Conservatives announce new tax credits for employees and solvency funding relief for sponsors of federally regulated pension plans
As anticipated, the first budget tabled by federal Minister of Finance Jim Flaherty provides for selected tax relief and focused federal spending. The budget contains a number of announcements relating to employers’ HR interests, such as new tax credits for employees and solvency funding relief for sponsors of federally regulated pension plans.
Funding Canada’s retirement income system
Federally regulated defined benefit (DB) pension plans: Recognizing that funding is a key, immediate issue affecting many DB plans, the budget proposes four temporary measures to provide solvency funding relief. The measures that follow will help employers that operate under federal jurisdiction.
•Plan sponsors may consolidate solvency payment schedules and amortize the entire solvency deficit over a single, new five-year period. This will smooth and potentially extend existing solvency payment obligations.
•Plan sponsors may extend the solvency funding period to 10 years, provided plan members are informed of the change and no more than one-third of members, active or retired, object.
•Plan sponsors may also extend the solvency funding period to 10 years, if the difference between the five-year and 10-year level of payments is secured by a letter of credit. This measure will reduce annual solvency amortization payments for sponsors, while protecting pension benefits for members and retirees.
•The solvency amortization period for federal Crown corporations will be extended to 10 years, subject to certain conditions.
Funding relief will be available only to plan sponsors whose contributions are up to date and only for the first valuation report filed before 2008. The budget announcement indicates the government will continue to monitor DB pension plans and will consider further action as necessary.
As a first step, sponsors of federally regulated DB plans should consider reviewing the funded positions of their plans to assess the potential impact of this funding relief.
Details of this measure will be addressed in draft regulations that are expected to be released shortly. It is possible the new rules may not be formally adopted by June 30, in which case any valuation reports that are due by then must be filed in accordance with the current funding rules. There may be a possibility to file a revised valuation report once the proposed rules are formally adopted.
The government’s initiative is welcome. This resembles the temporary measures the Quebec government adopted in 2005 for DB plans registered in Quebec. Other jurisdictions would do well to adopt similar measures.
But the relief is only temporary and other steps may be required to improve the viability of DB pension plans. Despite ongoing discussion in the pension industry of the need to relax the tax rules limiting the amount of surplus pension plans can hold without restricting employer contributions, the budget does not address this issue. Over the long term, such a change would have a broader impact on the funding of DB plans across Canada by providing more flexibility to employers to manage contributions.
Canada and Quebec Pension Plans: The government will discuss with the provinces the possibility of allocating a portion of any future federal year-end surpluses over $3 billion to the Canada Pension Plan and the Quebec Pension Plan. Accelerated funding would improve intergenerational equity in the CPP/QPP by improving the ratio of benefits to contributions for younger workers. The government believes pre-funding CPP/QPP obligations will also improve labour market participation over the long term by lowering payroll taxes in the future. HR managers should watch for further developments when discussions with the provinces begin.
Tax initiatives of interest to employers
There were several changes to personal income tax provisions that will affect payroll systems, benefit plans and recruiting.
Personal income tax rates: The budget announces changes to the lowest personal income tax rate and the basic personal amount (the amount Canadians can earn without paying federal income tax). Payroll systems will need to be adjusted to reflect these changes.
Pension income tax credit: The maximum amount of annual pension income eligible for the pension income tax credit will double to $2,000, effective retroactively to Jan. 1 this year. While welcome news to pensioners, this will have little if any effect on employers’ plan design decisions.
Medical expense tax credit: The 2005 federal budget proposed to expand the list of expenses eligible for the medical expense tax credit, but the enabling legislation did not pass before Parliament was dissolved last fall. This budget confirms the government’s intention to adopt the expanded list of eligible medical expenses.
A liberalized definition of “medical expenses” under the Income Tax Act could have implications for employer-sponsored health benefit plans, which are usually designed to qualify as private health services plans (PHSPs). To be tax effective, PHSPs are limited to providing medical and dental benefits that would otherwise qualify for the medical expense tax credit. The wording of many PHSP policies is such that an expansion of the list of items eligible for the medical expense tax credit would automatically expand the list of eligible expenses under the employer-sponsored plan. Employers may wish to consider whether they want to extend such coverage under their insured group benefit plans.
This measure will also expand the list of eligible expenses for employers that provide health spending accounts for their employees. The administration of group benefit plans that have a health spending account will need to be revised to reflect these changes.
Canada employment credit: The budget introduces a new “Canada employment credit,” a tax credit on employment income of up to $500, effective July 1. The income eligible for the credit will increase to $1,000 on Jan. 1 next year, and will be indexed in subsequent years. The budget states that this measure will put employees on a more equal footing with the self-employed in terms of the tax relief available for expenses incurred to earn income.
Employee tool expenses: To provide relief to employed tradespeople, the budget proposes a new deduction of up to $500 for the cost of tools in excess of $1,000 that a tradesperson must provide as a condition of employment. This measure will apply to tools acquired on or after May 2. Employers need to certify that the employee is required to acquire the tools as a condition of, and for use in, employment.
Apprenticeship job creation tax credit: The budget proposes a new apprenticeship job creation tax credit to encourage employers to hire new apprentices in certain trades, including electricians and plumbers. Effective May 2, eligible employers will receive a tax credit of 10 per cent of the wages paid to qualifying apprentices in the first two years of their contract, to a maximum credit of $2,000 per apprentice per year — that is, the credit will apply to up to $20,000 of the apprentice’s salary and wages. The credit will not apply to bonuses or profit-related payments.
Dividend tax credit: To eliminate double taxation of dividends paid by large Canadian corporations, the budget announces that for dividends paid after 2005, the dividend gross-up and dividend tax credit will be increased. This means the rate of tax payable on earnings distributed as dividends will more nearly approximate the rate of tax applicable to other types of investment income, such as interest income and income trust distributions. This change mirrors changes to the tax treatment of dividends first announced last November by former Minister of Finance Ralph Goodale. This measure may affect investment decisions made by employees in non-registered savings plans.
Health care – patient wait times
The government confirmed its commitment to working with the provinces and territories to reduce waiting times for publicly insured health services. Patient wait-time reduction targets for priority procedures are to be established by the end of this year. The budget states that patients should be given the option of receiving treatment at another hospital or clinic — even outside of their home province — if treatment is not available within a patient’s own area within a medically acceptable maximum time. The budget provides no additional funding to help the provinces meet this deadline over and above funds already promised following the September 2004 first ministers meeting on health care.
Steps to take
To sum up, on the immediate horizon, HR managers will need to ensure payroll systems are up to date to reflect income tax rate changes, consider the effect of proposed changes to the definition of medical expenses and, in industries employing skilled tradespeople, assess the potential benefit of the apprenticeship proposal. And unless they currently are in a surplus position, employers in the federal jurisdiction that sponsor DB pension plans will need to assess the potential impact of the temporary funding relief proposals.
Ian Genno is a principal of Towers Perrin in Toronto. This article was prepared with the assistance of colleagues in his office. He may be reached at [email protected].
Funding Canada’s retirement income system
Federally regulated defined benefit (DB) pension plans: Recognizing that funding is a key, immediate issue affecting many DB plans, the budget proposes four temporary measures to provide solvency funding relief. The measures that follow will help employers that operate under federal jurisdiction.
•Plan sponsors may consolidate solvency payment schedules and amortize the entire solvency deficit over a single, new five-year period. This will smooth and potentially extend existing solvency payment obligations.
•Plan sponsors may extend the solvency funding period to 10 years, provided plan members are informed of the change and no more than one-third of members, active or retired, object.
•Plan sponsors may also extend the solvency funding period to 10 years, if the difference between the five-year and 10-year level of payments is secured by a letter of credit. This measure will reduce annual solvency amortization payments for sponsors, while protecting pension benefits for members and retirees.
•The solvency amortization period for federal Crown corporations will be extended to 10 years, subject to certain conditions.
Funding relief will be available only to plan sponsors whose contributions are up to date and only for the first valuation report filed before 2008. The budget announcement indicates the government will continue to monitor DB pension plans and will consider further action as necessary.
As a first step, sponsors of federally regulated DB plans should consider reviewing the funded positions of their plans to assess the potential impact of this funding relief.
Details of this measure will be addressed in draft regulations that are expected to be released shortly. It is possible the new rules may not be formally adopted by June 30, in which case any valuation reports that are due by then must be filed in accordance with the current funding rules. There may be a possibility to file a revised valuation report once the proposed rules are formally adopted.
The government’s initiative is welcome. This resembles the temporary measures the Quebec government adopted in 2005 for DB plans registered in Quebec. Other jurisdictions would do well to adopt similar measures.
But the relief is only temporary and other steps may be required to improve the viability of DB pension plans. Despite ongoing discussion in the pension industry of the need to relax the tax rules limiting the amount of surplus pension plans can hold without restricting employer contributions, the budget does not address this issue. Over the long term, such a change would have a broader impact on the funding of DB plans across Canada by providing more flexibility to employers to manage contributions.
Canada and Quebec Pension Plans: The government will discuss with the provinces the possibility of allocating a portion of any future federal year-end surpluses over $3 billion to the Canada Pension Plan and the Quebec Pension Plan. Accelerated funding would improve intergenerational equity in the CPP/QPP by improving the ratio of benefits to contributions for younger workers. The government believes pre-funding CPP/QPP obligations will also improve labour market participation over the long term by lowering payroll taxes in the future. HR managers should watch for further developments when discussions with the provinces begin.
Tax initiatives of interest to employers
There were several changes to personal income tax provisions that will affect payroll systems, benefit plans and recruiting.
Personal income tax rates: The budget announces changes to the lowest personal income tax rate and the basic personal amount (the amount Canadians can earn without paying federal income tax). Payroll systems will need to be adjusted to reflect these changes.
Pension income tax credit: The maximum amount of annual pension income eligible for the pension income tax credit will double to $2,000, effective retroactively to Jan. 1 this year. While welcome news to pensioners, this will have little if any effect on employers’ plan design decisions.
Medical expense tax credit: The 2005 federal budget proposed to expand the list of expenses eligible for the medical expense tax credit, but the enabling legislation did not pass before Parliament was dissolved last fall. This budget confirms the government’s intention to adopt the expanded list of eligible medical expenses.
A liberalized definition of “medical expenses” under the Income Tax Act could have implications for employer-sponsored health benefit plans, which are usually designed to qualify as private health services plans (PHSPs). To be tax effective, PHSPs are limited to providing medical and dental benefits that would otherwise qualify for the medical expense tax credit. The wording of many PHSP policies is such that an expansion of the list of items eligible for the medical expense tax credit would automatically expand the list of eligible expenses under the employer-sponsored plan. Employers may wish to consider whether they want to extend such coverage under their insured group benefit plans.
This measure will also expand the list of eligible expenses for employers that provide health spending accounts for their employees. The administration of group benefit plans that have a health spending account will need to be revised to reflect these changes.
Canada employment credit: The budget introduces a new “Canada employment credit,” a tax credit on employment income of up to $500, effective July 1. The income eligible for the credit will increase to $1,000 on Jan. 1 next year, and will be indexed in subsequent years. The budget states that this measure will put employees on a more equal footing with the self-employed in terms of the tax relief available for expenses incurred to earn income.
Employee tool expenses: To provide relief to employed tradespeople, the budget proposes a new deduction of up to $500 for the cost of tools in excess of $1,000 that a tradesperson must provide as a condition of employment. This measure will apply to tools acquired on or after May 2. Employers need to certify that the employee is required to acquire the tools as a condition of, and for use in, employment.
Apprenticeship job creation tax credit: The budget proposes a new apprenticeship job creation tax credit to encourage employers to hire new apprentices in certain trades, including electricians and plumbers. Effective May 2, eligible employers will receive a tax credit of 10 per cent of the wages paid to qualifying apprentices in the first two years of their contract, to a maximum credit of $2,000 per apprentice per year — that is, the credit will apply to up to $20,000 of the apprentice’s salary and wages. The credit will not apply to bonuses or profit-related payments.
Dividend tax credit: To eliminate double taxation of dividends paid by large Canadian corporations, the budget announces that for dividends paid after 2005, the dividend gross-up and dividend tax credit will be increased. This means the rate of tax payable on earnings distributed as dividends will more nearly approximate the rate of tax applicable to other types of investment income, such as interest income and income trust distributions. This change mirrors changes to the tax treatment of dividends first announced last November by former Minister of Finance Ralph Goodale. This measure may affect investment decisions made by employees in non-registered savings plans.
Health care – patient wait times
The government confirmed its commitment to working with the provinces and territories to reduce waiting times for publicly insured health services. Patient wait-time reduction targets for priority procedures are to be established by the end of this year. The budget states that patients should be given the option of receiving treatment at another hospital or clinic — even outside of their home province — if treatment is not available within a patient’s own area within a medically acceptable maximum time. The budget provides no additional funding to help the provinces meet this deadline over and above funds already promised following the September 2004 first ministers meeting on health care.
Steps to take
To sum up, on the immediate horizon, HR managers will need to ensure payroll systems are up to date to reflect income tax rate changes, consider the effect of proposed changes to the definition of medical expenses and, in industries employing skilled tradespeople, assess the potential benefit of the apprenticeship proposal. And unless they currently are in a surplus position, employers in the federal jurisdiction that sponsor DB pension plans will need to assess the potential impact of the temporary funding relief proposals.
Ian Genno is a principal of Towers Perrin in Toronto. This article was prepared with the assistance of colleagues in his office. He may be reached at [email protected].
