The Unit Trust Control Act and Unlisted Investments
Funds making use of unit trust portfolios are also subject to the Unit Trust Control Act 1981. Unit trust management companies have thus far been able to offer investment portfolios that complied with regulation 28 of the Pension Funds Act.
The Unit Trust Control Act currently defines an unlisted investment as “securities other than stock exchange securities and such other securities determined by the registrar by notice in the Gazette.” Section 6(1) of the Act directs that “The registrar in concurrence with the Minister, by notice in the Gazette, may determine securities and other assets which may be included in a unit portfolio of a unit trust scheme and the minimum or maximum or both minimum and maximum restrictions and conditions subject to which such securities, classes of securities, or other assets may be included in a unit portfolio.
The Unit Trust Control Act and the Pension Funds Act are incompatible
With the introduction of unlisted investments as an obligatory asset class in terms of regulation 28 and 29, the provisions of the Unit Trust Control Act would only allow a unit trust to comply with the prescriptions of regulation 28 and 29 of the Pension Funds Act if the registrar of unit trust companies in concurrence with the Minister by notice in the Gazette directed that the provisions of regulation 28 and 29 of the Pension Funds Act would equally apply to unit trust companies. This is currently not the case and it is highly unlikely that anything will be changed by Namfisa and the Minister by 31 December 2014. In fact, we have been made aware of a draft gazette that requires a unit trust holding any unlisted investment, to convert such investment to a listed investment within 12 months, as the result of which unit trust management companies will not be able to offer regulation 28 compliant portfolios as far as the unlisted investment requirement goes.
The challenge for smaller pension funds investing in unit trusts
Smaller pension funds mostly invest either in a policy wrapped investment vehicle offered by insurance companies or in unit trusts. Unit trust management companies devised prudential balanced unit trusts specifically to cater for the needs of smaller pension funds. For one because the pooling of investments in a unit trust offers substantially reduced management fees through economies of scale and secondly because trustees require no in depth technical knowledge about investments.
Trustees of smaller funds will now be obliged to invest directly in one or more SPV’s for the reasons set out above. Each fund will now have to select 1 or more SPV without possessing the required technical knowledge. Besides the absence of the technical knowledge to take an informed decision, small funds will each have to enter into an agreement with an SPV, in many cases for quite small amounts. These small funds will also experience the constraints resulting from the illiquidity of unlisted investments more severely than large funds as individual member benefits tend to represent a much larger proportion of total fund investments, while the benefit of higher liquidity and economies of scale through pooling via a unit trust is currently not a viable avenue. These funds may not be able to realise the proportionate share of a retiree in its unlisted investments. This may result in the remaining members effectively being ‘loaded’ with the unrealisable value of the retiree’s unlisted investment and it may even lead to the fund now exceeding the 3.5% exposure limit.
Parameters for considering exemptions from investing in unlisted investments should be defined by Namfisa soonest
We are aware that as the result of growing regulatory pressures being exerted on pension funds, some smaller employers have already resolved to move to an umbrella fund. At this stage, there appears to be no intention on the part of Namfisa to consider exempting funds from the requirement to invest in unlisted investments, as became evident from discussions with senior officials of this regulator.
Since unlisted investments are illiquid and will not easily be transportable to an umbrella fund, it becomes more pressing that Namfisa needs to identify exceptional situations for granting exemption from the provisions of regulation 28 to the extent that such fund would have to invest in unlisted investments.
The time frame for concluding on unlisted investments by 31 December 2014 becomes unrealistic and Namfisa should acknowledge this now
Currently all funds, whether or not they invest in unit trusts are faced with the problem that no SPV and no unlisted investment manager has yet been approved by Namfisa, and we have now nearly reached the end of August.
Fund that invest via unit trusts, must at this stage assume that their unit trust management companies will not be able to comply with regulation 28 by 31 December 2014.
This means that all funds will have to have prospective unlisted investment managers present their unlisted investment capabilities to the trustees so that trustees are placed into a position to take a decision on a preferred unlisted investment manager/s and to finalise the contractual documentation with the chosen SPV’s and UIM’s. This process can of course only commence once Namfisa has registered any Special Purpose Vehicles and Unlisted Investment Managers. Since most funds typically only meet once a quarter or even less frequently, it should become very difficult to conclude this process between the time the first SPV’s and UIM’s have been registered by Namfisa and 31 December 2014, given also that funds are unlikely to want to settle with the ‘first best’ UIM that may present to them.
Conclusion and Recommendation
We advise that funds should assume that unit trust managers will not be able to comply with regulation 28 by 31 December 2014.
This means that all funds will have to make their own arrangements as far as the required investment in unlisted investments is concerned. Furthermore trustees will have to have prospective unlisted investment managers present their unlisted investment capabilities to the trustees so that trustees are placed into a position to take a decision on a preferred unlisted investment manager/s, once Namfisa has registered one or more Special Purpose Vehicle and its Unlisted Investment Manager.
We suggest that once an unlisted investment manager/s has/have been selected by the trustees, that the trustees should negotiate an investment of more than 1.75% in order to make provision for future growth of fund assets, possibly considering an investment close to the maximum of 3.5%. This topic should now be put on the agenda as a standing item so that appropriate attention is given to this obligation of the trustees.
In our last newsletter we expressed our opinion that Inland Revenue is contravening section 37A of the Pension Funds Act when claiming arrears tax, or a tax debt, from a benefit.
Namfisa approached Inland Revenue about these topics. The following specific concerns were raised in this context:
If a member borrows for housing purposes as contemplated in section 19(5) of the Pension Funds Act, a fund may not be able to recover the loan from the member where a benefit becomes payable to the member and the member has a tax debt with Inland Revenue.
In its response Inland Revenue advises that it acts well within its powers in doing so and suggests that funds should obtain from Inland Revenue a ‘goodstanding certificate’ before granting a loan to a member.
Our comment here is that the member’s tax status may change over time since the time the loan was granted, as a result of which this problem cannot be addressed effectively by this procedure. The current state of affairs dictates that funds should no longer grant housing loans at all, negating the intention of the legislator (with section 19(5) of the Pension Funds Act) and the undeniably positive impact on the economy that such loans have.
We believe that this matter warrants further investigation by funds.
If a provident fund member passes away and has not submitted tax returns, his or her beneficiaries will not be paid a benefit as Inland Revenue does not issue a tax directive where any tax returns are outstanding. It was suggested that Inland Revenue should issue a directive applying the maximum tax rate.
In its response Inland Revenue is rather unsympathetic to the plight of the beneficiaries, mostly minor children and insists that it will not issue a directive and wants to also use this opportunity to collect any tax debt.
Inland Revenue does not distinguish between ‘current tax’ (i.e. PAYE) and tax debt, where one view is that a tax debt may not be deducted from a pension fund benefit in terms of section 37A of the Pension Funds Act.
Inland Revenue’s response is that ‘tax’ is defined in the Income Tax Act as ‘any levy or tax levied under the Act’. It is of the opinion that via the appointment of an agent in terms of section 91 of the Act it has the powers to lay its hands essentially on any moneys of a person under the control of the agent (in our case the administrator).
Our comment is that section 83 of the Income Tax Act, which deals with recovery of tax, makes reference to tax due becoming a debt to the Government of Namibia. It goes on to advise how this tax may be recovered from that person by the Minister filing a statement with a clerk or registrar of a competent court a statement, and such statement shall have the effect of it being a civil judgement. Read in the context of section 37A of the Pension Funds Act, our argument of the debt not being contemplated as an allowable deduction from a pension fund benefit, should become more plausible.
We believe that this matter warrants further investigation by funds or an aggrieved tax payer.
With regard to tax on death benefits from a pension fund, the questions of, firstly, who is taxable on the benefit and, secondly, under what section of the definition of gross income this benefit is taxable, were raised. The latter question is very important for the purpose of establishing whether the amount is subject to the average or the marginal rate of tax of the tax payer.
Inland Revenue responded by merely expressing its surprise that this matter was unclear to the industry. It indicated that it might consider amending the Income Tax Act.
Our comment is that this matter appears to be unclear even to Inland Revenue officials as we experience totally inconsistent treatment of such benefits between different Inland Revenue offices and between different officials. Our view is that a maximum of 34% should be taxable as a cash withdrawal benefit, provided no dependants pensions’ become payable in consequence of the member’s death; and that the taxable benefit is taxable in the hands of the beneficiary. We have received written confirmation of this interpretation from Inland Revenue (except for our view that the taxable portion represents a cash withdrawal benefit), but this is not applied consistently. It is to be noted that this is quite different where the benefit is paid by a provident fund.
Inland Revenue appoints administrators as an agent to collect tax on tax exempt benefits e.g. retirement commutation and amounts to be transferred to another approved fund in terms of section 16(1)(z).
In response Inland Revenue states that the employer is obliged to obtain a tax directive in respect of any amount referred to in paragraph (d) of the definition of gross income but seemingly bases its argument on ‘accrued’ as the key word. Thus even if an amount is tax exempt in terms of this paragraph (or section 16(1)(z)) for that matter, a tax directive has to be obtained and in the event of there being a tax debt, again the appointment of an agent would give it the right to collect any tax debt.
In our opinion by including all benefits payable by a pension fund, but specifically excluding the lump sum on retirement, ill-health or death in paragraph (d) of the definition of gross income, these amounts in essence do not ‘exist’ for the purposes of the Income Tax Act and hence there cannot be a requirement to obtain a tax directive as contemplated in paragraph 9(3) of part II of Schedule 2 to the Act. As far as a benefit due to be transferred to another fund is concerned we would agree that the amount represents gross income in the first instance and would be exempt when transferred but it does create the opportunity for Inland Revenue to intercept these moneys at the time of issuing a tax directive that must be obtained by the fund administrator in respect of such moneys.
If Inland Revenue means to say that tax directives have to be obtained in respect of lump sums that are not gross income in terms of paragraph (d) of its definition, which is not clear from its response, we believe that this matter warrants further investigation by funds or an aggrieved tax payer.
Download the letter from Inland Revenue to Namfisa on these industry concerns, here...
- Larger well-established employers continue to join umbrella funds;
- The average ‘sub-fund’ in an umbrella fund has 484 members and R 297 million assets;
- 12 out of 100 stand-alone funds surveyed in 2014 indicated their intention to transfer in the next 12 months, 55 indicated they have considered it;
- Costs and reputation are the main factors influencing employers’ choice of fund;
- Main reasons for the transfer are cost savings, administrative convenience and fiduciary risk;
- There is an increased awareness of costs but understanding the cost complexities remains unsatisfactory;
- 64% of employer’s remuneration packages are based on total cost to company;
- Average employee contribution rate is 5.6% of salary;
- Average employer contribution rate is 8.5% of salary;
- Average cost of death benefits is 1.6%;
- Average cost of disability benefits is 1.2%;
- Average cost of administration is 0.8% of salary;
- Average allocation towards retirement is 10.5% of salary;
- 66% of employers provide risk benefits as part of the umbrella fund;
- Average death benefit is 3.1 times salary;
- 47% of sub funds deduct fund expenses (FSB levies, auditing fees and trustee reimbursements) from member accounts, 14% from contingency reserve and 16% include it in the administration fees;
- 83% of respondents indicated that the trustees are assisted by an investment consultant;
- 52% of respondents indicated that their consultant was independent of the sponsor;
- 31% of consultants are remunerated via commission, 24% via a negotiated fee;
- 64% of respondents felt that remuneration was commensurate with the consulting services provided;
- 69% of sub funds have a formalised strategy for rendering financial advice;
- 74% of employers offer member directed investment choice;
- 98% of sub-funds indicated that an appropriate default strategy was available for members who do not want make investment choices;
- 53% of sub funds offer life stage mandates as default strategy;
- Only 35% of employers target a pension and of these 57% target 80%+;
- 93% of employer are satisfied or very satisfied with the investment choice for these being a good variety;
- Investment feedback is provided annually by 32% of funds, half-yearly by 13%, quarterly by 37% on investment returns (77%), returns vs benchmarks (66%), portfolio asset allocation (63%), economic overview (60%) and risk analysis (41%);
- Majority of member communication is via printed material on investment performance (87%), benefit structure (87%), legislative changes (61%);
- 77% of funds make use of an internet facility;
- 42% of funds offer a net replacement ratio calculator;
- 34% of employers indicated that the umbrella fund has determined an appropriate default annuity product or are working on it, 15% have determined a product and 47% of these have selected the living annuity, 40% the guaranteed annuity;
It is concerning that 90% of members do not reassess their choices after making their initial decisions.
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