The proposed amendments contained in the National Social Security Bill, 2019 are very good for the employees (members of pension funds), the pension funds themselves and the economy as whole.
Pensions can be subject to tax at three different levels:
Currently the Income Tax law taxes pensions at level 1 - when an employee contributes to a pension fund, and also at level 2 when the pension fund invests the employees contribution to earn investment income. The only time an employee is exempt from tax is at the time when he has retired and starts drawing income from his pension.
Currently pension contributions made by an employee to both the NSSF and to a private pension fund is not deductible for tax. That means if a person who earns Shs 1m a month and is required by law to contribute 5% of his monthly income to NSSF has to first of all pay tax on the 5% contribution to the NSSF, and what is left after tax is what goes to the pension fund to provide for his retirement. This means that the person has to pay tax of 30% on the Shs 1m which is Shs 300,000 leaving him/her with Shs 700,000 after tax. Afterwards he/she is then required to pay 5% of the Shs 1m gross pay which is Shs 50,000 out of his/her net pay of Shs 700,000 to NSSF. That leaves the person with a net take home pay of Shs 650,000.
With the new proposed amendments, the person's 5% NSSF contribution will be taken out of the Shs 1m gross pay before tax. That means the person will be required to pay tax on Shs 950,000 (which is the Shs 1m less the 5% NSSF contribution). This means that the person will be paying less tax, as 30% of Shs 950,000 is Shs 285,000 as opposed to the Shs 300,000 tax he was paying before this change in the law. Based on this illustration, a person who earns Shs 1 million a month will be paying Shs 15,000 less in tax per month. This tax saving of Shs 15,000 is as a result of the Shs 50,000 NSSF contribution being exempt from tax. Shs 15,000 is the 30% tax saving on the Shs 50,000 contribution to NSSF.
Secondly, the current tax law also taxes members at level -2, that is when the pension fund invests the members funds on his/her behalf, the investment income earned is taxed at 30%. This ends up depleting the funds available to pay to members when they retire.
According to the proposed amendments, if the pension fund invests the members money to earn investment income, the pension fund will not be required to pay tax on that investment income. This is also good for members as it means that members funds will grow and accumulate without being taxed.
Currently as a saver – you pay tax twice ----- on your income that you contribute to a pension fund and on your investment income that you earn from the investments the pension fund makes on your behalf
The proposed change is very good for employees and a good development and it should be supported by employees, employers, pension funds and Parliament:
The proposal is now to tax pensions at the time when the pension is being drawn from the pension fund. However a person will only be required to pay tax on his / her pension if the money is withdrawn from the fund before the member is 60 years of age. This means that if a member is patient and waits until he/she is 60 years or over to start drawing his/her pension, he/she will never have to worry about paying tax to Government on his/her pension. This is very good, as it will encourage people to save for the long term.
On the other hand, if a member decides to access his / her funds mid term before they are 60 years of age, they will pay tax on the withdrawal from the fund. This is also good in way, that instead of a person paying tax when they are contributing (paying into the fund) they will now be taxed later when they are withdrawing (earning from the fund).
The most important thing is that members will only pay tax once on their pensions, when they withdraw their money from the pension. Currently members are paying tax twice on their pensions, when they contribute to the fund, and when they earn investments on the contributions they have made into the fund.
Every rational person who knows and appreciates the time value of money will agree that it is better to defer payment of taxation as far away as possible and allow one's income or fund to grow and accumulate as quickly as possible without the fear and risk of taxation. That is what the new NSSF Amendment Bill is saying.
To use the analogy of a farmer, currently the tax law taxes the member at the time he is planting and the tax is applied on his / her seeds when he sows (makes a contribution to the pension fund). When the seed germinates and starts producing fruits, the tax law again taxes those fruits when they are still on the tree (the investment income earned by the pension fund on behalf of the farmer), then finally when the farmer harvests the ripe fruits from his farm and sells them, the tax law exempts him from paying tax on the profits earned from the selling of his fruits.
The new Bill, is correcting the above anomaly. The farmer will no longer be taxed on his seeds (contributions are going to be exempt from taxation). The farmer will no longer be taxed on his fruits when they are still up on the tree (investment income earned by the pension fund on behalf of the member will not be subject to tax).
And finally the farmer will be taxed on the proceeds from the selling of his produce after he has harvested his fruits, processed them and sold them to the market at a profit (members will be taxed at the time of withdrawing their pension from the fund). It is also possible for the farmer to avoid paying tax completely on his produce even after harvesting and selling to the market, as long as he harvests and sells his produce during the dry season (in this case as long as the member waits until he / she attains the age of 60 years before he/she withdraws his /her pension.
The proposed amendment to the NSSF Act is good for employees, employers, pension funds, fund managers, retirement benefit schemes, provident funds, insurance companies, the banking sector and the economy as a whole.
By Francis Kamulegeya
Chartered Tax Adviser and Senior Partner
Tel: +256 (0) 312 354 400