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: Would a plan constitute a salary deferral arrangement for purposes of the Act?
Position: Question of fact.
Reasons: It appears that no right to receive an amount is being deferred and the plan is not tax motivated but this determination would require a review of the terms of the plan and any other relevant facts.
August 25, 2000
TORONTO CENTRE TSO HEADQUARTERS
S.M.E., Verification & Enforcement Division M.P. Sarazin
(613) 824-5441
Attention: Naomi Tsuji
2000-003500
Salary Deferral Arrangement
We are writing to you in response to John Gordon's memorandum of June 27, 2000, wherein he requested our views as to whether a specific employee incentive plan would constitute a salary deferral arrangement for purposes of the Income Tax Act (the "Act"). We understand that Mr. Gordon has retired and his file has been assigned to you.
Your client had requested an interpretation from this directorate and they were informed that the review of completed transactions fell within the responsibility of tax services offices and it is the practice of this directorate not to comment on such transactions when the identities of the taxpayers are not known. The client has identified the taxpayers involved and has asked for your views regarding the employee incentive plan.
Facts
XXXXXXXXXX (the "Company") carries on business in the U.S. and, through a number of subsidiary corporations, in XXXXXXXXXX other countries including Canada. The subsidiary that carries on business in Canada is XXXXXXXXXX ("Canco"). The Company is a subsidiary wholly-owned corporation of XXXXXXXXXX.
The Company has implemented an equity incentive plan (the "Plan") for all non-senior employees of its subsidiary corporations, including the employees of Canco ("the Canadian Employees"). The Plan was approved and adopted by the Company's Board of Directors on XXXXXXXXXX.
The client has described the relevant terms of the Plan as follows:
(a) The Plan has two distinctive elements: the "Incentive Units" and the "Incentive Bonuses".
(b) In the years XXXXXXXXXX, the Company will award Incentive Units to qualifying employees which include the Canadian Employees. The grant of an Incentive Unit does not give the Canadian Employee any absolute right to receive any payments under the Plan. The right to receive any payments will only arise when and if an Incentive Unit vests.
(c ) Incentive Units will only vest to the extent that the Company subsequently achieves certain set targets for the growth in its earnings before interest, taxes, depreciation and amortization (the "Base Earnings"). The Company has established a scale of Base Earnings targets that provides for a range of vesting percentages. For example, in each of the first XXXXXXXXXX years, anywhere from XXXXXXXXXX of the Incentive Units previously granted may vest depending on how the Company's Base Earnings for that period compare to the Company's target earnings for that period. The Base Earnings targets reflect the growth in earnings for each year that the Company wants to achieve. The Plan will only reward employees for future service provided to their employers.
(d) Where an Incentive Unit vests in a particular year because the Company has achieved a Base Earnings growth target established at the beginning of the year, the participants in the Plan will be paid an Incentive Bonus. The Incentive Bonus is a set percentage of the estimated value of the Incentive Unit vested in that year. The purpose of the Incentive Bonus is to provide each employee with a cash bonus to help pay the income taxes that will have to be paid on the payout of the Incentive Units, as described in (e) below. Consequently, Incentive Bonus rates are based on the top personal tax rate in the country of residence of the qualifying employees. The prescribed percentage for Canadian Employees is XXXXXXXXXX% and no Incentive Bonuses will be paid after XXXXXXXXXX.
(e) Once Incentive Units vest, they will become eligible for repurchase by the Company. Beginning in XXXXXXXXXX, the Company will begin to repurchase, on an annual basis, XXXXXXXXXX% of the cumulative number of vested Incentive Units held by all employees, including the Canadian Employees. Since the final award of Incentive Units will be made in XXXXXXXXXX and no further vesting will occur after XXXXXXXXXX, the employees' vested Incentive Units will all be repurchased as follows: XXXXXXXXXX.
(f) The repurchase price for the Incentive Units that will be redeemed in each year beginning in XXXXXXXXXX and ending in XXXXXXXXXX will be based on a specified percentage of the Company's Base Earnings for the immediately preceding year. Therefore, the higher the Base Earnings the higher the amount that the Company will pay to repurchase the Incentive Units in the following year. The amounts paid are described as cash bonuses for the employees' contributions to the growth in the Company's Base Earnings.
The Company's representative is of the view that the Plan does not constitute a salary deferral arrangement within the meaning assigned by subsection 248(1) of the Act and the amounts paid under the Plan constitute employment income in the year the amounts are received by the Canadian Employees. The Plan does not qualify as a salary deferral arrangement because the amount that might be received as a result of the existence of the Incentive Units and the Incentive Bonuses do not relate to services rendered in the year the Incentive Units are granted or any preceding year and none of the main purposes of the creation or existence of the Incentive Units or Incentive Bonuses is to postpone tax payable under the Act. The Plan was designed to reward employees for future services only and not for past services and it was developed outside Canada for all employees of the Company. Consequently, it would be difficult to conclude that one of the main purposes is to postpone Canadian taxes.
The Company's representative describes the primary objectives of the Plan as follows:
- to motivate employees to increase the Company's earnings in future years (units only vest if the Base Earnings targets are achieved or surpassed and the value of Incentive Units is dependent directly on the future earnings of the Company),
- to retain employees, and
- to manage cash flow related to the payment of the Company's obligations under the Plan.
It is not clear to us that the Incentive Units granted to Canadian Employees do not represent a right to receive an amount after the year in respect of services provided in the year. The Plan would have to be reviewed in order to determine whether the Incentive Units have a value at the time that they are granted to Canadian Employees. Where the Incentive Units have a value at the time that they are granted to the Canadian Employees, you would have to conclude that the Incentive Units were granted in respect of services provided in that year. Consequently, the amount paid to repurchase the Incentive Units may include an amount representing compensation for services rendered prior to the date the Incentive Unit was awarded even if the repurchase is triggered by an increase in earnings of the Company after that date. If the Incentive Unit value reflects compensation for services rendered and not solely for future services to be rendered, then tax motivation is generally presumed and a salary deferral arrangement may exist at that time.
Another element of the Plan that causes us concern is the proposed payout over several years. If the Incentive Units have a value at the time that they vest under the Plan, the value would be attributable to services rendered by the Canadian Employees in the year of vesting or a preceding year and it would be very difficult to argue that one of the main purposes of the proposed payout over several years is not to postpone taxes payable under the Act. The fact that the Plan was drafted outside of Canada for the benefit of employees all over the world is not conclusive in making this determination.
We suggest that you request a copy of the Plan and you review the terms of the Plan before providing any comments or opinions to the representative.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. 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 LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (613) 994-2898. A copy will be sent to you for delivery to the client.
Patricia Spice
for Director
Financial Industries Division
Income Tax Rulings Directorate
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