- Pension Plan Expenses, Contribution Holidays and Plan Conversions – recent Ontario court decision raises thorny questions for plan sponsors
- Recoverability of GST by Employers and Pension Fund Trusts: Canada Revenue Agency to Revisit Administrative Policy
Pension Plan Expenses, Contribution Holidays and Plan Conversions – recent Ontario court decision raises thorny questions for plan sponsors
The Ontario Divisional Court decision in the case of Nolan et. al v. Kerry (Canada) Inc. (the "Kerry case") is the first Canadian case that squarely addresses several of the more difficult legal issues that plan conversions give rise to, and stands as a warning to plan sponsors to undertake the necessary legal due diligence in respect of plan conversions and to adequately communicate material proposed changes in plan design to plan beneficiaries where beneficiary elections are required. This case involved an appeal by former employees of Kerry (Canada) Inc. from two decisions of the Ontario Financial Services Tribunal (the "FST"). Leave to appeal to the Ontario Court of Appeal was granted on July 17, 2006.
The Kerry case also clarifies the law with respect to charging expenses to a trusteed pension fund, and confirms that in the case of trusteed plans, historical plan and trust language is critical in determining whether an employer can validly amend a plan to either provide for the payment of expenses from a pension fund, or expand the nature of the expenses that can be charged to the pension fund.
The plan was established in 1954 pursuant to a trust agreement. The original trust agreement contemplated that any taxes in respect of the pension fund could be charged to the fund, and that if the Trustee's expenses incurred in performing its duties were not paid from the trust fund, until paid by the Company such expenses constituted a charge on the trust fund. The original trust agreement was otherwise silent with respect to the payment of expenses from the plan. The original trust agreement, while reserving a general power of amendment to the employer, stated that no amendment to the trust fund could result in money from the trust fund being used "other than for the exclusive benefit of …employees." From the inception of the pension plan in 1954 until 1984, all of the pension plan's expenses were paid by the employer.
In 1975, the plan was amended, among other things, to give the employer the discretion to direct that certain plan expenses be paid from the trust fund. Similar amendments related to plan expenses were made in 1987 and 2000. The employer also entered into a new trust agreement with a new trustee in 2000 which purported to expand the scope of permissible plan expenses that could be paid from the trust fund under the original trust agreement.
In 1999, employees were given notice of the opportunity to convert their defined benefit entitlements under the plan to a new defined contribution provision under the same plan. Those who chose not to convert continued to accrue benefits under the defined benefit provisions of the plan. New employees hired after January 1, 2000 became members of the defined contribution provision of the plan.
The plan conversion was effected in 2000. As is commonly the case, the defined contribution provision of the plan was funded through an insurance contract. The defined benefit provision of the plan continued to be funded through the trust arrangements. Commencing in 2000, Kerry applied surplus in the defined benefit provision of the plan to fund the employer contribution obligation under the defined contribution provision of the plan.
Plan Expenses Appeal
The first appeal concerned whether the terms of the pension plan permit the employer to pay certain administrative expenses out of the pension fund.
The Court stated that to determine whether an employer can unilaterally make valid amendments to a pension plan to permit the payment of administrative expenses from the trust fund involves a three step inquiry:
- Is the plan constituted as a trust?
- If yes, did the employer reserve, in the original trust agreement, the power to revoke the trust?
- Do the amendments in question constitute a revocation of trust?
The Court held that the original trust agreement did not reserve any power of revocation to the employer and noted that the trust specified that contributions were for the "exclusive benefit" of plan members. The Court rejected Kerry's argument that the provision in the trust agreement which created a charge on the trust fund for unpaid fees and expenses of the trustee permitted the payment of expenses from the trust fund. The Court ruled that this provision did not benefit Kerry since the clause also stipulated that the expenses were to be paid by the employer and the charge was solely for the benefit of the trustee in the event of default by the employer.
The 1975, 1987 and 2000 amendments concerning the payment of plan expenses were held to be invalid as purported revocations of the trust. The Court noted that the power to amend the trust was subject to the proviso that amendments had to be for the exclusive benefit of the employees. The Court ruled that the payment of administration fees, although beneficial to employees, was not for the "exclusive benefit" of employees when the terms of the trust required the payment of such costs by the employer. Instead, the Court found that the payment of administrative expenses from the trust fund was for the primary benefit of the employer by relieving it of a financial burden. The Court also stated that, for these purposes, it was irrelevant whether the expenses were internal to the plan administrator or paid by the administrator to third parties.
The Court also concluded that the FST was correct in concluding that neither it, nor the Superintendent, had jurisdiction to order Kerry to amend the pension plan or trust agreement so that all amendments dealing with the payment of expenses would be consistent with the original trust agreement.
Contribution Holiday Appeal/Plan Conversion Issues
Contribution Holiday in Defined Benefit Plan
Both the FST and the Court stated that Kerry was entitled to take contribution holidays under the defined benefit provisions of the plan. The Court referenced the decision of the Supreme Court of Canada in Schmidt v. Air Products of Canada in ruling that there is nothing inherently offensive about an employer taking a contribution holiday in a defined benefit pension plan. The Court stated that "[i]t is not a breach of trust and does not constitute misuse of trust funds because the trust only attaches to money in the fund after it has been paid into the fund." The Court noted that the obligation to contribute cannot be said to be impressed with a trust. Contribution holidays are permitted unless specifically prohibited by the terms of the plan. The Kerry plan contained no such prohibition.
Cross – subsidizing DC plan with surplus from DB plan
The FST held that Kerry was not entitled to use trust monies from the previously established defined benefit provision of the plan to fund the employer contribution obligation under the new defined contribution provisions of the plan. The FST stated that this would be an improper use of trust funds because it would result in trust funds being used for "purposes other than for the exclusive benefit of" the beneficiaries of the trust. However, the FST also suggested that Kerry could amend the plan, retroactive to January 1, 2000, to designate members of the defined contribution plan as beneficiaries of the trust in respect of the defined benefit plan. The FST ruled that if this was done, Kerry could use any surplus assets in the defined benefit plan to fund its obligations under the defined contribution plan.
The Court agreed with the FST that cross-subsidization of the defined contribution plan was not permitted as that amounted to a partial revocation of trust, i.e. assets of the trust would be used for purposes other than for the exclusive benefit of the plan members of the defined benefit provisions that were subject to the trust. However, the Court ruled the FST was wrong to propose as a "remedy" that members of the defined contribution plan be designated beneficiaries of the defined benefit plan.
The Court held that although Kerry may have structured the pension plan as one plan with two parts (defined benefit provision and defined contribution provision), at law it was two (2) plans with two (2) funds and two (2) classes of members.
Notice of Conversion
The FST concluded, on the facts, that there were shortcomings in the disclosure given to plan members about the conversion, which shortcomings "raise questions as to whether employees were adequately informed of the material factors that might affect their conversion decisions by the time they had to make that decision." The Court agreed with the FST's conclusion that the notice sent to employees about the plan conversion did not accurately inform members or put them in a position to make an informed decision as to their options. However, unlike the FST, the Court found that the administrator's failure to give proper notice amounted to a failure to administer the pension plan in accordance the statutory standard of care that applies to plan administrators, including the obligation to adequately communicate to members the proposed changes to the plan. As a result, the Court held that the FST and Superintendent erred in failing to refuse registration of the plan text that effected the conversion. The plan conversion was, in effect, set aside.
Costs before the FST
The Court upheld the majority decision of the FST that it had no jurisdiction to order costs to be paid out of the pension's trust fund since, as a statutory administrative tribunal, it does not have such power from the legislature.
The Kerry case stands for a number of propositions:
- The ability to pay plan expenses from a pension trust fund will depend on the historical trust language.
- Neither the Superintendent nor the FST has authority to order a plan sponsor to amend a pension plan or trust agreement.
- Contribution holidays are permitted unless specifically prohibited by the terms of the pension plan.
- In the case of a conversion of a defined benefit plan to a defined contribution plan, there are circumstances in which a plan sponsor may not be able to use surplus from the defined benefit plan to fund contributions under the successor defined contribution plan.
- Attempting to structure a conversion as one plan with two components (i.e. defined benefit and defined contribution) will not necessarily permit the use of surplus to fund the employer's defined contribution plan contribution obligation.
- Failure to give adequate notice of a plan conversion can be fatal to the transaction. The adequacy of notice is subject to review by the FST and the courts.
- The FST does not have jurisdiction to order the payment of costs from a pension plan in respect of proceedings before the FST.
By Paul Dempsey
Recoverability of GST by Employers and Pension Fund Trusts: Canada Revenue Agency to Revisit Administrative Policy
The Canada Revenue Agency ("CRA") administers the federal goods and services tax ("GST"), a value-added tax that is applicable to most supplies of services and property made in Canada. The CRA recently confirmed its intention to revisit its administrative policy on the recoverability of GST paid by employers on pension fund trust expenses. The existing policy denies employers the right to recover GST on a range of expenses that the CRA views as expenses of the pension fund trust.
It remains to be seen whether the CRA will be able to amend its administrative policy to bring it more clearly within the wording of the legislation, while managing to avoid a loss of substantial GST revenues. Employers and pension fund trusts currently incur very significant amounts of unrecoverable GST on investment advice and portfolio management services.
The Excise Tax Act (Canada) (the "Tax Act") deems a trust, including a pension fund trust, to be a separate legal entity for GST purposes. A pension fund trust is unable to recover GST incurred on taxable services or property acquired as inputs into the trust's operations. The exception is for supplies acquired in respect of investments in real property that result in taxable supplies of real property being made by the pension fund trust.
By contrast, the Tax Act provides that a business is entitled to fully recover GST incurred on property or services acquired for consumption, use or supply in the course of a business of making taxable supplies. As a result, most employers are entitled to recover all of the GST incurred in operating their businesses. As a consequence, the provisions of the Tax Act suggest that an employer should be entitled to recover GST incurred by the employer in respect of a pension plan for its employees to the extent the GST is payable by the employer, rather than the trust.
As the GST treatment of expenses incurred by the employer and the pension fund trust differ, one must review the documentation and legislation governing each pension plan to determine the scope of expenses and related GST that is payable by the employer. The respective responsibilities of employers and pension fund trusts can vary significantly from plan to plan.
Existing CRA Policy
The CRA's current published administrative policy is set out in Technical Information Bulletin B-032R "Registered Pension Plans" . As is argued below, the CRA largely avoided any analysis of the provisions of the Tax Act in establishing its current administrative policy in 1993. The CRA formally announced its intention to review the current policy on February 22, 2006.
The CRA's current policy provides that certain services or property that are acquired in respect of a pension plan are required for the operation of the employer's business (which are referred to by the CRA as "Employer Expenses"), while other services and property acquired in respect of a pension plan are required for the operation of the pension fund trust (which are referred to by the CRA as "Plan Trust Expenses").
The current policy proceeds to list "examples" of Employer Expenses, including expenses in respect of the establishment of the pension plan trust, the retention of a trustee, and the filing and preparation of statutorily required reports, as well as "examples" of Plan Trust Expenses, including what are generally the most significant cost to a pension fund trust, namely investment advice and portfolio management services.
The current policy implies that these "examples" should be determinative of the expenses for which an Employer may recover GST, while seeming to ignore the documentation and legislation governing any particular pension arrangement. This administrative approach appears to be based less on a principled interpretation of the Tax Act, and more on a statement of the CRA's view of what should remain unrecoverable by a pension plan trust.
Indeed, much of the current policy sets out a structure of deemed supplies and administrative concessions to effect this overall approach to the GST. For example, the current policy notes that if an employer undertakes certain activities in respect of a pension plan on an "in-house" basis, the CRA will consider there to be a taxable supply of those services made to the pension fund trust. Furthermore, the CRA will consider the supply to be made for fair market value consideration, whether or not the employer charges the pension fund trust for those services, on the assumption that the employer and the pension fund trust are not operating at arm's length.
To date there has been a general lack of relevant domestic case law that has permitted the CRA's administrative policy to persist, even though some case law in respect of the value added tax in the United Kingdom would suggest an analysis in favour of a greater recovery of GST by employers.
An exception would be the 2002 decision of the Tax Court of Canada in BJ Services Company Canada Inc. v. R. In that case, the Court allowed a company to recover GST incurred on services required to counter a hostile takeover bid. The CRA had argued that the expenses were incurred to increase the value of the company's shares and not in the course of the company's business. However, the Court ruled that maximizing shareholder value was a part of the company's business. Employers might argue in an analogous and common sense way that GST incurred on services to establish and maintain a pension plan trust is also incurred in the course of the employer's business.
Review of the Current Policy
We understand that one objective of the CRA in revisiting its administrative policy is to more clearly link its administrative position to the provisions of the Tax Act. In so doing, the CRA will face the challenge of respecting the language of the Tax Act, while avoiding the loss of significant GST revenues. The revised policy is currently expected to be released in draft before the end of 2006.
By Michael Bussmann
We will report on developments in the CRA's administrative policy in a future issue of Pensions @ Gowlings.
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