'Tis that season; but sadly no presents for the pension funds.
Comment on the Norwegian National Budget 2019. October 9th 2019
It is that time of year when journalists line up outside the home of the Minister of Finance at 06.30 in the morning. Just in order to tape the Minister and her briefcase (well, a bag this year, in fact), and yell things like "what's the budget like, then, Minister?". To which the Minister answers "very good, actually", before getting into the car. Broadcast and streamed live. And still they say that quality journalism is a thing of the past.
The Norwegian 2019 National Budget was out yesterday, and with it a rather extensive collection of changes touching on asset management, pensions and insurance. A major change of potential interest to our clients, concerns taxation of Norwegian life insurance companies and pension funds.
Life insurers and pension funds have been subject to two different principles that did not really meet well. On the one hand, insurers and funds have as a matter of general principle been subject to taxation along the same line as other corporates.
On the other hand, however, it has also been a principle that there should not be taxation of investment returns and other revenues that accrue directly or indirectly to beneficiaries. The previous solution for combining these two opposite principles has been less than perfect.
A pension fund would treat premiums and investment returns as taxable revenues, but has been allowed to deduct allocations to beneficiaries for tax purposes. As long as allocations matched the sum of premiums and investment returns, the net effect should be 0. But that is where the resident devil of the details raises horns. Some of the investment returns, such as from certain types of equities, are free of tax for all Norwegian corporates - including life insurers and pension funds. The method used for tax deductions, however, has essentially been to look at the ordinary accounts and consider all allocations as being equal. Anything allocated to beneficiaries has thus been treated as tax deductible, even those based on revenue / return items that would not be subject to tax in the first place. Deductions have consequently on average been higher than taxable income. That not only made the pension funds and life insurers effectively free of any taxes, but even allowed for the building up of deferred tax assets. For life insurers belonging to bancassurance groups, that has been jolly useful on a consolidated basis. And the pension funds at least had a tax deduction reserve in case of a bad investment year. Additionally, in the case of a positive biometric risk result, 50% of that surplus could be allocated to quasi-equity and deducted from taxable income.
It has been a pretty sweet deal. But one that is now over, as from the current year. There are quite a few bits and pieces in the new model, but the approximate net effect is that assets allocated to customers are still free of tax. However, returns on equity and quasi-equity, as well as any profits from biometric risk covers, will be subject to the same taxation as any other corporate.
The pension funds have taken issue with the whole taxation of equity topic, but unfortunately too little and too late (as the Ministry pointedly states, the general tax status was not a topic for this round of consultations, but it was in 2015 - when the Ministry did not register any views on a general tax exemption for pension funds). Pension funds make the point that while they hold surplus capital as buffers against market movements and the like, they do not have anything that is really equity in the sense that it is owned by anybody. That is not quite as clear cut as the funds make it out to be, but it is in any case a moot point: The Ministry did not accept that line of reasoning, thus landing the funds with a new tax liability as from 2018 / 2019. Estimating the level of potential taxation is difficult, given that it inter alia depends upon both future investment returns and asset allocations. The Ministry still quotes a figure of an expected increase of 3 BNOK in annual tax contributions, which is presumably conservative and based on current interest rates. 3 BNOK in extra revenues for the Ministry is obviously 3 BNOK in extra costs for the pension funds and life insurers.
It is probably fair to say that the timing could have been better for the pension funds. As discussed in our article in Finansavisen earlier this year, the pension funds have a considerable need for new surplus capital / equity, as Solvency II principles will be applied to them from 2019. When that happens at the very same time as the returns on that extra capital suddenly becomes taxable - effectively increasing the cost of capital with the equivalent of the tax rate - a phrase such as "adding insult to injury" rather springs to mind.