24 May 2000 External T.I. 1999-0007315 - SDA, EBP, CONSTRUCTIVE RECEIPT

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: In the context of deferred salary and wages, what is the interaction, if any, of constructive receipt and the "salary deferral arrangement" provisions?

Position: Where an SDA exists (i.e. there is a right to receive an amount and the purpose test is met), the deferred amount in respect thereof is taxed currently, and not upon receipt. The right to receive an amount under an SDA is interpreted very broadly. Where no SDA exists, an amount is generally only taxed on receipt unless the doctrine of constructive receipt applies.

Reasons: Our interpretation of the wording of the Act and our understanding of tax policy.

XXXXXXXXXX 						1999-000731

Attention: XXXXXXXXXX

May 24, 2000

Dear Sirs:

Re: Constructive Receipt and Salary Deferral Arrangements ("SDAs")

This is in reply to your letter dated December 16, 1998, wherein you requested clarification of the Department's (now the Canada Custom and Revenue Agency - the "Agency") position regarding constructive receipt and rights under phantom stock plans. We regret that we were not able to provide a more timely response because we decided to address this issue by providing a general explanation of our interpretation of the SDA rules and the interaction of these rules with the concept of constructive receipt.

Employment Income and Amounts "Received"

Generally, a taxpayer's income from an office or employment for a taxation year includes only those amounts "received" by the taxpayer in the year. Subsection 5(1) includes in an individual's income the "salary, wages and other remuneration, including gratuities, received by the taxpayer in the year" and paragraph 6(1)(a) includes in income "the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of an office or employment". Numerous other provisions also apply with respect to computing income from an office or employment, however, the focus of this letter is upon the taxation of amounts related to arrangements to defer salary and wages. This letter also does not specifically address the potential of including an amount in income as a benefit received or enjoyed by a taxpayer in a year pursuant to paragraph 6(1)(a) described above, or pursuant to subsection 56(2) if appropriate.

Amounts Received and Constructive Receipt

The Agency's views on this were outlined in the response to Question 13 in the 1984 Revenue Canada Roundtable at the Thirty-Sixth Tax Conference of the Canadian Tax Foundation. That response was:

The Department considers an amount to have been received by an employee upon the earlier of the date upon which payment is made and the date upon which the employee has constructively received a payment. Constructive receipt is considered to occur in situations where an amount is credited to an employee's debt or account, set apart for the employee, or otherwise available to the employee without being subject to any restriction concerning its use. The position is the same following termination of employment, retirement, or death. An election to receive payment in installments must be made before the amounts become available to the employee.

Subsection 70(2) will have application where an employee has, at the time of his death, a vested right to receive additional compensation in respect of his employment which is payable, in the event of his death, to his estate or beneficiaries.

Although these comments continue to represent the Agency's general views, they must also be considered in light of the SDA rules which were introduced after these comments were made. The SDA rules are addressed in greater detail below.

Where an arrangement is not an SDA, the comments above regarding an election to defer receipt of payments will apply so that those payments will only be taxed upon actual receipt. This point has been confirmed in numerous interpretations provided by the Department, particularly with regard to the payment of retiring allowances in installments (see ¶s 8 and 11 of IT337R3, Retiring Allowances and document 9803685) and the payment of amounts from employee benefit plans (see ¶s 10 and 11 of IT-502, Employee benefit plans and employee trusts and document 9826425). As noted above these comments are only applicable where an arrangement is not an SDA and whether or not a particular arrangement is an SDA is a question of fact. For example, it is possible that an arrangement that purports to pay a retiring allowance may be more appropriately viewed as an arrangement to defer salary and wages, and thus in fact be an SDA (see ¶7 of IT-337R3).

The SDA Rules

The SDA rules, described below, do not require receipt or constructive receipt for any amount to be included in a taxpayer's income. Rather, an arrangement that may be viewed as deferring salary and wages from current taxation may be subject to their application. As such, it is our view that these rules are more relevant in determining amounts that are to be included in income than the possible application of constructive receipt.

Subsection 248(1) of the Income Tax Act (the "Act") defines an SDA as an arrangement "under which any person has a right in a taxation year to receive an amount after the year where it is reasonable to consider that one of the main purposes for the creation or existence of the right is to postpone tax payable under the Act by the taxpayer in respect of an amount that is, or is on account or in lieu of, salary or wages of the taxpayer for services rendered by the taxpayer in the year or a preceding year (including such a right that is subject to one or more conditions unless there is a substantial risk that any one of those conditions will not be satisfied)".

Where a "deferred amount", as defined in subsection 248(1) of the Act, exists that amount will be included in a taxpayer's income from an office or employment pursuant to subsection 6(11).

It is important to note that a number of plans or arrangements have been excluded from the SDA definition. These include registered pension plans, deferred profit sharing plans, employees profit sharing plans, employee trusts, plans or arrangements under which bonuses or similar payments are paid within 3 years following the end of the year in which the services related to the bonus were rendered (ATR-64, Phantom Stock Award Plan, dated April 20, 1995, provides an example of a plan that meets the paragraph (k) exception in subsection 248(1)), and prescribed plans or arrangements. The prescribed plans or arrangements are outlined in section 6801 of the Income Tax Regulations (the "Regulations"), the most prevalent of which are deferred salary leave plans described in paragraph 6801(a) of the Regulations and deferred share unit plans described in paragraph 6801(d) of the Regulations. ATR-39, Deferred Salary Leave Plan, is an example of a plan that complies with paragraph 6801(a) of the Regulations. With regard to many paragraph 6801(d) plans, employees are generally entitled to elect in advance as to what percentage of salary they wish to have fall under the plan provisions. It is our view that this choice is a feature of a plan that falls within the parameters of paragraph 6801(d) of the Regulations and does not give rise to a circular consideration of whether or not this election, in and of itself, creates an SDA - it does not. The election mechanism is a feature of a plan that comes within the SDA exception provided by paragraph 6801(d) of the Regulations.

In addition to these statutory exclusions, the Agency has ruled that certain other plans are not SDAs. The plans upon which we have ruled fall into two general types (and are accepted as not being SDAs where the Agency has sufficient comfort that one of the main purposes of the arrangement is not to postpone taxes payable by the taxpayer in respect of an amount that is, or is on account of or in lieu of, salary or wages for services rendered in the year or a preceding year). The first are plans that are unregistered, unfunded pension plans. The Agency has accepted, for example, that unfunded plans that provide retirement benefits in excess of those allowed under the limits imposed on registered pension plans ("RPPs") generally do not meet the purpose test in the SDA definition. An example of such a plan is contained in ATR-21, Pension Benefit from an Unregistered Pension Plan, dated May 8, 1987.

In addition, the Agency has accepted that certain incentive plans are not SDAs. These plans are future-oriented plans whose payout value to a participant at inception are nil and which provide no rights to cash out until a fixed date (at which point an amount may be paid or payable under the plan). The Agency's views on these plans originate from comments made in the response to Question 26 in the 1988 Revenue Canada Roundtable at the Fortieth Tax Conference of the Canadian Tax Foundation regarding phantom stock plans. That response was:

It is the Department's view that where, on a specified date, the value of the phantom shares on that date will be paid to the employee, the plan will be considered an SDA, notwithstanding that the value on the payment date may be less than the value at the time such shares were granted. On the basis of our review of phantom stock plans, we have noted that where the amount paid to the employee is based on the full value of the specified shares, the phantom shares were generally granted in respect of the employee's past services. It should be noted that paragraph 8(1)(o) of the Act provides a deduction to the employee in a situation where the value of the shares on the payment date is less that the amounts previously included in income.

On the other hand, where, on a specified date, the employee is entitled to receive only the increase in the value of the underlying phantom share, this type of plan (which we refer to as a stock appreciation rights plan) will generally not be considered a salary deferral arrangement. From our review of stock appreciation rights plans, we have noted that where the underlying amount paid to the employee is based on the increase in the value of the underlying shares, the phantom shares were generally granted in respect of the employee's future services.

ATR-45, Share Appreciation Rights Plan dated February 17, 1992, provides an example of a share appreciation rights plan that was not considered to be an SDA. An important element of that ruling that applies equally to all incentive-based plans is contained in the editor's note. Specifically, where an arrangement provides that an employee can "cash-in" the value of whatever incentive has accrued to date, the Agency no longer has comfort at that point that one of the main purposes of the rights under the arrangement is not to postpone taxes payable in respect of salary or wages for services rendered in the year or a preceding year. Accordingly, no ruling will be provided that the arrangement is not an SDA with respect to the period subsequent to the date a right to cash-in arises. It is important to note that the Agency is not concluding that the arrangement at that point is an SDA. Rather, in these situations we have insufficient evidence to conclude one way or the other since that determination would be a question of fact.

The interpretation of the phrase "a right in a taxation year to receive an amount after the year" contained in the SDA definition also warrants some analysis. Our interpretation of the term "right" in this context is very broad and thus would include any plan or arrangement under which an individual is or may be entitled to receive amounts in the future. The words in the definition relating to a right "including such a right that is subject to one or more conditions unless there is a substantial risk that any one of those conditions will not be satisfied" in our view supports our broad interpretation of what a right is for these purposes and plans designed to circumvent the SDA rules by purporting to involve a substantial risk of forfeiture will generally fail in this regard.

Notwithstanding the comments in the preceding two paragraphs, it is difficult to provide more definitive guidance on the favourable or fatal attributes of such incentive plans as each plan must be analyzed upon its facts and a determination will be made by the Agency regarding the purpose test contained in the SDA definition.

In summary, a plan or arrangement where salary of wages are to be deferred must first and foremost be designed to avoid characterization as an SDA. Plans or arrangements that meet the statutory exclusions to the definition will not be SDAs. Other incentive-based plans that are designed to pay amounts based solely on future performance or results and that do not provide cash-out rights have also been accepted as plans that are not SDAs as well as most unfunded unregistered pension plans.

Returning to deferred salary and wages in general and the interaction of the SDA rules and the doctrine of constructive receipt, it is our view that there is an overlap in intent, that is, to currently tax amounts which the employee has earned and should have received. Although the SDA rules provide a statutory basis for this end and are broad in application, in our view there will be cases where constructive receipt would apply and the SDA rules could not; for example where the main reason (or reasons) for the deferral is other than to postpone taxation or the amount is currently payable to or at the disposal of the employee.

We trust the above comments will be of assistance.

Yours truly,

Patricia Spice
for Director
Financial Industries Division
Income Tax Rulings and Interpretations Directorate