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Chapter 10. Primary Distribution of Income Account A. Concept and Coverage 10.1 The purpose of the primary distribution of income account will be stated along the lines of the introduction to Chapter VII
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Chapter 10. Primary Distribution of Income Account A. Concept and Coverage 10.1 The purpose of the primary distribution of income account will be stated along the lines of the introduction to Chapter VII of the 1993 SNA. The nature of the economic process of income generation and distribution will be outlined, along the lines of 1993 SNA para. 7.2, and linked to gross national income. Then, the section will show the relationship of the primary income account and its balancing item to other international accounts. Primary income will be shown as the return for contributions to the production process and for provision of financial assets or renting tangible nonproduced assets to other units. Distribution of primary income will be contrasted with other economic processes, namely, production, secondary redistribution of income, and holding gains The manual will adopt the 1993 SNA use of primary income for income in BPM5 terminology. (Correspondingly, the 1993 SNA uses secondary income for what are called current transfers in BPM5.) [Question: Should the terminology be harmonized with the 1993 SNA?] 10.3 The manual will include an example to show the presentation of the primary income account, along the lines of Table CHAPTER 10 Table 10.1 Overview of Primary Distribution of Income Account Credits Debits Balance of goods and services account Compensation of employees Investment income: Direct investment Direct investment abroad: Income on equity: Dividends, distributed branch profits Reinvested earnings Income on debt (interest) Long-term Short-term Claims on direct investors Income on equity: dividends Income on debt (interest) Long-term Short-term Direct investment in reporting economy: Income on equity: Dividends, distributed branch profits, and other income on equity Reinvested earnings Income on debt (interest) Long-term Short-term Liabilities to direct investment enterprises Income on equity: dividends Income on debt (interest) Long-term Short-term Portfolio investment: Income on equity (dividends) Income on debt (interest): Long-term Short-term Income on other instruments Other investment Income on equity (dividends and other income on equity ) (if untraded equity moved from portfolio investment) Income on debt (interest) by instrument Income on other instruments 143 PRIMARY DISTRIBUTION OF INCOME ACCOUNT Credits Debits Reserve assets Other primary income: Rent Taxes on products and production Subsidies on products and production Total income credits and debits Balance on primary income Balance on goods, services, and primary income The debits on direct investment abroad and credits on direct investment in the reporting economy are caused by reverse investment The presentation will be compatible with that for the financial account and international investment position in terms of detail. This will facilitate analysis of rates of return. Some presentational changes from BPM5 will be incorporated. Income on reserve assets will be shown separately from income on other investment. This presentation will mean that there is consistency between income and the corresponding financial flows and positions. Rent will be shown separately so that it is not confused with returns on financial assets. Property income attributed to insurance policyholders and pension fund beneficiaries will be shown as a separate item, if relevant. [Question: BPM5 uses the term investment income as a synonym for property income in the 1993 SNA. The new manual will clarify this term as being limited to income from financial assets. Is this suitable?] B. Scope and Characteristics 10.5 This section will outline the components of income and how they each represent returns to different economic contributions: (a) (b) (c) (d) Compensation of employees (return to labor); Dividends and reinvested earnings (return to equity finance); Interest (return on debt finance); and Rent (return on nonproduced nonfinancial assets). It will then discuss each component in more detail. 144 CHAPTER Compensation of employees 10.6 Compensation of employees will be defined as amounts receivable/payable in return for the supply of labor, as discussed in BPM5 paras and 1993 SNA paras The linkage to the residence of the employer and employee (Chapter 4, Economic Territory, Units, Institutional Sectors and Residence) will be referenced. The section will deal with the borderline between service contracts and employment There will also be discussion of supplements to wages and salaries, such as pension contributions and benefits in kind. There will be a mention that the employees who are employed outside their economy of residence may have expenditure in their economy of employment in travel (Chapter 9 Goods and Services Account) and be subject to the payment of income taxes (Chapter 11 Secondary Distribution of Income Account). The manual will take into account any change in the treatment of unfunded pension schemes that is made to the 1993 SNA, to recognize the accrual of unfunded obligations with consequent effects in the primary distribution of income and financial accounts Benefits in kind will be discussed, that is, compensation of employees in the form of goods, accommodation, other services, shares, etc., rather than as financial payment. The principle will be given that these benefits should be valued at the market equivalent price. It will be noted that to give a consistent and economically meaningful way of recording benefits in kind, there may be rerouting. That is, although the benefits are purchased by the employer, the benefits are treated as if the employer paid the amount of the benefit to the employee who, in turn, acquired the item. The rerouting may affect the resident-tononresident nature of the transaction Employee stock options are an example of a benefit in kind. The treatment of employee stock options in terms of valuation and classification will be stated. 2. Dividends, distributed branch profits, and other income on equity The concept of dividends will be explained, following BPM5 and the 1993 SNA paras The concept will be linked to the instrument classification. In addition to dividends from corporations, all income arising from equity should be included under this heading, including from quasicorporations (unincorporated branches, unincorporated joint ventures), mutual funds, trusts, income accruing to partnerships, and sole proprietorships. However, since equity in insurance and pension funds does not give rise to dividends, it is classified as income on other instruments The timing principle for dividends will be set out, that is, that dividends are recorded at the time they are declared payable, as in 1993 SNA para (which could differ slightly from the date payable in BPM5 para. 282). 145 PRIMARY DISTRIBUTION OF INCOME ACCOUNT It will be noted that income on mutual funds is to be recorded as dividends, even when some or all of the mutual fund s income is derived from debt instruments. This treatment will be explained as based on the nature of the ownership by the mutual fund investors, that is, as equity Income attributed to insurance policyholders and beneficiaries of funded pension schemes will be explained. This item will also be required as a supplementary item for national accounts purposes, as in BPM Treatment of unfunded pension schemes will be covered, in accordance with the results of discussions currently under way (including through an electronic discussion group operated by the Fund) Income that is retained by mutual funds could be attributed to unitholders or shareholders (consistent with ESA95 paras. 4.49(b) and 4.54(b)) or not (consistent with BPM5 and the 1993 SNA). [Question: Should retained earnings of mutual funds be treated as other collective investment schemes, or is there some reason to make a distinction?] There will be a section on stock dividends, bonus shares, and liquidating payments. These will be explained and treatments given, consistent with BPM5 para. 290: (a) (b) (c) stock dividends, that is, where the stockholder elects to receive payment of dividends in the form of issue of new shares. These arrangements are treated as income payable (in the primary distribution of income account), which is then immediately reinvested (in the financial account); issue of bonus shares, that is, where new shares are issued to all stockholders in proportion to existing ownership. These arrangements are treated as not being transactions because no resources change hands; and liquidating dividends, whether partial or total, on the termination of a company. These are treated as a withdrawal of investment, shown in the financial account, as a convention based on the assumption that liquidation dividends are more likely to involve previously existing equity rather than current income. [Question: Is there any need to change any of these treatments or mention any other special cases of dividends?] Issues specific to reinvested earnings will be dealt with in detail under direct investment (in this chapter ahead). 146 CHAPTER Interest in general The concept of interest will be explained, following 1993 SNA para The concept will be linked to the instrument classification. It will be noted that interest accrues continuously (with a cross-reference to Chapter 3 Accounting Principles) and that it is capitalized as a part of the financial instrument. No entry is made for interest not yet accrued (as in BPM5 para. 532) It will be noted that interest payable to or receivable from a financial intermediary is designed to allow a margin to cover the costs, bad debts, and operating surplus of the intermediary. The treatment of this margin (FISIM) and its measurement will be dealt with in Chapter 9 Goods and Services Account. Consequent to the treatment there, this chapter will note that if FISIM is included in services, then interest payable to a financial intermediary will have a service charge subtracted to give the pure investment income component, with the comparable adjustment to the interest receivable by the financial institution. (Splitting a transaction into interest and service components is an example of partitioning. ) Similarly, interest receivable from a financial intermediary is seen as having had a service charge already deducted, so the interest receivable will be increased by the value of the service received. There will be a cross-reference to Chapter 9 Goods and Services Account for the derivation of FISIM from the reference rate The manual will discuss the treatment of indexed-linked debts where principal and/or interest payments are adjusted on the basis of a price index or other indicators, or exchange rate. Such adjustments are treated as interest in the 1993 SNA para and BPM5 para The manual will recommend that for debt instruments with both principal and coupons indexed to a foreign currency, the change in principal in domestic currency terms that arises from a change in the exchange rate should be shown as a revaluation. At the same time, the effect of changes in the exchange rate on the amount of accrued interest expressed in domestic currency is to be included in interest The manual will clarify the calculation of interest for other index-linked debt instruments in view of the inadequate guidance given in the existing statistical manuals. 4. Interest on debt securities As interest accrues continually over the life of the debt and is added to the principal, it will be noted that payments (such as coupons) are financial account transactions for the instrument concerned and do not represent interest The section will explain premiums and discounts on issue of debt securities, including deep discount and zero coupon bonds. An example of calculating interest, to take into account premiums and discounts, will be given, along the lines of BOP Compilation Guide Table PRIMARY DISTRIBUTION OF INCOME ACCOUNT The section will briefly introduce the issues associated with measuring interest on securities that cover more than one period. The manual will outline the alternatives, viz., implicit rate on issue (often called the debtor approach ), current market yield to maturity (often called the creditor approach ), and acquisition approaches. A numerical example will be given and papers on the issue cited. The implications for the other changes account will also be noted. As agreed by the Advisory Experts Group on National Accounts (AEG) in its February 2004 meeting, the manual will state that interest is recorded following the debtor approach, as embedded in the 1993 SNA. In view of this decision, it may be useful to provide data according to the creditor approach as memorandum or supplementary items. [Question: Should data on interest according to the creditor approach be included either as memorandum or supplementary item?] 5. Accrual of interest on impaired loans The valuation of interest accrued on impaired loans will be discussed. The treatment will be linked to the treatment of the principal and nonperforming loans and bonds (to be discussed in Chapter 6 International Investment Position). Like the principal, the interest remains a legal liability of the debtor, so interest should continue to be accrued unless the liability has been legally extinguished (i.e., by repayment, or after winding up of the debtor due to bankruptcy, or other write-off). However, for some analysis, it may be more useful to exclude, from primary income measures, interest that is not realistically expected to be collected. It will, therefore, be proposed that a memorandum item for these components could be shown when they are significant and quantifiable. As methods of quantification of expected losses differ, it will be emphasized that metadata should provide information on the method adopted. [Question: Is this approach to interest suitable?] The liability for interest when guarantees are activated will be addressed. There will be guidance on when the interest switches from accruing to the original debtor to accruing to the guarantor. 6. Interest on financial leases It will be noted that the implication of treating financial leases as a loan is that interest accrues on the loan. There will be a cross-reference to the appendix to the manual on financial leases, which will bring together the goods, services, income, and loan transactions and positions as they related to financial leasing and provide an example of the calculation of the interest component. 7. Rent Rent will be defined as covering income receivable for putting tangible nonproduced assets at the disposal of another unit. Examples will be given including rent of land, fishing 148 CHAPTER 10 rights, grazing rights, mining rights. In addition, putting intangible assets at the disposal of another unit, such as internet domain names, would be rent, except in the case of intangible assets associated with research and development (which are included in services). Payments for the combined use of land and buildings will be mentioned as being classified as a service, so they are excluded from rent and included as rentals under services. It will be noted that payment or receipt by government of rent of land without buildings (e.g., for military bases) should be shown as rent, not as government services n.i.e The manual will discuss the distinction between rent arrangements and cases where some ownership of the asset is transferred (e.g., a ten-year fishing right would convey ownership of an asset and would be shown in the capital account, while a six-month fishing right would be rent). Criteria that assist in distinguishing capital and current arrangements will be given cancellability, demonstrable value, risk of holding gains or losses, transferability, length of license (given in Dippelsman and Maehle) while recognizing that the delineation is difficult The manual will note that notional direct investment enterprises created for holdings of land and long-term leases will normally generate rent (or rental services if there is a building on the land). When the land or buildings are used by their owners (who are nonresidents), an imputation for rent or rental services (credit entries) would be necessary, if considered significant (e.g., in territories that had a large number of vacation homes owned by nonresident households). The income from direct investment is treated as income from financial assets. 8. Taxes and subsidies on products and production Taxes and subsidies on products and production will be included in the primary distribution of income account to be consistent with the 1993 SNA. (Taxes on income and wealth are included in the secondary distribution of income account.) BPM5 included all taxes as current transfers. At present, cross-border taxes and subsidies on products and production do not appear to be significant but may occur in economic unions. They would arise if an international or regional organization levied its own taxes or paid subsidies (which are believed to be done through national governments in all cases at present), and if there was cross-border activity that was insufficient to constitute a branch (so the values are likely to be relatively small and difficult to measure) However, this treatment will be included in case the situation arises to maintain the conceptual consistency with the 1993 SNA and to ensure the equality between the primary income account balance and the difference between GDP and gross national income. If they exist, subsidies would be shown separately from taxes, rather than netted off taxes In some cases, an exporter of a good contractually agrees to pay import duties. In such cases, the duties are outside the scope of the primary distribution of income account. The payment of duties is treated as an obligation of the importer, with the amount of duties treated as a reduction in the f.o.b. value of the goods. Similarly, if an importer agrees to pay 149 PRIMARY DISTRIBUTION OF INCOME ACCOUNT export taxes, the tax is still an obligation of the exporter, with the amount of the tax treated as an increase in the f.o.b. value of the goods. (Chapter 9 Goods and Services Account deals with this issue under valuation.) [Question: Are these proposals suitable?] 9. Other primary income It will be noted that ownership of financial derivatives does not give rise to interest or any other kind of income The treatment of revenue from lending of securities and gold and other valuables (whether a service or a primary income) has yet to be determined. The recommendations of the Technical Group on Reverse Transactions will be incorporated into the new manual (following discussions with BOPCOM, the ISWGNA, and other interested groups.) [Question: Are there other possible issues under primary income that could be mentioned here?] 10. Issues specific to direct investment There will be a cross-reference to Chapter 5 Classifications, where direct investment relationships are defined. This section will note that direct investment gives rise to dividends, distributed branch profits, and interest. Direct investment income is limited to income from financial assets. (Mixed income is potentially included, but the rare cases of other income such as compensation of employees and rent are excluded from direct investment income.) The general principles for income on direct investment are the same as those already described for income earlier in this chapter. In addition, this section will deal with the following issues concerning income that are specific to direct investment, namely, reinvested earnings, income flows on reverse investment, and transfer pricing. [Comment: The classification of interest on nonpermanent debt between financial intermediaries, and income on mutual funds, pension, and insurance technical reserves, etc. in a direct investment relationship is discussed under Chapter 5 Classifications.] a. Reinvested earnings This section will introduce the concept of the impu
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