EU pieces falling into place
The EU employer-sponsored pensions environment is slowly beginning to take shape. After a decade of relatively fruitless discussion, followed by a couple of years of productive activity culminating in a directive, as well as parallel initiatives by the Commission and the Court of Justice, the latest Court judgments and national legislative changes are starting to have an effect on the European pensions landscape.
Most international benefits practitioners will be aware of the key milestones: the Institution for Occupational Retirement Provision’s (IORP) directive of September 2003; the European Commission’s ‘Tax Communication’ of April 2001; some key cases in the European Court of Justice, notably the Danner and Skandia cases; and subsequent legal actions by the Commission against individual countries including Denmark, Belgium, Spain, France, Ireland, Italy, Portugal and the UK.
These have recently been followed by announcements from France and Spain that their laws will be changed to stop discriminating against non-domestic EU pension plans, changes by Finland and Sweden to their national legislation further to the Danner and Skandia cases, and a comprehensive review of legislation in the UK replacing the concept of ‘approval’ of domestic plans with ‘registration’ of both domestic and non-domestic EU plans.
It is important to remind ourselves that developments are occuring concurrently in two separate but interconnected fields of regulatory supervision and taxation. The first development is the IORP directive introducing the ‘single passport’ concept already familiar to insurance companies, whereby a pension fund regulated by one member state must be treated as being just as well regulated as a pension fund regulated by another member state. The directive introduces the concept of ‘registration’ which is a simple process distinct from ‘regulation’: plans are regulated in one member state only, but need to be registered in all the member states where there are plan members resident. Registration is a formality that cannot be refused, but is needed to ensure compliance with the various rules. The second development is the commission’s efforts on the tax front to remove any differences of treatment based purely on where within the EU the plan is located.
The effect of both of these is that, from September 2005, tax relief on contributions to a non-domestic EU pension plan cannot be refused:
q On the grounds of nationality, ie, because it is simply outside the member state in question, as that is illegal according to the commission and the ECJ;
q On the grounds of not conforming to national domestic supervisory/
prudential rules and regulations, as from September 2005 the directive will require ‘mutual recognition’ of these rules and regulations, although there are two important conditions that apply;
q Tax relief is only granted on contributions up to the limits applicable in the member state where the employee is resident – after all, why should an member state be more generous on contributions paid to another member state’s plan than to a domestic plan?
q The plan must comply with the social/employment law of the country where the employee is resident.
The latter point is where the practical challenges really lie.
Member states are entitled to insist that all residents comply with their social and employment legislation. Consider the example of vesting of pension benefits. In the UK, pension plans must currently provide a vested deferred benefit to all employees who leave the plan after two or more years’ service. Is this:
q a prudential/supervisory/regulatory provision, that should apply to all members of a UK regulated pension plan, whether the members are resident in the UK or elsewhere in the EU, but not to UK resident members of a pension plan regulated elsewhere in the EU; or
q a feature of UK employment law, that should apply to all UK resident members of EU pension plans, ie, regulated in the UK or elsewhere in the EU, but not necessarily to non-UK-resident members of UK regulated plans?
The first option could simply drive UK employers to seek the ‘lowest common demoninator’ of pension protection around the EU, which could be politically challenging. The second option would also be politically challenging, as it discriminates against the plan members who do not happen to be resident in the UK, although as taxation is different according to the country of residence, such treatment ought to be legally acceptable. It may be that both approaches are applied, ie, UK vesting rules (and other member protection rules such as compulsory pension increases) are applied to all members of UK regulated pension funds as well as to all UK resident members of non-UK regulated funds.
Other member states will also need to address similar issues before the September 2005 deadline, although in cases where pension legislation is not very developed they are likely take the easy route of treating all the rules as social and employment legislation, and applying them to all residents.
In practice, the directive is making little noise in most countries around the EU because in the member states with more developed occupational pension systems, the prevailing view has been that domestic business far outweighs any cross-border business that may be provided. Consquently, the directive needs to be implemented in a way that causes minimum disruption to a domestic regulatory system that may have evolved over a long period of time and provides a good level of protection and regulation for employees based in that member state.
In contrast, in the member states with less well developed pension systems, existing occupational pension provision has been through insurance companies, already regulated by the life insurance directives. Member states in this situation appear to have little motivation to focus on the directive unless they are intending to introduce an entirely new pension regime separate from the insurance regulator. But in these cases the concept of regulated pension plans may not even be relevant, as their tax legislation will in due course (and in some cases already does) allow tax relief on contributions to non-domestic pension funds in the same way as to the domestic insurance-based arrangements.
At least two Irish companies have already applied for Irish registration of their UK pension plans. From a multinational employer’s point of view, this makes sense, due to similarities in the legal framework and general design of pension plans in the two countries, as well as a common language.
Recall that Irish employees’ membership of UK plans and vice versa was common practice until the late 1980s. It is also interesting to note that the fact that the two countries had different currencies then (as now) was not a problem from a benefit calculation and administration point of view, and is unlikely to be a problem in future either.
From September 2005 (once the directive has been implemented) and the various member states have aligned their tax legislation as required by the commission, an employer should be theoretically able to design pension benefits for employees in a particular member state, and choose a single financing vehicle to fund and deliver them from anywhere in the EU. However, why might this not always be the case, and what challenges might an employer encounter?
q Funding requirement for cross-border plans: The wording in the directive is likely to lead to requirements around funding being tougher for cross-border IORPs than for domestic ones. If, for example, a UK employer decides to include some non-UK employees in the UK pension fund, representing say 5% of the total, do the efficiency gains involved outweigh the costs of implementing tougher funding requirements in respect of the other 95%?
q Local pension legislation restricting benefit design: Dutch pension plans must not pay benefits in lump sum form. This is not just a tax requirement, it is a regulatory requirement. If this is not changed, then the Netherlands will not be an attractive place to base a cross-border IORP that is to include Belgian resident or UK resident employees, who for tax reasons expect their benefits to be paid partly or wholly in lump sum form.
q Local tax legislation: Member states are fully entitled to decide their own income tax legislation without interference from other member states, as long as this legislation does not discriminate on the basis of nationality. In particular, Germany is entitled to continue to decide that tax relief on contributions to funded pension arrangements can be heavily restricted, whereas tax relief can be granted to a much greater extent on balance sheet provisions in relation to unfunded direct pension promises. A multinational employer is therefore likely to want to handle its German-resident employees separately from its other EU employees, and grant them tax efficient local direct pension promises instead of including them in a cross-border IORP.
Once the necessary changes have been implemented in national legislation, there will be a wide range of new opportunities for employers regarding pension provision for their employees across the 25 countries of the EU.
The choice for individual employers will very much depend on their current position. They may wish to use the plan in one member state (eg, the one with most employees?) as the basis for a pan-EU plan, gradually extending it to other member states as needed and as appropriate. (Surveys of multinational employers have confirmed this as a widely-held opinion.)
Alternatively, if the employer intends to transform benefit design and introduce different arrangements for new employees, perhaps as part of a push to defined contribution or hybrid arrangements, a completely new plan might assist this.
In summary, there are bound to
be obstacles to establishing and operating a complete pan-EU pension plan covering all an employer’s employees everywhere in the EU. However, opportunities are sure to arise in a significant number of EU countries, and efficiencies should in almost all cases be available from an early stage.
Tim Reay is an international pension consultant with Hewitt in London