Questions and Answers
- Non-resident plan administrator
- Conversion from DC Provision to DB Provision
- Recognition of Past Service
- Quebec's Indexing Benefit
- Quebec's Indexing Benefit Where Plan Benefit at Maximum
- Prescribed Compensation during Certain Temporary Absences
- Treatment of Excess Member Contributions
- Amendments to Designated Plan Rules
- Annuity purchases
- Interest on Employee Contributions
- Acceptable Use of the Commuted Value of a Pension That Exceeds the Prescribed Amount in Regulation 8517
- Earnings recognition for transferred employees and service purchases
Question 1 - Non-resident plan administrator
In come cases, RPD has determined that, where a Canadian plan administrator has delegated signing authority for some pension-related matters to a U.S.-domiciled employee, the U.S. employee is required to apply for permission to act as a "non-resident administrator". Would RPD clarify its position in light of the fact that the Canadian corporation is a "person" under the ITA and remains the plan administrator, legally responsible for plan administration?"
Answer 1
Subsection 147.1(6) of the Income Tax Act (Act) requires the plan administrator to be resident in Canada, unless the Minister otherwise permits in writing. We recognize that a resident Plan Administrator will often delegate some of its duties to another person who may not be a resident in Canada. The pension plan documents must clearly identify who has the ultimate responsibility for the administration of the plan. If the ultimate responsibility for the administration of the pension plan remains with the resident Plan Administrator, then permission to act as a non-resident Plan Administrator is not required.
If it is not clear, based on plan documentation, that the plan administrator is resident in Canada, we may request clarification.
Question 2 - Conversion from DC Provision to DB Provision
In a conversion from a defined contribution (DC) provision to a defined benefit (DB) provision, section 147.3(2) of the ITA mentions that the amount transferred must be to fund benefits provided under the defined benefit provision.
What about when the value in the member's DC account is higher than the DB value? For example DC= $50,000 and DB = $10,000?
Provincial legislation will not let a member lose $40,000 of benefits.
i) Can the extra $40,000 be considered as AVCs under the DB provision or can we construct a DB design that gives the higher of the DB and DC (in a way acceptable to CCRA, such as the DC value + the excess of the DB over the DC).
ii) When we say the amount transferred must be to fund benefits provided under the defined benefit provision, do we mean on a going concern basis, on a solvency basis or on the higher of the 2?
Answer 2
(i) On conversion, the amount in the member's account in a money purchase provision can be used to fund benefits in the defined benefit (DB) provision of an RPP pursuant to subsection 147.3(2) of the Act. If the amount in the money purchase provision exceeds the amount required to fund benefits in the DB provision, the additional funds can remain in the money purchase provision of the plan or be transferred to another MP provision under subsection 147.3(1) of the Act.
We no longer accept plans that provide benefits based on the greater of a DB promise and a MP component. We would, however, accept a DB provision offset by a MP provision as suggested.
We remind you that when retirement benefits become provided to an individual under a defined benefit provision with respect to post-89 service, a past service pension adjustment (PSPA) results. The amount transferred from the MP provision would be a qualifying transfer and will reduce the PSPA accordingly.
(ii) If the amounts are to be transferred from a MP provision to fund benefits under a DB provision of an RPP under subsection 147.3(2)(c) of the Act, we will accept the transfer on either a going-concern or a solvency basis, unless the plan is a designated plan. For designated plans, the transfer must be on the lesser of the going concern or the maximum funding basis.
Question 3 - Recognition of Past Service
Following a recent change in the law, self-employed persons may now incorporate and receive a salary, for example a dentist... We wish to put a plan in place for these people but when can we credit past service? I understand that there has not been an employer/employee relationship but that is because they could not have such a relationship if they could not incorporate. Is CCRA going to let them recognize the past years of service in the current situation?
Answer 3
Paragraph 8502(a) of the Income Tax Regulations (Regulations) requires that the primary purpose of a pension plan is to provide payments to individuals after retirement and until death in respect of their service as employees.
If a self-employed person is incorporated, the plan can recognize his service as of the date of the incorporation. Since no employee-employer relationship existed during the period prior to the date of the incorporation, the service will not be a period of eligible service under paragraph 8503(3)(a) of the Regulations. Therefore, the plan will not be permitted to recognize service for the years prior to the date of the incorporation.
Question 4 - Quebec's Indexing Benefit
At the November 21, 2002 Consultation Session, we were informed that RPD would accept an additional benefit required by the Supplemental Pension Plans Act of Quebec (the "SPPA") if it was provided in any form of benefits that did not generate a PSPA and the following list of forms acceptable to RPD was provided:
- indexing of benefits reflective of the increase in the average wage or CPI,
- reduced early retirement reduction factor,
- reducing the age when an unreduced pension may become payable within the limits of paragraph 8503(3)(c) of the ITR,
- reducing the number of years used to determine final average earnings.
It was also indicated that the plan terms could permit a plan member to choose which ancillary benefit to apply.
Our understanding is that the SPPA requires that the additional benefit must be determined at the date of termination and must be provided by means of a life annuity and cannot be provided in the form of an ancillary benefit. In light of the SPPA requirement, RPD's advice does not seem to be workable.
RPD seems to expect amendments that provide the additional benefit to be done on a case-by-case basis in this regard. This is not practical given the number of plans that have members employed in Québec.
Could RPD comment on the status of any ongoing discussions between RPD and the Québec government concerning this matter and any resolutions that may have been identified.
Answer 4
We are aware that the requirements under Quebec's Supplemental Pension Plans Act (SPPA) are more restrictive than our requirements under the Act. We had hoped that the Régie des rentes du Québec (RRQ) would have permitted the upgrades that we had proposed at the last consultation session in November 2002. It has always been a requirement that when there is an increase in the benefit accrual rate, the plan text would specifically have to provide for it.
Initially, we had discussed our concerns with the RRQ and felt that the restrictions under the SPPA would cause administrative burdens on plan administrators. We feel that the concerns of plan administrators and consultants should be expressed directly with the RRQ, since the limitations are imposed by the SPPA.
Question 5 - Quebec's Indexing Benefit Where Plan Benefit at Maximum
This question again relates to the Quebec indexing benefit mentioned above. Where the Quebec member's lifetime retirement benefit according to the terms of the pension plan before adding the indexing benefit is at the maximum benefit limit in section 8504 of the ITR, the SPPA requires the additional benefit to be paid in a cash lump sum. RPD has advised that this lump sum payment is neither a permissible benefit under subparagraph 8502(c) (iii) of the ITR nor a permissible distribution under paragraph 8502(d) of the ITR. The result is unworkable.
Could RPD comment on the status of any ongoing discussions between RPD and the Québec government concerning this matter and any resolutions that may have been identified.
Answer 5
We had found that the lump sum payment caused a conflict with the Regulations. Since the lump sum amount did not represent the value of a specific benefit under the plan, it was not a permissible distribution under subsection 8502(d) of the Regulations. We asked the Department of Finance to look at the matter and they decided they would propose a change to the Regulations. We have received a letter of comfort in this regard, allowing the lump sum payments to be a permissible distribution under 8502(d), and have been accepting plans that provide for such lump sum payments. Any amounts in excess of section 8504 of the Regulations must be paid in a lump sum and cannot be transferred.
Question 6 - Prescribed Compensation during Certain Temporary Absences
In some cases, provincial maternity/parental leave legislation requires that any increase in earnings scheduled during the leave be reflected in the member's pension benefits. We understand that RPD has a problem with this. Please confirm that using earnings that the member would have received during the leave is acceptable.
Answer 6
The definition of compensation in subsection 147.1(1) of the Act includes "prescribed compensation" which is described in section 8507 of the Regulations. Compensation is primarily prescribed for a period of eligible service during which the individual receives reduced or nil earnings, such as a period of maternity/parental leave. Generally, it is the amount that it is reasonable to consider the individual would have received had the individual worked on a regular basis throughout the period. If an increase in earnings is scheduled during a period of leave, it is reasonable to reflect the increase in the individual's prescribed compensation.
Question 7 - Treatment of Excess Member Contributions
We wish to seek clarification regarding the options available to a member of an RPP who retires or terminates under the plan and is entitled to a refund of excess member contributions under the 50% cost-sharing rule under pension benefits standards legislation. Subparagraph 8502(c)(iii) of the ITR permits a plan to provide additional benefits attributable to the application of the 50% cost-sharing rule. Newsletter 98-2, dated July 8, 1998, explains the amount of the excess contributions that can be transferred on a tax-free basis to an RRSP. However, the Newsletter does not address the case of a transfer to an insurance company to purchase an annuity with a refund of the excess contributions.
Specifically, please confirm the following:
Whether a member may elect to transfer excess amounts that are refunded under the 50 % cost-sharing rule to an insurance company to purchase an annuity, where the member elects to receive an immediate or deferred pension from the pension plan (where the plan permits such transfer). Whether a member may elect to transfer excess contributions under the 50% cost-sharing rule to an insurance company to purchase an annuity where the pension plan does not specifically allow members the option to apply the excess contributions to provide additional benefits from the pension plan itself (but where the plan permits such transfer).
Answer 7
Subparagraph 8502(c)(iii) of the Regulations permits the payment of additional benefits under a plan as a result of applying the 50 % funding rule under a designated provision of the law of Canada or a province. The plan terms must allow for the payment of such benefits. Generally, pension benefit legislation allows you to pay excess member contributions to the member, transfer them to another RPP or an RRSP, use them to increase the basic retirement benefit or to purchase an annuity.
Yes, in the case of a member receiving an immediate or deferred pension, the excess member contributions may be used to purchase an annuity as long as this purchase is provided for under the terms of the plan as registered.
If the plan terms do not have a provision to allow members to purchase additional benefits as a result of the 50 % funding rule, it would not be possible for the members to purchase an annuity.
Question 8 - Amendments to Designated Plan Rules
In our experience, the requirements of ITR 8515 are causing significant solvency deficiencies in many cases. In our view this overreaches the original policy goals of this section. In particular:
The required valuation assumption of 7.5% is punitive in today's low interest environment.
Maturing plans that were not previously designated plans can fall within the definition of designated plan by virtue of declining active membership. These plans often have a large proportion of pensioner liability compared to the active liabilities. The designated plan funding restrictions prevent the non-active liabilities from being adequately funded on a solvency basis.
It can be argued that the restrictive funding rules should not apply to non-active liabilities at all, or at least should cease to apply to non-active liabilities at some point as they become proportionately larger than the active liabilities.
Please indicate whether CCRA and the Department of Finance will consider:
- replacement of the fixed 7.5% interest rate assumption with a measure that moves with market rates, and
- a change in the definition of designated plan, an exemption, or other measure so that the restrictive funding rules do not apply to non-active liabilities.
Answer 8
A change in the prescribed interest rate would involve a change in policy and such a change is not being pursued at this time, nor is a change with respect to the definition of a designated pension plan.
If you feel that your plan should not be considered a designated pension plan, you can use the waiver provisions currently in place to request an exemption.
Question 9 - Annuity purchases
Section 147.4 of the ITA provides that when an annuity is purchased that complies with that section; the purchase is not a taxable event. One requirement is that the annuity must provide for payment of a benefit that is not materially different from the benefit the member would be entitled to under the plan. Pension standards legislation in certain jurisdictions requires that on termination of employment, a member must be given the option of transferring his or her commuted value to purchase a life annuity from an insurance company.
The individual will usually not be able to purchase an exact replicate of the pension that could have been paid from the plan. For example:
The commuted value used to purchase the pension is less than the premium required to purchase an exact replica, so the pension amount or some other feature of the pension is adjusted while remaining within the range of acceptable benefits, or
A feature of the plan pension, such as contractual indexing, is not available from the insurer. In offering this required option plan administrators can notify the plan member of the tax risk. However that notification is difficult for the plan member to understand. There is no guidance from CCRA.
Would CCRA provide a list of examples of differences that it has determined are not material?
A terminating member can transfer the commuted value to an RRSP, subject to the 8517 limits, and then purchase an annuity. We believe that section 147.3(4) should be amended to specifically permit the direct purchase of an annuity (one that could be provided by any registered pension plan) with the commuted value, subject to the 8517 transfer limit. This would not contradict the objective of s.147.4 and would permit plan administrators to comply with provincial pension standards legislation without communication concerns.
Will CCRA and the Department of Finance consider such an amendment?
Answer 9
The determination of whether a difference between what the member is entitled to under the plan and the annuity purchase is material can only be made after consideration of the specific circumstances of each case and after the annuity has been purchased. Therefore, CCRA cannot provide a list of differences that it has determined are not material.
With respect to the examples provided, currently the commuted value of the benefit under the defined benefit provision may be less than the premium required to purchase an exact replica in the form of an annuity. In such cases either the plan sponsor makes up the difference or annuity provisions are adjusted downward, that is, the plan member suffers a loss. Under previous market conditions, the commuted value may have been greater than the premium required to purchase the annuity. In those cases, an unintended windfall occurred. We agree that many insurers do not provide contractual indexing and that the benefit must be reconfigured. Thus, the environment at the time of termination determines what differences we will accept as not being materially different.
Currently, subsection 147.3(4) of the Act does not permit the direct transfer of the commuted value; subject to the 8517 transfer limits, to purchase an annuity. Although the annuity purchase option is available under section 147.4 of the Act, the Department of Finance is not currently pursuing an amendment to the Act to provide for the purchase of an annuity where the rights under the annuity contract are materially different from those under the pension plan.
Question 10 - Interest on Employee Contributions
Please confirm that interest on employee benefit contributions under a DB provision may be credited at the rate of:
- the greater of CANSIM and net fund return;
- the greater of 0 and net fund return.
Answer 10
We will accept any reasonable method used to credit interest on employee contributions under a DB provision.
Examples of reasonable methods to credit interest on employee contributions under a DB provision are:
- fund rate of return
- 5 year personal deposit rate (CANSIM series)
- long term Government Canada bonds (CANSIM series).
The method chosen under which interest on employee contributions is credited should remain consistent over the long-term time horizon of the pension plan. This is not to say that the assumption cannot be modified over time, but simply that it should not jump from one method to another on a regular basis.
As the interest rate to be credited on employee contributions is specified under the provinical jurisdictions, we will only accept the "greater of" approaches specified above if they are required by the Federal or Provincial pension standards legislation.
For example, the PBA of Ontario requires that contributions, other than additional voluntary contributions, of members and former members of a DB pension plan to be credited annually with interest calculated at a rate that is not less than the yields of five-year personal fixed-term chartered bank deposit rates (CANSIM series). Alternatively, a pension plan may provide that the contributions be credited not less frequently than annually with interest calculated at a rate that is not less than such rate of return as can reasonably be attributed to the pension fund or to that part of the pension fund to which the contributions are made. There is no requirement that the fund rate of return be greater than the CANSIM series.
The determination of whether assumptions which differ from the assumptions listed above are reasonable can only be made on the specific circumstances of each case. What we accept in one case may not be acceptable for a similar case at another time.
Question 11 - Acceptable Use of the Commuted Value of a Pension That Exceeds the Prescribed Amount in ITR 8517
A member's normalized pension payable at age 65 is $10,000. His early retirement pension is $9,000. The commuted value of the member's pension is $150,000. The maximum transfer value is $110,000. The commuted value of the member's lifetime retirement benefits payable from age 68 for the remainder of the member's lifetime is $110,000. Paragraphs 8503(2)(m) and 8503(7) allow for the partial commutation of a member's benefit so the member could commute only the post-67 piece and transfer $110,000 to their RRSP. The remainder of the member's entitlements would be paid out in $9,000 instalments from the member's early retirement date to age 68. Newsletter 94-2 also describes this situation but uses age 65 as an example rather than age 68. The terms of the plan and the commuted value basis will determine the age after which the benefits are commuted. Some CCRA analysts have taken the position that the member can only commute post-64 benefits and they have referred back to 94-2. We believe that the age 65 in 94-2 is an example and not a rule. We believe Paragraphs 8503(2)(m) and 8503(7) and Regulations permit this type of distribution. There is no mention of age 65 in either paragraph. If the Directorate believes that payment of the above temporary pension is not permitted under the Act and Regulations, we respectively request direction to the section of the Act or Regulations that prohibits such.
Answer 11
We agree that the situation outlined in the answer to question 6 in Pension Reform Update 94-2 is an example and also that there is nothing in the pension registration rules that would prevent a member from commuting, for example, their post-age 67 lifetime retirement benefits and receiving their pre-age 68 benefits directly from the plan. However, according to the interpretation of Regulations 8517(4) and (5), the transfer limit would be nil as there would be no reduction in the individual's normalized pension. at age 65. So, while it would be possible to commute the post-age 67 benefits, it would not be possible to transfer the value to an RRSP on a tax-free basis. The assumption in Regulation 8517(5)(b) that the member had attained age 65 makes it possible (together with the remaining periodic payments rule in Regulation 8503(7)) to receive pre-age 65 benefits directly from the plan and commute and transfer the post-age 64 lifetime retirement benefits without having any impact on the Regulation 8517 transfer limit. It would also be possible to commute and transfer, say, post-age 62 benefits without impact on the transfer limit. There would therefore be an adverse impact on the transfer limit only if LRBs remain payable after age 64.
Question 12 - Earnings recognition for transferred employees and service purchases
Plan members and plan sponsors are in need of clarification from CCRA of its position concerning the recognition of earnings with one employer in a plan sponsored by another employer. CCRA has, in question # 10 of the December 6, 2001 consultation session, published its position concerning the recognition of predecessor employer earnings when there is a purchase and sale transaction in which a company or division has broken off and started a new plan. We note, however, that in our experience, this issue may not always have been dealt with by CCRA staff in accordance with the stated position.
Furthermore, there are many other situations where the same issue can arise, including the following:
In a purchase and sale transaction where there is a transfer of assets or liabilities to an existing plan of the purchaser (i.e., a new plan is not required);
In a purchase and sale transaction where there is no transfer of assets or liabilities (accrued benefits up to the date of transaction stay with the vendor) - in this case, the vendor may want to recognize future earnings with the purchaser and vice versa;
In the context of transfers between two or more plans sponsored by separate corporate entities that are all "related", but which do not participate in each other's plans;
In the context of reciprocal transfer agreements between plans that may be sponsored by related or unrelated entities - this is particularly common with public sector plans; and
Where an individual chooses (according to his right under the applicable pension standards legislation) to transfer his benefit to another registered plan upon termination of employment.
Will CCRA please indicate its position with respect to each of these scenarios, both for purposes of the prior employer's plan and the current employer's plan?
We believe that an alternative interpretation of the ITA may be possible at least for purposes of recognizing past earnings that are associated with past service credited in the second employer's plan. However it would likely be preferable to amend the ITR in order to clearly provide that prior and/or successor employer earnings can be recognized in a plan. Such recognition:
- would be consistent with overall tax/fiscal policy as it would simply permit the accrual of the same level of benefits that would be permissible if there was only one employer;
- would allow members to retire with a "whole" benefit rather than a reduced benefit as a result of a corporate transaction;
- would allow employers to be able to fulfill their contractual obligations under purchase and sale transactions.
Will CCRA or the Department of Finance take the steps required to address this issue?
Answer 12
As indicated in our response to question # 10 of the December 6, 2001 Consultation Session, section 8504 of the Regulations permits only the earnings from an employer who participates in the pension plan to be used when determining the pension benefit.
Section 8504 of the Regulations imposes a limit on the maximum lifetime retirement benefits a plan member is entitled to receive under a defined benefit provision of a registered pension plan. One of the factors used in the determination of the afore-mentioned maximum is the member's "highest average compensation". The "highest average compensation" is determined in accordance with subsection 8504(2) of the Regulations. Only compensation received from an employer who participates in the provision can be used for determining the member's highest average compensation.
The term "participating employer" is defined in subsection 8500(1) of the Regulations. Also, in respect of persons connected, one of the factors used in the determination of the maximum for a "specified year" under subparagraph 8504(1)(a)(i) of the Regulations is "the aggregate of all amounts each of which is the member's compensation from an employer who participated under the provision in the year for the benefit of the member."
Therefore, compensation for purposes of section 8504 of the Regulations does not include compensation received from a prior employer who did not participate under the provision.
However, in our response to Question # 10 of the December 6, 2001 Consultation Session, we stated that we have permitted earnings from a "predecessor employer" to be used. To be a "predecessor employer" in accordance with subsection 8500(1) of the Regulations, an employer must have sold, assigned, or otherwise disposed of all or part of its business to another employer.
Although the Act does not specifically permit the earnings from the predecessor employer to be used in the determination of the afore-mentioned maximum, we have discussed the issue with the Department of Finance. They have confirmed that it was not their intent to prohibit the use of earnings from a predecessor employer in the situation of a purchase/sale.
It should be noted that the Department of Finance has indicated its intention to recommend an amendment to Regulation 8504(2) that would allow a member's compensation from a predecessor employer (as defined in subsection 8500(1)) to be taken into account for purposes of the maximum pension limit, as long as the member's pensionable service includes service with that predecessor employer.
Until the amendment becomes law, the Registered Plans Directorate can, on an administrative basis, accept plan terms that reflect this condition.
Five scenarios were presented to us for comment:
1. In a purchase and sale transaction where there is a transfer of assets or liabilities to an existing plan of the purchaser (i.e. a new plan is not required);
Scenario 1: As the seller is considered to be a "predecessor employer", compensation from the seller can be used provided that service with the seller is recognized as pensionable service in the purchaser's plan.
2. In a purchase and sale transaction where there is no transfer of assets or liabilities (accrued benefits up to the date of the transaction stay with the vendor) - in this case, the vendor may want to recognize future earnings with the purchaser and vice versa;
Scenario 2: The seller is considered to be a "predecessor employer", however, as the purchaser is not recognizing service with the seller, the purchaser cannot take compensation from the seller into consideration unless, the seller is a participating employer in the purchaser's plan. In addition, the seller cannot take into consideration compensation from the purchaser unless the purchaser is a participating employer in the seller's plan.
3. In the context of transfers between two or more plans sponsored by separate corporate entities that are all "related", but which do not participate in each other's plans;
4. In the context of reciprocal transfer agreements between plans that may be sponsored by related or unrelated entities - this is particularly common with public sector plans; and
5. Where an individual chooses (according to his right under the applicable pension standards legislation) to transfer his benefit to another registered plan upon termination of employment.
Scenarios 3, 4 and 5: There are no "predecessor employers". Therefore, compensation in each plan is limited only to compensation from an employer who participates in the particular plan.
