Presentation on theme: "CONFERENCE ON VOLUNTARY PENSION SYSTEM ORGANISED BY SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN “ACCOUNTING AND TAX IMPLICATIONS / INCENTIVES” by SYED."— Presentation transcript:
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 KARACHI, AUGUST 11, 2005
2 CONTENTS UNDERSTANDING OF THE PROPOSED SYSTEM PENSION FUND – ACCOUNTING ELIGIBILITY TO THE SCHEME TAX INCENTIVES / IMPLICATIONS PRESENT TAX CONSIDERATIONS FOR PENSION SCHEMES THE FUTURE- LINKAGES AND MARKETABILITY
3 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.
4 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.
5 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.
6 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.
7 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.
8 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.
9 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.
10 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.
11 BEFORE RETIREMENT GOOD LUCK PENSION FUND Rupees in million Seed Money 150 ___ 150 Rupees in million Debt sub-fund50 Equity sub-fund 50 Money Market sub-fund50 50 Net Asset Value Rs 150 million Unit : 1.5 million units of Rs 10 each ACCOUNTING FOR PENSION FUND (Continued; Illustration)
12 Mr. A contributes Rs 450,000 to VPS over the period Allocation15,000 units of Debt Fund 15,000 unit of Equity Fund 15,000 units of Money Market Fund Value at Redemption: Debt Fund Rs Equity Fund Rs Money Market Rs 9.80 ACCOUNTING FOR PENSION FUND (Continued: Illustration)
13 Total Redemption: From Debt Fund 225,000 From Equity Fund 300,000 From Money Market 147, ,000 Repayment: 25% in Cash 168,000 75% for Annuity Scheme504, ,000 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. ACCOUNTING FOR PENSION FUND (Continued; Illustration)
14 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.
15 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.
16 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.
17 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.
18 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.
19 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.
20 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.
21 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.
22 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;
23 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.
24 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.
25 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.
26 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.
27 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.