Luxembourg only enacted a legal framework for occupational pensions with the law of June 8, 1999. Company pension plans existed long before this law. In the past, companies provided mainly defined benefit (DB) second pillar schemes in book-reserve systems, as in Germany. Book reserve systems were tax-driven: allowances for pension liabilities provisions were tax deductible expenses for companies and not considered as taxable income for employees. Final benefits at retirement age were taxable.
The occupational pension law has two main tax issues worth mentioning: limitation of benefits and up-front taxation. For all employees hired after January 2000, the total premium or contribution for risk benefits cannot exceed 20 % of the “annual ordinary remuneration” which is the monthly salary multiplied by 14.4. For employees that have already participated in a DB plan on December 31, 1999, the tax threshold is not 20% of the contribution but the total pension benefit (social security plus occupational pension) is limited to 72% of the last “annual ordinary remuneration”.
Another issue which has attracted much more criticism from interested parties is the up-front taxation. Pensions are not taxed any longer when benefits are disbursed but at the moment when premiums are paid. The up-front taxation of 20% is charged to the employer and is a business expense for the corporation. This means in fact that employers are now paying a tax that was paid by the beneficiary in the former regime. The 20% is roughly half of the highest marginal tax rate in Luxembourg (38.95 %). On the other hand, benefits (pensions and lump sums) are now tax free.
Luxembourg is (together with Germany for Pensionskassen and direct insurance) the only EU country relying on a tax system, which is referred to as TEE. ‘T’ stands for taxation of premiums, the second ‘E’ stands for exemption of investment income in the accumulation vehicle while the last ‘E’ represents exemption of final benefits paid out. The reason for choosing TEE is obvious: Luxembourg has been successful in attracting many foreign qualified workers. A majority of these workers intend – as many Luxembourgers themselves – to spend their retirement years in sunny France or Spain instead of rainy Luxembourg. Occupational pensions however, in line with art 18 of the OECD model convention are to be taxed in the country of residence.
The Luxembourg legislator was not ready to accept tax deductible expenses on items where it is was very likely, right from the beginning, that in many cases he cannot claim taxes from recipients on final benefits corresponding to these expenses.
The European market for occupational pensions is far from being achieved. One of the major obstacles remaining is taxation. The recent Danner judgement from the ECJ has already eliminated some barriers. We wonder if the TEE system could not be a solution to solve the tricky tax issue European wide. TEE is not the model that the Commission has signalled in the communication dated April 19th, 2001 on taxation of occupational pensions Com (2001)_214, but we see three main advantages:
o If all EU countries would exempt benefits from occupational pension schemes and tax contributions instead, workers could freely move within the EU without having to think about tax planning for their company pension.
o The tax would be very easy to collect, as employers would pay it to the taxman.
o Tax revenue would occur immediately. Every state is assured that it can collect the tax on an item that it has allowed to be tax deductible in its jurisdiction.
Fernand Grulms is general manager of PECOMA International, a risk benefits consultancy in Luxembourg and member of the IBN network