The 2004 federal budget: Implications for HR managers

An in-depth look at items of interest from an HR perspective

On March 23, federal Minister of Finance Ralph Goodale tabled his first budget. Within hours, the key spending proposals and financial initiatives were thoroughly analysed and commented upon from the perspective of various interest groups. One perspective that has not yet received as much attention is that of HR managers — mainly because the budget contained few proposals of significant and immediate impact on HR. There were several announcements, though, relating to employers’ HR interests — such as health-care funding, pension plan investments, CPP and EI revisions, and some technical issues.

Broad strokes for employer-sponsored pension and benefit plans

The minister acknowledged the financial pressures arising from an aging population and the resulting need to manage the federal government’s finances more prudently so that social security commitments can continue to be met in the future.

Since Old Age Security and government funding for health care are two of the cornerstones on which employers’ private pension and health-care programs rest, it was reassuring to hear the minister describe the need for financial prudence in these terms.

The budget forecast for federal government bond yields calls for rates to remain low through 2004, and to increase only moderately in 2005. From a pension perspective, a continuing low interest rate environment will mean that funding and accounting costs for defined benefit pension plan sponsors will remain relatively high, and pension payments for those members of defined contribution plans who choose to buy annuities upon retirement will remain relatively low.

Health care

The government confirmed $2 billion in additional funding to the provinces and territories for health care, as previously announced at the January 2004 First Ministers’ meeting. In addition, the government has committed $665 million of funding over three years to improve Canada’s readiness to deal with public health emergencies.

According to the Canadian Institute for Health Information, publicly funded health spending was expected to total $85 billion in 2003 (roughly seven per cent of GDP), with a further $36 billion in private health spending on top (an additional three per cent of GDP). Public and private health spending is growing steadily each year, both in absolute dollars and as a proportion of the GDP — placing a financial strain on the health-care system that must be addressed.

The budget papers confirmed a previous announcement that a First Ministers’ Meeting will be convened this summer to discuss strategies for ensuring the sustainability of the health-care system.

Increased federal funding, coupled with strategies to address the continued viability of the overall health-care system, should indirectly benefit employers that sponsor health-care plans which supplement the public medicare system.

Registered Pension Plan (RPP) Investments

Beginning in 2005, the budget proposes to limit the amount that registered pension plans may invest in business income trusts. Income trusts are unincorporated businesses that provide participation in the equity and debt of a company through units in the trust. The structure of income trusts allows for the distribution of pre-tax income to the unit holders. Since the income is not taxed at the corporate level and only in the hands of the unit holders, double taxation is eliminated and more income is available for distribution.

Employer-sponsored pension funds, for the most part, do not currently invest in income trusts due to the lack of a clear statutory limitation on unit holders’ liability (unlike that provided to holders of common shares). It was expected that once this issue was addressed in provincial legislation, pension funds might have invested substantial amounts in income trusts. This, in turn, could have reduced government revenues because of the tax-exempt status of pension funds. The budget announcement will prevent this from occurring. The long-term consequence of this measure is that as more businesses continue to restructure into income trusts, the universe of potential investments from which pension funds may choose will shrink and portfolio diversification may suffer.

Under the budget proposals, pension funds will be limited to holding no more than one per cent in aggregate of the book value of fund assets in business income trusts and no more than five per cent of the units of any given business income trust.

Excess holdings in a business income trust would be subject to a one-per-cent-per-month penalty tax, similar to the foreign property rules. Amounts invested by pension plans in mutual funds and pooled funds will also be limited if more than one per cent of the fund’s holdings are in restricted investments. Pension funds that invest in mutual funds will need to ensure these investments do not become restricted investments under this measure. Other tax-deferred savings plans that are not RPPs, such as Registered Retirement Savings Plans (RRSPs) and Deferred Profit Sharing Plans (DPSPs), will not be affected.

This measure will not affect pension plan investments in real estate investment trusts or resource royalty trusts. Existing investments by RPPs in business income trusts will be given transitional relief.

For now, the budget proposals are of theoretical interest to most pension plan sponsors, and will have little immediate practical consequence. Until the provinces enact legislation that clearly limits the liability of unit holders, employers will generally be reluctant to invest pension plan assets in a business income trust.

Ontario introduced a bill in December 2003 and the Mar. 24 Alberta budget proposed legislation to address this issue in 2004 — so some momentum is building among the provinces.

Pension plan committees will need to assess a variety of issues relating to current holdings in any mutual funds and pooled funds that invest in business income trusts, as well as any future direct investments they may make in business income trusts.

Canada Pension Plan (CPP), Employment Insurance (EI)

The budget included several announcements relating to CPP and EI contributions, as well as CPP disability benefits.

EI premiums: The government previously promised to have a new rate-setting mechanism in place to determine EI premium rates starting in 2005. If legislation to implement these rules is not passed in time, the government proposes to give cabinet the authority to set the EI rate for 2005.

For planning purposes, the government is assuming an employee premium rate of 1.98 per cent of insurable earnings for 2005. The corresponding employer premium rate would be 2.77 per cent of insurable earnings.

Excess CPP and EI contributions: In situations where two employers merge or one employer acquires all or part of the business of another employer — and the affected employees technically end up working for two employers over the course of a year — the current CPP and EI rules can result in the two employers remitting, in aggregate, more than the maximum annual CPP contribution or EI premium in respect of such employees.

Effective Jan. 1, 2004, the government proposes to amend the CPP and EI legislation for such situations so that the amounts remitted for a given employee by the first employer in a year are deemed to have been remitted by the second employer. This avoids excess contributions.

CPP disability benefits: the government proposes to amend the CPP legislation to facilitate the transition of persons with disabilities into employment. Currently, recipients of CPP disability benefits who attempt to return to work, but who abandon their efforts due to their disability, must reapply for CPP disability benefits. The new rules will allow for the reinstatement of disability benefits if a former recipient is required to cease working due to the disability within two years of returning to work. This measure will be effective as of a date to be negotiated with the provinces.

From a broader perspective, the budget notes that as a result of reforms in 1997 and other measures, the CPP is now actuarially sound for at least 75 years.

Ending the deduction of fines

The Income Tax Act generally allows taxpayers to deduct fines and penalties levied by a government or government agency in calculating business income.

The budget proposes to introduce measures to ensure that statutory fines and penalties levied by a government, government agency, regulator, court or other tribunal are not deductible for income tax purposes. (Certain fines and penalties may be exempted.) It is expected that this will affect, for example, deductions for late filing fees and penalties levied under the Income Tax Act or by a provincial or federal pension standards regulator for late-filed Annual Information Returns, Pension Adjustments, Past Service Pension Adjustments and Pension Adjustment Reversals.

This measure will apply to fines and penalties imposed after Mar. 22, 2004.

Tax pre-paid savings plans (TPSPs): Still no news

In reviewing the budget proposals affecting employers’ HR programs described above, there was one notable missing piece.

Buried deep in an appendix to the 2003 federal budget, the government announced it would consider the possible introduction of TPSPs as a retirement savings vehicle. In a TPSP, contributions are not deductible but investment returns and plan withdrawals are tax-exempt. This is similar to the Roth Individual Retirement Account available in the United States.

A year has now passed; no visible progress has been made. In the 2004 budget documents, the government stated it is continuing to examine and assess TPSPs and other approaches to improve the tax treatment of savings.

Unfortunately, no date was provided for any possible action resulting from this study. We await further news on what could be a useful addition to the tool kit for designing employers’ and individuals’ retirement savings arrangements.

C. Ian Genno is a consulting actuary and principal in the Toronto office of Towers Perrin. He may be contacted at (416) 960-7420 or [email protected]. This article was prepared with the assistance of colleagues in the Toronto office.

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