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Luxembourg Domestic Supplementary Pension Law - Commentary
Barnett Waddingham - 23 July 1999.
New Luxembourg Pension Laws Published
Two new pension laws have been published in the Grand Duchy of Luxembourg having received Royal Assent in June. The laws put in place the framework for cross-border pension vehicles and funded domestic second-pillar pension arrangements.
The cross-border products have received nearly all of the attention from the European pension press, mainly due to the anticipated appearance of pan-European pension funds. However, the arrangements for Luxembourg's domestic supplementary pension schemes are just as important for the Grand Duchy.
Background to Domestic Pension Provision
In Luxembourg, state pension provision is generous for the average employee. For this reason, the domestic market for supplementary pension schemes has been small and such pension arrangements have stayed largely unregulated.
The system for the remaining schemes is that of book reserve schemes. Here, the employer will also often purchase an insurance policy, which is intended to match the book reserve liability. However, on wind-up, the pension liabilities rank equally with other creditors and the insurance policy is treated as simply another company asset.
However, in common with many European countries wary of the "demographic time-bomb", the Luxembourg Government wishes to move towards a system of funded pension provision.
New Domestic Pension Law
This new law requires insolvency insurance to be put in place for book reserve schemes. It also creates a framework for funded, external pension schemes and group insurance policies.
It is intended that these funded arrangements will replace the unfunded supplementary arrangements currently in place and crucially, it introduces tax incentives for setting up such arrangements.
Barnett Waddingham, with its experience of funded pension schemes in the United Kingdom together with an office in Luxembourg, is ideally placed to advise on these new schemes.
Since Luxembourg will not be following the Spanish approach of compulsion (Spanish companies are being forced to move from book reserves to funded pension schemes) it will be interesting to see the degree to which employers in Luxembourg embrace these changes.
However, since funded schemes are likely to offer greater investment returns than the existing insurance policies, companies in the Grand Duchy are likely to be attracted by these new products.
Background to International Pension Provision
The overseas pension market in Luxembourg has, until now, been restricted to offshore arrangements, the most widely used vehicle being the SICAV ("société d'investissement à capital variable"). These are generally unsuitable - in the UK, at any rate - as a tax liability is generated when funds are repatriated. More importantly, there is no legislation in place relating to cross-border pensions.
However, Luxembourg - and in particular the Luxembourg Banking Association (ABBL or "Association des Banques et Banquiers Luxembourgeoises") - is trying to focus on what it sees as niche areas like pensions. This is its attempt to keep its place as a European financial centre, to compensate for losses of business that have arisen from the recent spate of bank mergers and the introduction of the Euro.
New International Pension Law
There are two cross-border vehicles proposed: variable-capital pension savings companies (SEPCAVs or "sociétés d'epargne pension à capital variable"); and pension savings associations (ASSEPs or "associations d'epargne pension").
The SEPCAV is a defined contribution vehicle. It is classified as a corporate entity and is therefore subject to limited taxation. The beneficiaries are the shareholders of the SEPCAV and upon their retirement, the SEPCAV will repurchase its own shares from the beneficiaries.
The ASSEP is designed for defined benefit schemes, though it may also be used for defined contribution arrangements. It operates on insurance techniques - the beneficiaries are creditors of the ASSEP and the amount of the claim is shown under the technical reserves. There are no special tax arrangements for the ASSEP - it is simply classified as a corporate entity subject to income tax. On retirement from an ASSEP, a life annuity is bought.
Both SEPCAVs and ASSEPs will be regulated by the Luxembourg Central Bank (BCL or "Banque Centrale Luxembourgeoise"), though the reporting requirements will be much less formal than for, say, the UK's Department of Trade and Industry ("DTI"). The only specific Luxembourg legal requirement will be to adopt a binding pension plan. It will then be up to the employer's consultants to draw up a plan satisfying as many of the member states as is required.
For both arrangements, the tax-deductibility of employer contributions will be dealt with by the employer's local legislation. Similarly, the taxation of benefits will be in the beneficiary's own country.
Uses for ASSEPs and SEPCAVs
The main reason for the excitement surrounding these new international pension products is the potential for pan-European pension schemes. Because of the flexibility inherent in ASSEPs and SEPCAVs, they are seen to be ideal vehicles for this purpose. This is true, but there are other ways in which these schemes could be effectively used.
One opportunity is for a simple cross-border arrangement. Rather than trying to set up a scheme covering employees in several different countries, why not try and create a pension plan for employees in just one country outside Luxembourg? An ideal candidate would be a country such as Germany, where the market for funded pension schemes is undeveloped.
Another suggestion is that companies may indulge in "regulatory arbitrage", that is, move their pension arrangements to Luxembourg to take advantage of the relative lack of bureaucracy in pension law. Why suffer the constraints of the UK Pension Schemes Office ("PSO"), Department of Social Security ("DSS") and Occupational Pensions Regulatory Authority ("OPRA") when you can have it easy in Luxembourg?
International Pension Taxation
So what is stopping the £1trillion UK pension market from migrating over the Channel to Luxembourg? It is, of course, taxation. At the moment, no European governments are prepared to offer tax relief on contributions to overseas pension plans.
The traditional argument for this is that in a traditional scheme, although a company gives tax relief on contributions, it gets part of this tax back when the pension comes into payment. Therefore, a tax authority in country A will be reluctant to give tax relief on contributions in for employees in country B since it will not get the tax back.
However, moves are afoot to bring about change.
In the European Commission, Romano Prodi's DGXV has already issued a communication recommending a framework for cross-border membership of pension schemes. In particular, harmonisation of tax regimes is given as a requirement. However, Prodi accepts that it will be some years before any agreement is reached with this approach and that is too long for some.
An alternative route was first pursued by the Pan-European Pension Association ("PEPA") led by Robin Ellison of Eversheds. Its aim was to solve the problem by launching a test case in the European Court of Justice. Because of the large number of organisations involved, this attempt floundered. However, a similar attack is being mounted by another band, this time anonymous apart from their leader, Geoffrey Furlonger of William Mercer. The basis for these claims was Article 59 of the Treaty of Rome, supported by the Safir judgement by the European Court of Justice ("ECJ"). This implied that any company wishing to provide pension benefits in another EU member state should be allowed to do so without any adverse taxation consequences.
It is likely that the various tax authorities would all cry "Bachmann" in response. This was another ECJ judgement that implied that member states could impose tax barriers if their purpose was to protect the taxation system as a whole. However, this ruling is generally accepted to have been both specific and anomalous.
There is another potential route for companies wishing to set up cross-border pension plans: to approach tax authorities on a case by case basis. Although there is no guarantee that this will be any more successful, a well put argument could help establish the first scheme - without the need for a pitched battle with the taxman.
The Way Forward
The door is already open for funded pension schemes in the Grand Duchy - it is just a question of promoting their merits.
However, Luxembourg is not alone in wishing to enter the international pensions market. In particular, the Republic of Ireland is positioning itself as a potential home for overseas funds. However, even though the tax issue may not be solved soon, Luxembourg's banks - and, crucially, its pension consultants - need to be ready to take new business as soon tax laws allow.
Barnett Waddingham - 23 July 1999.