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CONFERENCE ON VOLUNTARY PENSION SYSTEM ORGANISED BY SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN

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Title: CONFERENCE ON VOLUNTARY PENSION SYSTEM ORGANISED BY SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN


1
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

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
    participants 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 (Contd)
  • 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 individuals 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 (Contd)
  • 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
ACCOUNTING FOR PENSION FUND (Continued
Illustration)
12
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

13
ACCOUNTING FOR PENSION FUND (Continued
Illustration)
  • Total Redemption
  • From Debt Fund 225,000
  • From Equity Fund 300,000
  • From Money Market 147,000
  • 672,000
  • Repayment
  • 25 in Cash 168,000
  • 75 for Annuity Scheme 504,000
  • 672,000
  • 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.

14
ELIGIBILITY TO THE SCHEME
  • 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 (Contd)
  • 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
  • Exemption to income of Pension Fund and Pension
    Fund Manager.
  • 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.
  • 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 (Contd)
  • Tax Credit on contribution by a Participant
  • 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.
  • The amount of such tax credit shall be computed
    according to the following formula, namely
  • Where- (A/B) x C
  • 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 (Contd)
  • Is the persons taxable income for the tax year
    and
  • Is the lessor of
  • The total contribution or premium paid by the
    person in the year or
  • 20 per cent of the persons 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
  • Five hundred thousand rupees.

19
TAX INCENTIVES / IMPLICATION (Contd)
  • 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 (Contd)
  • 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
  • Withdrawn before the retirement age.
  • Withdrawn, if in excess of 25 per cent of his
    accumulated balance, at or after the retirement
    age.

21
TAX INCENTIVES / IMPLICATION (Contd)
  • The tax shall, however, not to be deducted in
    case the balance in the persons individual
    pension account is
  • Invested in an Approved Income Payment Plan of a
    pension fund manager or
  • Paid to a life insurance company for the purchase
    of an Approved Annuity Plan or
  • 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 (Contd)
  • 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 participants 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
  • It is primarily arising an investment in listed
    securities that are exempt from tax

23
TAX INCENTIVES / IMPLICATIONS (Contd)
  • It is difficult to identify the amount of
    accretion to a particular withdrawal and lastly
  • 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 Companys Annuity scheme are
    taxable.

25
PRESENT TAX CONSIDERATIONS FOR PENSION SCHEME
(Contd)
  • 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.
  • No Professional Manager or mechanism available
    for investment of the assets of the fund
  • 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 (Contd)
  • 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
  • Correction in Eligibility criteria with regard
    to entitlement of benefit to the scheme.
  • 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.
  • 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.
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