CRA finds that a public company’s proposed use of an EPSP trust to create the equivalent of a stock option plan for CCPC employees would be abusive tax avoidance

A Canadian public company (Employerco) proposed that the share appreciation right (SAR) units of its employees be converted into an equivalent value of deferred share units (DSUs), with the payout of the referenced number of shares on the retirement etc. of each employee participant to be taken care of by an employee’s profit sharing plan (EPSP) trust (settled by Employerco at the time of the conversion into DSUs). The EPSP trust would use an interest-bearing loan from Employerco to fund its purchase of the matching number of Employerco shares and fund the loan interest with dividends on the shares and annual contributions from Employerco – both of which were taxable income to it but with an offsetting interest deduction, so that there would be no annual income inclusion to the participant under s. 144(3). On retirement, Employerco would make a further contribution (deducted by it under s. 144(5)) to enable the EPSP Trustee to repay the applicable portion of the loan, with that amount being included in the participant’s income under s. 144(3), and with the EPSP trust distributing the shares to the participant. Similar features provided participants with dividend-equivalent DSUs and subsequent pay-out.

CRA found that this plan “failed on technical grounds,” i.e., the conversion of the units from SARs to DSUs and addition of dividend equivalents would be a fundamental change triggering an immediate disposition of the units, thereby resulting in an immediate employment income inclusion – or alternatively, the conversion of the units from SARs to DSUs would breach the post-amble of Reg. 6801(d), resulting in the plan becoming a salary deferral arrangement, with an immediate income inclusion under s. 6(11).

CRA went on to indicate that even if this structure were instead implemented on a prospective basis, it would refer such a plan to the GAAR Committee as being abusive, stating:

[T]he structure is highly artificial, provides significant tax deferral and rate reduction benefits on employment compensation, and represents an abuse of the EPSP rules. Here, there is no profit-sharing in purpose or effect. …

Furthermore … the favourable tax results … are similar … to those available under the employee stock option rules … . even though … the requirements of paragraph 110(d) or (d.1) are not satisfied.

Neal Armstrong. Summaries of February 2019 Internal T.I. 2018-0762101I7 under s. 144(3), Reg. 6801(1)(d) and s. 245(4).