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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues:
1. Where employee's salary increases during the plan year, can the employer give the employee cash in lieu of additional flex credits during the year, and include the amount in the employee's income.
2. Can the employer calculate the flex credits bases on estimated salary at the beginning of the plan year, as opposed to salary levels when the flex credits are allocated?
3. Can employer award flex credits based, in part, on employee performance?
4. Can the employer calculate the flex credits as a percentage of total compensation including fringe benefits?
5. Can the employer set total compensation levels, with a certain percentage being flex credits, so that flex credits would automatically increase as total compensation increases?
6. Can a flex plan have only two options with one being cash and the other being a health spending account?
Position:
1. The plan would not be affected by the payment of cash to the employees.
2. As long as flex credits are notional, allocated prior to the plan year, and the benefits are selected prior to the plan year, calculation of the benefits based on a reasonable estimate of compensation would probably not, by itself, affect the plan's status. We would need to consider the plan in its entirety.
3. Entire plan must be reviewed in order to determine consequences.
4. Same as 2
5. Where salary levels increase during the year, additional flex credits cannot normally be allocated during the plan year unless the increase in salary was due to a change in employment status. However, all the facts must be reviewed in order to make definitive comments.
6. Can only be determined after reviewing all of the facts.
Reasons:
1. Since the amount received is included in income, it would not cause the plan to fall outside the guidelines in IT-529.
2 & 4. IT-529 does not set out a formula for calculating the allocation of benefits. If the conditions set our in the bulletin are satisfied, and the calculation of the number of flex credits is based on a reasonable estimate of compensation, the plan would likely not fall outside the IT-529 guidelines.
3. Flex credits must be notional, credits must be allocated prior to the plan year, and benefits must be selected before the beginning of the plan year. Credits can vary from year to year, but, in this case, all the facts must be considered to determine if the plan falls within the guidelines of IT-529.
5. Question of fact.
6. The plan may meet the conditions set our in IT-529 but more information is required.
XXXXXXXXXX 2001-008409
Wayne Antle, CGA
October 25, 2001
Dear XXXXXXXXXX:
Re: Flexible Employee Benefit Plans
This is further to your letter of May 11, 2001, in which you asked for our comments on several hypothetical situations involving the calculation and allocation of flex credits in a flexible employee benefit plan ("Flex Plan").
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R4 dated January 29, 2001. The following comments are, therefore, of a general nature only.
In your correspondence, you ask us to consider the requirements set out in paragraphs 7 and 9 of IT-529, Flexible Employee Benefit Plans, in the context of five different scenarios. Paragraph 7 essentially provides that a flex plan will not be considered to be an employee benefit plan as defined in subsection 248(1) of the Income Tax Act, if the flex credits are notional, and the employee is required to make an irrevocable (except in situations where a life event occurs, or employment circumstances change) selection of benefits to be provided with the flex credits prior to the beginning of the plan year. The flex credits are considered to be notional if they have no redemptive value, or nothing of value was forfeited by the employee to acquire the credits.
Paragraph 9 states that the conversion of any portion of an employee's salary, bonus, vacation pay or similar entitlement to flex credits will result in the converted amount being included in employment income. However, there will be no income inclusion where an employment contract is renegotiated after the expiration of an existing contract to provide for a decrease in salary levels, and a commensurate increase in the number of flex credits allocated to each employee. The determination of whether an existing contract has expired can only be made after reviewing all of the facts and documentation.
We will now comment on the scenarios presented in your letter. In each scenario, the flex plan year runs on a calendar year basis.
Scenario 1
In scenario 1, employees are awarded flex credits equal to 5% of their base salary. The flex credits would be allocated to the employees before December 1, 2001 for the 2002 plan year, and the selection of benefits would have to be made by this date. You ask us to consider the following two questions:
1. Would the status of the flex plan be affected if the credits were allocated based on the estimated January 1, 2002 salary levels as opposed to the salary levels in effect on December 1, 2001?
2. If an employee's salary increases during the year and additional flex credits cannot be allocated to the employee during the plan year, would the flex plan be affected if the employee were paid cash in lieu of additional flex credits, and the amount paid was included in the employee's income?
In response to the first question of Scenario 1, while a method using reasonably estimated salary levels to determine the allocation of flex credits may not, in and of itself, affect the status of the plan, we would need to consider the plan, in its entirety, in order to provide definitive comments.
Concerning the second question, it is noted that additional flex credits cannot normally be allocated to employees during the plan year. Where an employee's salary increases during the year, the employee receives cash in lieu of any additional flex credits, and the amount received is included in the employee's income, it is our view that this, by itself, would not cause the plan to fall outside the guidelines in IT-529.
Scenario 2
In this scenario, employees would receive flex credits of between 1% and 5% of their base salary. The number of flex credits issued to each employee would be, in part, a function of the employee's performance in the year preceding the plan year. The allocation of flex credits and the selection of benefits would be made prior to the plan year, and the flex credits would not be convertible to cash.
In order to determine the tax treatment of flex credits awarded to employees as a performance bonus, we would need to consider all of the facts, including the basis for determining the bonus, the timing of the bonus, whether it is paid to employees who are not participants in the flex plan, and whether an employee could elect to receive cash in lieu of additional flex credits prior to the plan year.
Scenario 3
In scenario 3, employees would be allocated flex credits based on their total value of compensation, including fringe benefits. The flex credits would be awarded to employees as a percentage of their estimated total compensation, which includes the employee's base salary, and the value of other benefits such as stock options, estimated bonuses, and employer's contributions to the Canada Pension Plan and Employment Insurance programs.
Consistent with our comments on the first question in scenario 1, while a method of allocating flex credits based on a reasonable estimate of total compensation would likely not, by itself, cause the flex plan to fall outside the guidelines in IT-529, we would need to consider all of the facts in order to provide definitive comments.
Scenario 4
In scenario 4, the employer would determine an employee's total compensation level with a certain percentage being the value of the flex credits. For example, an employee's total compensation level may be $52,500 in 2001, with base salary being $50,000 and flex credits allocated prior to the plan year being $2,500. During 2002, the employer increases the total compensation level of the employee to $60,000. Base salary would therefore increase to $57,000 and the value of the flex credits would rise to $3,000.
The calculation of flex credits in this scenario is basically the same as that used in scenario one, wherein the flex credits are calculated as a percentage of base salary. However, in this situation, it appears that the flex credits would automatically increase as salary increases. It has been our longstanding view that, in order for a flex plan to stay within the guidelines in IT-529, an employee cannot normally change the number of flex credits allocated to various benefit options during the plan year. However, we cannot definitively determine the tax consequences in this case without considering all of the facts and documentation including the structure of the flex plan, the existing employment contracts, the basis upon which additional flex credits are allocated among benefit options during the year, whether the allocation of additional flex credits is done in the same proportion as that used in the irrevocable benefit selection made prior to the plan year, and whether the employee can elect to receive cash in lieu of the additional flex credits during the plan year.
Scenario 5
In scenario 5, a flex plan has only two benefit options, cash and a health spending account. The employee would be allocated flex credits equal to 5% of base salary prior to the beginning of the plan year, and the employee must select the option before the start of the year.
As noted in IT-529, a flexible benefit plans can generally be described as a program of delivering company benefits where the employees are able to select the type and level of coverage from among a menu of available benefits. In the situation outlined above, we would need to consider all of the facts and documentation including the existing employment contracts and the flex plan agreements in order to provide definitive comments.
With respect to the scenarios outlined above, where an employer is considering setting up a new flexible benefit plan, or amending an existing flex plan, we would be willing to examine the proposed transactions in the context of an advance income tax ruling request.
We trust that our comments will be of assistance.
Yours truly
John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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