Brian J. Denning, Contributor
DENNING
AS DR. Omar Davies, Minister of Finance and Planning, prepares to deliver his 2006/07 Budget tomorrow, it is hoped that the minister will amend certain tax rules which may otherwise have a negative impact on the nation's pension reform programme.
The Government's 2001 White Paper on Pension Reform stated that the reform of Jamaica's pensions regime has two key features:
The enhancement of Jamaica's social security system - National Insurance Scheme - so that more meaningful benefits can be provided to eligible contributors and their beneficiaries; and
The regulation of cccupational pension schemes and approved retirement schemes within an effective legal framework.
A primary objective of this reform programme is to ensure that proper arrangements are made by, and for, persons during their working lives, so that they can receive an adequate pension upon retirement.
This includes the establishment of an appropriate framework for self-employed persons and persons in non-pensionable employment to make sufficient provision for their retirement.
The Pensions (Superannuation Funds and Retirement Schemes) Act, 2004 (which came into force on March 1, 2005) and accompanying regulations provide the legal framework within which this reform shall take place.
To date, however, our taxation laws have not been amended in order to ensure that our tax rules complement and support the objectives of the pension reform.
One of the objectives of a well-designed tax system is to influence and shape behaviour in society.
In the context of pensions, a well-designed tax system encourages persons to set aside a sufficient portion of their income during their working lives in order to ensure they have sufficient funds to live on in retirement.
Tax regimes normally encourage this behaviour by:
Granting tax relief for contributions (up to specified limits) to approved pension or retirement schemes;
Providing a tax exemption for such schemes, so that the schemes can maximise their build-up of funds (and in turn the pensions which can be made available to contributors upon retirement).
Unfortunately, our tax rules currently fall short in providing the above incentives as outlined in further detail below.
MINIMAL TAX-RELIEF FOR SELF-EMPLOYED
Section 13 of the Pensions Act sets out the requirements which must be met by a superannuation fund (to which persons in pensionable employment contribute), in order for the fund to be approved by the Financial Services Commission (FSC) under this act.
Among the conditions listed is the requirement that ordinary annual contributions made by an employer shall not exceed 10 per cent of employee's annual salary or wages.
In addition, the employee's yearly contributions must not exceed this cap.
This provision is complemented by the Income Tax Act which currently provides that ordinary annual contributions made by a contributor (whether as employer or employee) to an approved superannuation fund are tax-deductible up to a maximum of 10 per cent of the employee's remuneration.
Regrettably, the same cannot be said for self-employed persons and those in non-pensionable employment (who would contribute to Approved Retirement Schemes).
Section 14 of the Pensions Act sets out the requirements which must be met by a retirement scheme in order for the scheme to be approved by FSC.
Among the conditions listed is the requirement that the annual rate of contribution made must not exceed 20 per cent of the 'annual income or emoluments' of the contributor.
Notwithstanding this, the Income Tax Act currently provides tax relief in respect of contributions by self-employed persons (and persons in non-pensionable employment) to approved retirement schemes up to a maximum of $6,000 per annum.
This unrealistic ceiling has provided little incentive for such persons to provide for their retirement through approved retirement schemes and, therefore, these schemes remain unattractive.
It is critical, therefore, that this ceiling be lifted in order to enable the self-employed and those in non-pensionable employment to provide for their retirement in a tax-efficient manner.
The Government's 2001 White Paper on Pension Reform acknowledged that this ceiling should be increased and had suggested that a ceiling of 20 per cent of the chargeable income of the contributor, subject to a maximum chargeable income of J$4,999,200 per annum.
The effect of this would be to increase the tax-deductible ceiling from J$6,000 per annum to J$999,840 per annum. To date, the ceiling has not been increased and, therefore, I would encourage the minister to increase this ceiling accordingly in the upcoming Budget.
DISPARITY BETWEEN APPROVAL REQUIREMENTS
In addition to securing approval from the FSC under the Pensions Act, it is also vital that pension and retirement schemes secure and maintain approval from the Commissioner of TAAD under the Income Tax Act. Schemes approved under the Income Tax Act enjoy preferential tax treatment over unapproved schemes for a number of reasons, including that income derived by approved schemes are exempt from income tax; while contributions to such schemes are tax deductible up to prescribed limits.
The Pensions Act provides that one of the conditions which must be met by a superannuation fund (in order to obtain FSC approval) is that any lump sum or maximum annual pension payable to a member shall not exceed certain prescribed limits.
For example, where the lump sum is payable on death, the amount may not exceed two years salary and wages or the actuarial value of the member's interest in the fund, whichever is greater. Where the lump sum is payable on retirement, an amount not exceeding the commuted value of one-quarter of the accrued pension (up to a prescribed maximum) may be paid.
In contrast, the Income Tax Act currently provides that the Commissioner of TAAD may not approve a superannuation scheme for income tax purposes, if the lump sum payable exceeds J$120,000 or the pensions/annuities payable exceed two-thirds of the salary of the employee at the date of his retirement.
Similarly, the Pensions Act provides that a retirement scheme (for the self-employed etc.) may not be approved by the FSC, unless the maximum annual pension payable falls within certain prescribed limits. In contrast, the Income Tax Act currently provides that the Commissioner of TAAD may not approve a retirement scheme for income tax purposes, if the lump sum payable exceeds J$75,000.
The present disparity between our tax rules and the Pensions Act means that pension funds and retirement schemes (and their members) will not be able to fully benefit from the provisions of the 2004 Pensions Act, as long as the schemes remain constrained by existing tax rules in order to maintain their current tax status.
If this matter is not addressed, then it may serve as a further disincentive to pension reform. I would, therefore, encourage the Minister to overhaul Jamaica's tax rules as they pertain to approved superannuation and retirement schemes in the upcoming Budget in order to ensure that our tax rules (including the tax-free thresholds for lump-sums payable upon retirement) complement the Pensions Act provisions.
WITHHOLDING TAX ON INVESTMENT INCOME
As indicated earlier, the Income Tax Act currently provides a tax exemption for income derived by approved superannuation schemes (i.e. for persons in pensionable employment) and approved retirement schemes (for self-employed persons and those in non-pensionable employment). This tax exemption is considered important, as it enables the scheme to maximise the roll-up of funds in the scheme (which in turn has a positive impact in terms of the level of funding required for the scheme/the level of pensions available to contributors).
In practice, the value of this tax exemption has been eroded given the level of withholding tax suffered on income received by approved superannuation and retirement schemes on their investments. While this withholding tax is recoverable by way of refund from the tax authorities, the pension schemes continue to report significant delays in the process, thereby, leading to a build-up in refunds outstanding.
Recent media reports suggested that approximately $2 billion in such withholding tax has yet to be refunded. The delay in securing these refunds negatively impacts on the performance of these pension funds (and in turn negatively impacts their contributors) in that the pension funds forego investment opportunities and returns, while their monies remain tied up in the refund process. In addition, any temptation to view this withholding tax as a source of revenue (albeit temporary) to finance the nation's expenditure requirements (at the expense of the pension funds and their contributors) should be avoided.
A relatively simple solution to this issue would be to amend the Income Tax Act (specifically Section 31A), so that financial institutions and others (known as prescribed persons) who are liable to account for the withholding tax upon making interest payments shall be entitled to pay such interest gross, upon presentation by an approved superannuation or retirement scheme of a suitable declaration (certified by the tax authorities as appropriate).
This would enable the approved pension funds to better fulfil their mandate by re-investing their income earned on a timely basis and would also allow the tax authorities to re-direct resources, currently tied up in administering this refund process, to other areas which will yield net tax inflows.
This approach could also be easily extended to other tax-exempt persons such as charitable organisations and approved funds. The declaration I am suggesting would state that the income earned from a specified deposit account or other investment is beneficially owned by the approved superannuation or retirement scheme (and charitable organisation, etc.) and the tax authorities could certify the declaration to the effect that the scheme or organisation is so approved.
The scheme would also undertake to notify the institution of any change in its status and would be held accountable for any failure to do so. The declaration would then be retained on file by the prescribed person and remain valid for a specified period (say three years) at which point a fresh declaration would need to be submitted. This approach is not dissimilar to that used in other jurisdictions in order to avoid the issue we currently face in Jamaica.
In light of the above, the minister should consider amending the Income Tax Act to firmly support and complement the Government's pension reform programme.
Brian Denning is a partner with PricewaterhouseCoopers, specialising in taxation. He may be contacted at brian.denning@jm.pwc.com
