Accounting of municipal pension plans: tax relief measure to mitigate the effects of COVID-19
On July 13, 2020, the Ministère des Affaires municipales et de l’Habitation (MAMH) announced the implementation of a tax relief measure* to limit the pandemic’s impact on taxation related to municipal defined benefit pension plans. The drop in stock markets and interest rates caused by the pandemic has led to a deterioration of pension plans’ financial situation since the beginning of 2020.
Without any visible market recovery by year-end, a worsening of the pension plans’ financial situation could result in an increase in accounting expenses starting in 2021 and in required taxation. This increase would be caused by, among other things, the amortization of actuarial losses for 2020 and the increase in interest expenses.
However, two existing mechanisms can reduce the effect of such a deterioration:
- The recognition of constructive obligations, which act as a sort of financial cushion and that can offset actuarial losses with actuarial gains as these constructive obligations are cancelled.
- The smoothing of the assets’ value, which allows the recognition of asset-related actuarial losses over a maximum period of five years.
As such, the accounting and fiscal impact of the pandemic may be relatively limited for certain municipal pension plans. The relief measure complements both mechanisms. It aims to limit the volatility of the additional taxation that may be required.
The new relief measure works by recording expenditures under “amounts to be taxed or funded in the future” (often referred to by the French acronym “DCTP”), which is a tax deferral mechanism: all relief expenditures must eventually be taxed. Taxation is simply deferred, not cancelled. The measure is applied according to the following main criteria:
- Only the effects of total net actuarial losses (assets and obligations) to occur at the end of 2020 can be considered. For example, these net losses can include asset-related actuarial losses, but also obligation-related losses caused by a decrease in the discount rate assumption.
- A taxation deferral is possible for the effects of these net losses on accounting expenses in excess of a threshold, which is established in proportion to the employer’s current service costs (CSC). This threshold is set at 0% of the CSC for 2021, 5% for 2022, and 10% for each subsequent year. Therefore, the total effects of these net losses on the accounting expenses for 2021 may lead to a tax deferral, while only a portion of these effects on the accounting expenses can be subject to a tax deferral as of 2022.
- The period during which a tax deferral is allowed corresponds to two years more than the smoothing of asset-related gains and losses period (e.g., seven years for a five-year smoothing period).
- While actuarial gains to occur after 2020 will reduce the possible use of the measure, actuarial losses to occur after 2020 will not increase it.
- Each deferred tax amount must be taxed over a period beginning the year following the deferral and ending in 2030. The required tax amount is determined by a straight-line amortization formula.
In these times of market uncertainty, this measure is an additional tool for municipalities ahead of the 2021 budget planning.
* Document in French only.
For more information, contact your Normandin Beaudry consultant or email us.