Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Are employees' contributions to an RCA deductible pursuant to paragraph 8(1)(m.2) of the Act?
Position: Question of fact - general comments provided
Reasons: Pertinent issues that may be considered have been addressed in the response.
September 16, 2005
SURREY TSO HEADQUARTERS
Income Tax Rulings
Attention: Sigrid Hagglund Directorate
Kimberly Duval
(613) 599-6054
2005-013240
Deductibility of an Employee Contribution to a Retirement Compensation Arrangement
This is in response to your letter of May 19, 2005 requesting information on the deductibility of employees' contributions to a Retirement Compensation Arrangement (an "RCA") pursuant to paragraph 8(1)(m.2) of the Income Tax Act (the "Act"). Of particular concern are RCAs benefiting individual employees where significant contributions are involved.
An RCA is defined in subsection 248(1) of the Act as generally being an arrangement under which payments are made by an employer to a custodian in connection with benefits that are to be received by an employee on, after or in contemplation of any substantial change in the services rendered by the taxpayer, the retirement of the taxpayer, or the loss of an office or employment of the taxpayer, subject to certain listed exclusions. As the definition of these arrangements is quite broad, there are many issues that may arise in the determination of whether or not any particular arrangement is, in fact, an RCA as intended under the law.
The RCA rules were originally intended to ensure that unregistered pension benefits accruing to employees are not accorded the same tax benefits as registered plans. However, it has recently come to our attention that innovative tax plans purporting to be RCAs are being marketed and promoted to allow both employers and employees to avoid tax and offer further benefits to employees over and above those offered to registered plans. For this reason, excessive contribution amounts and/or suspicious activities involving the use of an RCA, such as the scenario you've presented, should be flagged for further review.
The issues surrounding whether or not a contribution to such a plan is reasonable in the circumstances and qualifies as an allowable deduction under the law, requires a thorough understanding of the plan itself, in addition to other pension plans in which the particular employee may be a member. The analysis should, therefore be twofold: first a detailed examination of the particular plan itself and whether it is a valid RCA as defined in 248(1) of the Act and second, an analysis of the contribution amount in relation to other pension plan contributions and whether the specific provisions of the Act have been met.
Is the Plan a Valid RCA?
The determination of whether the particular plan was entered into with an intention of funding benefits that may be paid after retirement or the severing of or substantial change in employment services rendered will depend upon the unique facts in a given situation. This may require a review of the plan documents themselves and discussions with both the employer and the employee to ascertain the ultimate intentions of the plan. If the facts lead to a conclusion that the plan was entered into with the intention of paying or allowing for discretionary payment of benefits to employees before a termination of employment, or where there has been no substantial change in the services rendered by the employees, the plan may not qualify as an RCA. Similarly, we would view a series of loans made from the particular plan back to the employer as potentially jeopardizing the validity of the plan as an RCA as the intentions of the plan become questionable.
It must also be ascertained that the plan in question is not, in fact, a salary deferral arrangement as defined in subsection 248(1) of the Act. As the definition of RCA specifically excludes a salary deferral arrangement, the facts of any situation must support that none of the main purposes for the creation of the plan or existence of the right under the plan was to postpone tax payable under this Act by either party. As such, a review of an employee's prior years employment record and remuneration with the employer may be required to ensure consistency in earnings from one year to the next. A sudden decline in the amount of remuneration paid to an employee suggests salary being rerouted through the particular plan to avoid tax and raises the question as to whether or not the plan is in fact a salary deferral arrangement and not a valid RCA.
Are Employee Contributions to the RCA Deductible?
The Act does not specifically dictate what level of benefits may be provided under an RCA. However, an employee may only deduct amounts paid in the year as contributions under an RCA to the extent that the conditions in paragraph 8(1)(m.2) of the Act are met. Specifically, paragraph 8(1)(m.2) was intended to be a relieving position which would in part permit, within limits, the deduction of employee contributions where they are required under the terms of an unregistered pension plan that also meets the RCA definition. Consequently, before any amount will be deductible under paragraph 8(1)(m.2), the plan or arrangement has to be a pension plan. Where it is established that the plan or arrangement constitutes a pension plan, an employee contribution will be deductible under paragraph 8(1)(m.2) of the Act where all of the following conditions are satisfied:
(a) the amount is paid to a custodian (within the meaning assigned by the definition of an RCA in subsection 248(1) of the Act) of the arrangement who is resident in Canada;
(b) the taxpayer was required, by the employer's conditions of employment, to contribute the amount; and
(c) the amount contributed to the RCA in the year does not exceed the amounts contributed to the RCA in the year by any other person in respect of the taxpayer.
The provision was not intended to allow the deduction of amounts which were unreasonable in the circumstances and which would be considered unreasonable if paid in full by any employer to the RCA. In other words, it is our opinion that an employer should not be permitted to contribute otherwise unreasonable amounts to an RCA by first paying part of the contribution to an employee and thereafter having the employee pay them to the RCA. Therefore, it must be established that the contributions to the RCA were made under bona fide terms and conditions of employment. Certain issues may arise in the review of an employee's terms and conditions of employment in situations where a non-arm's length relationship exists between the employer and the employee.
As the Act is silent with respect to the determination of whether or not a contribution to an RCA is reasonable, it is always a question of fact and depends on the circumstances surrounding each plan. Contribution amounts that are clearly supported by either an actuarial valuation or the use of some other formula-based calculation may be more justifiable; however, reasonability must be weighed taking into account all the relevant factors.
In the absence of any concrete evidence to support a specific contribution amount, a review of any employer sponsored registered pension plans or group plans may also be warranted. It would be necessary to ascertain that the salary level and benefits accruing to the employee is, in fact, reasonable in relation to other formula-based pension benefits in all registered plans and the amounts should also be comparable to either other employees in the company or executives in the same or similar industry.
To summarize, you may wish to consider the following when reviewing a particular fact situation:
1. Is the plan a valid RCA as defined under subsection 248(1) of the Act?
? Is there any indication that funds held in the plan are not being held with an intention of funding benefits that may be paid to the employee after retirement or the severing of or a substantial change in employment?
? Is there any evidence that funds held within the plan are being loaned back to the employer or loaned to a related entity in or outside of Canada?
? Has there been any notable decrease in remuneration paid to the employee that may correlate with the contributions made to the particular plan that may indicate that salary is being deferred using this arrangement?
2. Is the employee's contribution an allowable deduction pursuant to paragraph 8(1)(m.2) of the Act?
? Is there any indication that the relationship that exists between the employee and the employer is, in fact, a non-arm's length relationship? In other words, does the employee have the power and control to determine all or any aspects of the plan, including funding amounts?
? Are there any other employees of the employer who are members of this particular unregistered plan? How do the benefits under the plan compare?
3. Is the employee's contribution reasonable pursuant to section 67 of the Act?
? Is there any evidence that these contribution amounts for each of the particular years are based on any actuarial valuation or formula-based benefit calculation?
? What other retirement benefits are accumulated for the benefit of the employee in a separate registered pension plan? How are these benefits determined and how do they compare to benefits accumulating for other employees?
We trust that these comments will be of assistance.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Robin Maley
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch
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