It is nice to be able to report on a legal development that is good news for plan sponsors. The federal government’s 2005 budget gave the Canadian pension industry a proposal to repeal the Foreign Property Rule (FPR)applicable to tax-deferred retirement plans, through future amendments to the Income Tax Act(ITA). The elimination of the current FPR should simplify plan administration, reduce investment costs and facilitate a broader array of investment opportunities for pension plans. In fact, this proposal, once enacted, is likely to have a much larger impact on the industry than the Monsanto case. The FPR imposes penalty tax on plans where investments in foreign property exceed 30% of the cost amount of the plan’s assets. Foreign property consists of shares and debt issued by non-resident entities, as well as investments in certain (Canadian and foreign)trusts and partnerships. Many different kinds of innovative investments have been created over the years to help pension plans achieve increased international exposure without exceeding the 30% FPR. These have included derivatives and synthetic investments. But these approaches are often more costly than investing directly in the underlying asset, usually due to management fees. The elimination of the FPR will undoubtedly cause plan administrators to, over the next year, reconsider the need for these structures. Repealing the FPR will also enable registered plans to invest in a wider range of pooled fund trusts and partnerships, many of which are currently considered to be foreign property under the ITA. However, the government intends to release a consultation paper which may propose rules/limits on investments in flowthrough entities such as partnerships and income trusts. In addition, proposed new tax rules dealing with nonresident trusts and foreign investment entities are still under consideration. Post-FPR, there are also interesting legal considerations for those who invest pension plan assets. A pension plan sponsor’s overriding legal duty is to prudently invest the plan’s portfolio of assets; prudence includes ensuring that assets of the plan are adequately diversified. While the FPR was in place, it would have been difficult to criticize a plan sponsor for investing plan assets in Canada to avoid incurring a penalty. Once the FPR is eliminated, however, penalty tax will not be relevant and sponsors will have to review their investment policies to determine the appropriate level of exposure to foreign investments. Sponsors must also consider the related risks associated with currency fluctuations and how to manage those risks with increased international exposure. With defined contribution plans, sponsors will need to re-evaluate the range of investment options offered to members. If increased foreign investment is contemplated, members will need to be educated on the risks and benefits. The proposed repeal of the FPR is effective for 2005, but will not become law until the legislation is actually passed by parliament. While there is a risk the proposal will not ultimately become law, this is unlikely. Plan sponsors should hold off making any major changes until the draft legislation to amend the ITA is available. Once a sponsor does decide to act, it will be necessary to review plan documents and to consider amendments. Although it raises a number of legal issues, for the most part, the elimination of the FPR can only be described as good news for those who administer and invest pension assets. Paul Litner is a partner in the Pension & Benefits Department at Osler, Hoskin & Harcourt LLP. plitner@osler.com For a PDF version of this article, click here. |