of Debt Fund
15,000 unit of Equity Fund
15,000 units of Money Market Fund
Value at Redemption:
Debt Fund
Rs 15.00
Equity Fund
Rs 20.00
Money Market Rs 9.80
12
ACCOUNTING FOR
PENSION FUND
(Continued;
Illustration)
Total Redemption:
From Debt Fund
From Equity Fund
From Money Market
225,000
300,000
147,000
672,000
25% in Cash
75% for Annuity Scheme
168,000
504,000
672,000
Repayment:
This Rs 504,000 can be kept in ‘Income Payment Plan’,
however, after 75 year it has to be placed in an Annuity Plan
issued by a Life Insurance Company.
13
ELIGIBILITY TO THE SCHEME
1. The Eligibility is:
– All Pakistani nationals over the age of eighteen years who
have a valid National Tax Number and are not employed in
any position entitling them to benefits under any
approved occupational pension scheme shall be eligible
to contribute to the pension fund authorised under these
rules;
– Provided that Pakistani nationals who were or are entitled to
benefits under an approved occupational pension scheme,
but are not entitled to benefits in respect of the current
year of service, shall be eligible to contribute to the
pension fund during that year.
14
ELIGIBILITY TO THE SCHEME (Cont’d)
2. There seems to be no rationale of exclusion for the persons
who are entitled to benefits under any approved occupational
person scheme. The question to be decided is whether this
exclusion has been made for tax reasons or otherwise. In my
view, the scheme, even where the ‘Benefit’ has been deemed to
be taxable, has no ‘Clash’ with the pension scheme presently
applicable. Accordingly, even if a person is entitled to a ‘pension
scheme’ through his / her employment even than there is no
basis to exclude the said person from the proposed scheme for
the current services.
15
TAX INCENTIVES / IMPLICATION
1. Exemption to income of Pension Fund and Pension Fund
Manager.
a) The income of a Pension Fund under the scheme is exempt
from tax. This is not a conditional exemption. All incomes of
a pension fund from whatever sources are exempt from tax.
Unlike other mutual funds etc there is no concept of
distribution of profit etc.
b) Profit or gain or benefit derived by a Pension Fund Manager
from a pension fund on redemption of the Seed Capital
invested in pension fund. The fund manager, which will be
an Asset Management Company or a Life Insurance
Company, shall not be subject tax on the increment arising
to it on the redemption of seed capital of Rs. 50 million each
in the sub-funds.
16
TAX INCENTIVES / IMPLICATION (Cont’d)
2. Tax Credit on contribution by a Participant
a) Tax credit on contribution (as defined in the scheme
not exceeding Rs 500,000 in a tax year) to an
approved pension fund will be allowed.
b) The amount of such tax credit shall be computed according to the
following formula, namely:
c) Where-
(A/B) x C
A. Is the amount of tax assessed to the person for the tax year,
before allowance of any tax credit under Part X of Chapter III.
17
TAX INCENTIVES / IMPLICATION (Cont’d)
B. Is the person’s taxable income for the tax year; and
C. Is the lessor of:
a) The total contribution or premium paid by the person in
the year; or
b) 20 per cent of the person’s taxable income for the
relevant tax year, however, for a person joining the fund
at the age of forty one years or above, during the first ten
years of the notification of VPSR, there shall be allowed
additional contribution of 2 per cent per annum for each
year of age exceeding forty years subject to the condition
that the total contribution allowed to him shall not exceed
50 per cent of his total taxable income of the preceding
year; or
c) Five hundred thousand rupees.
18
TAX INCENTIVES / IMPLICATION (Cont’d)
• This effectively means that participant will be allowed tax credit
equal to the effective tax on contribution. It appears that such
tax credit will be available even if the amount of contribution is
paid by the employer.
• The matter to be resolved in this situation is that the amount of
contribution made by the employer will qualify as expense for
tax purpose whilst calculating the taxable income of the
employer and at the same time employee will be allowed tax
credit for the same.
19
TAX INCENTIVES / IMPLICATION (Cont’d)
3. Withholding tax on withdrawal of balance under Pension
Fund
– Pension Fund Manager whilst making payment from
individual pension account shall be required to deduct tax at
the rate specified in section 12(6) [average rate of tax for
the preceding three tax years] from any amount:
a) Withdrawn before the retirement age.
a) Withdrawn, if in excess of 25 per cent of his
accumulated balance, at or after the retirement age.
20
TAX INCENTIVES / IMPLICATION (Cont’d)
– The tax shall, however, not to be deducted in case the
balance in the person’s individual pension account is:
a) Invested in an Approved Income Payment Plan of a
pension fund manager; or
a) Paid to a life insurance company for the purchase of an
Approved Annuity Plan; or
a) Transferred to another individual pension account of the
taxpayer maintained with any other Pension Fund
Manager under Change of Pension Fund Manager
option specified in the VPSR.
21
TAX INCENTIVES / IMPLICATIONS (Cont’d)
•
Tax issues which are not yet properly sorted out:
– Why the withdrawal prior to retirement be subject to tax
withholding; primarily for the reason that amount lying in the
fund is participant’s own money which does not tantamount
to income.
– The issues from the tax viewpoint are (a) a tax credit has
been allowed at the time of contribution and (b) the
accretion over the period.
– It is considered that tax credit for contribution cannot
convert a redemption of principal amount of investment into
income. Thus, principal sum remains non-taxable.
Therefore, the question of withholding or tax liability should
not arise. The only other issue is accretion which it is
opined should be exempted inter alia for the reasons:
a) It is primarily arising an investment in listed securities
that are exempt from tax;
22
TAX INCENTIVES / IMPLICATIONS (Cont’d)
b) It is difficult to identify the amount of accretion to a
particular withdrawal; and lastly
c) As a measure of promotion of savings.
– The income from ‘Life Annuity’ and ‘Income Payment Plan’
are required to be specifically exempt from tax. It is so for
the reason that all approved pension schemes enjoy
exemption under the tax laws. If such pension schemes are
not exempt, then it will not be tax beneficial for persons to
opt for the present scheme.
23
PRESENT TAX CONSIDERATIONS FOR PENSION
SCHEME
• At present, two kinds of pension schemes are in operation,
which are ‘Funded’ or ‘Unfunded’ schemes.
• In both the situations, the benefit of pension from employers is
exempt from tax. This is irrespective of any particular amount of
pension.
• For the employers, the contribution to the pension funds are tax
deductible charge. In other words, there is Double Benefit i.e.
deduction of expense for the employers and exemption for the
beneficiary.
• Subsequent to July 1, 2005 all benefits arising from Life
Insurance Company’s Annuity scheme are taxable.
24
PRESENT TAX CONSIDERATIONS FOR PENSION
SCHEME (Cont’d)
• The pension funds which are presently kept under the trust are
not allowed to invest openly in the market. The funds are
effectively used in the purchase of Debt Instrument issued by
the Government.
25
THE FUTURE-LINKAGES AND MARKETABILITY
•
Pension Schemes, presently being operated, face the following
problems from individual and national perspective which need to be
sorted out. This seems to be the rationale of the proposed scheme.
Nevertheless, the proposed scheme has to synchronize its structure
with the present system.
a) No Professional Manager or mechanism available for investment
of the assets of the fund;
b) No in-road for investment in market securities; and
c) Capital markets not supported by long-term investment by the
pension funds.
The proposed scheme , in principle , resolves these issues in a certain
manner. However, there is a need for linkages which are essential for
marketability.
26
LINKAGES AND MARKETABILITY (Cont’d)
•
These issues can only be sorted out if ‘LINKAGES’ or
‘INTEGRATION’ are made between the present pension
schemes and the Proposed Voluntary Pension System as
envisaged. This will require:
a) Correction in ‘Eligibility’ criteria with regard to entitlement of
benefit to the scheme.
b) Inter-linking the present employer-based pension scheme to
the proposed scheme whereby ‘employers’ are allowed
deduction for amount of contribution made on behalf on the
employee in the Approved Pension System. Employees to
enjoy the exemption from Annuity or Redemption of Asset.
c) There has to be certain mechanism for converting the
existing pension schemes to the proposed mechanism. This
will give a real boost to savings and add strength to capital
markets.
27