2004 Ruling 2004-0068151R3 - EBP - 248(1)(k) SDA

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: 1. Is the deferred bonus plan (Plan) excluded from the definition of salary deferral arrangement?

2. Is the proposed Plan an EBP?

Position: 1. Yes.

2. Yes.

Reasons: 1. The Plan satisfies the requirements of paragraph (k) of the definition of SDA in subsection 248(1).

2. The Plan meets the definition of an EBP.

XXXXXXXXXX 								2004-006815

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Corporation") (Account # XXXXXXXXXX )
XXXXXXXXXX . ( the "Employer") (Account # XXXXXXXXXX )

This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the Corporation, the Employer and the Participants. We also acknowledge the information provided during our various telephone conversations (XXXXXXXXXX), your letters of XXXXXXXXXX, and your E-Mails of XXXXXXXXXX, which resulted in amendments to the facts and proposed transactions.

Unless otherwise stated, all references to statute are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter, (the "Act"), and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

DEFINITIONS AND ABBREVIATIONS

In this letter, the following terms have the meanings specified:

"DSU" means Deferred Stock Unit.

"Effective Award Date" for a particular Award means December 31 of the calendar year immediately preceding the date the Award is made by the Board of Directors ("Board") unless otherwise specified by the Board or as set forth in the Award Agreement.

"Eligible Person" means a person who is an employee and an XXXXXXXXXX of the Employer and is in a position, in the opinion of the Board, to make contributions to the growth, management and success of the Employer and shall include a person who has ceased to be an employee and an XXXXXXXXXX of the Employer due to disability and who becomes entitled to receive long-term disability benefits under the terms of a long term disability plan sponsored by the Employer.

XXXXXXXXXX.

"Participant" means an individual who holds DSUs pursuant to the Plan.

"public corporation" has the meaning assigned by subsection 89(1).

"taxable Canadian corporation" has the meaning assigned by subsection 89(1).

FACTS

1. The Employer is a wholly owned subsidiary of the Corporation. Both the Employer and the Corporation are taxable Canadian corporations and have a fiscal year-end as of XXXXXXXXXX.

2. The Corporation is a public corporation and its common shares are listed on the XXXXXXXXXX Stock Exchange.

3. The Employer is a XXXXXXXXXX.

4. XXXXXXXXXX are employees of the Employer who are licensed to sell XXXXXXXXXX to individual clients of the Employer. The Employer derives a significant portion of its profits from the commissions generated by the XXXXXXXXXX sales to individual clients of the Employer.

5. The Employer has established a number of compensation and benefit programs for eligible XXXXXXXXXX, including a cash compensation program that provides XXXXXXXXXX with a commission that is calculated as a percentage of their gross production for the fiscal year. The commission rates range from XXXXXXXXXX % to XXXXXXXXXX % of the XXXXXXXXXX gross production, with the commission rates increasing as the XXXXXXXXXX level of gross production increases as set out in the following table.

Gross Production Level
Cash Payout
From
To

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

The term Gross Production Level refers to the fees charged to clients for particular transactions or in respect of the sale of particular products. The amounts set out in this grid represent the regular or normal compensation paid to XXXXXXXXXX.

6. While a relatively new corporation, the Employer has expanded rapidly because it has been willing to pay higher remuneration in order to attract successful XXXXXXXXXX and it has acquired other businesses.

PROPOSED TRANSACTIONS

7. The Corporation proposes to implement a compensation plan under which XXXXXXXXXX will be entitled to receive additional compensation from the Employer in the form of an annual bonus, which will be linked to their individual sales success. The bonus will be in addition to and not in lieu of regular or normal compensation or commission that could be received by an XXXXXXXXXX in a particular taxation year. The proposed program is designed to reward the individual XXXXXXXXXX who exceed certain production targets and to encourage them to remain with the Employer. Further, the payment of the bonus is intended to encourage the XXXXXXXXXX to increase their sales volume because that activity will increase the Employer's revenue and profits.

8. The bonuses can be distinguished from regular commissions because they are only available to successful XXXXXXXXXX who generate annual gross commission income that exceeds $XXXXXXXXXX in a taxation year. Therefore, there is an incentive element that is not present with regular commission income. In addition, in order to receive the bonuses, the individual must be an employee at the end of the year (or only ceased to be an employee due to disability during the year) whereas, regular commissions are typically paid on a monthly basis and are not contingent on ongoing employment after the commission has been earned. Thus, there is a retention feature that is not present with regular commissions.

9. The bonus will be based on the annual gross production of the XXXXXXXXXX determined as at the end of each taxation year. Set out below is the range of the proposed bonuses:

Production Levels

Bonus Award
Percentage
From
To

XXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

10. Receipt of the bonus that the XXXXXXXXXX would otherwise be entitled to receive, as described in 7 to 9 above may be deferred at the direction of the Corporation's Board. In the event that XXXXXXXXXX are able to elect whether or not to defer their bonuses, such election to defer the bonus must be made before the bonus becomes payable and the election will not be revocable.

11. The Corporation intends to establish a DSU Plan (the "Plan") under which an Eligible Person ("Participant") will be selected by the Corporation's Board to be awarded a number of DSUs (also called "Awards" in this document), which will be evidenced by an Award Agreement. This Award Agreement is not available at the time of this letter. You have informed us that it will contain information regarding the gross commissions earned, the bonus earned and the number of DSUs awarded to a Participant. It will also set out a short summary of the terms and conditions of the Awards. The number of DSUs allocated to a Participant, for a taxation year, will be based on the bonus amount determined in accordance with the grid set forth in 9 above and amended by the Board from time to time. Each DSU that is awarded will entitle the Participant to receive one common share in the capital stock of the Corporation (the "Shares") from a trust, established to acquire and hold such Shares, as described in 12 below.

12. Pursuant to the Plan a trust will be established pursuant to the laws of the Province of XXXXXXXXXX (the "Trust"), the majority of whose trustees will be residents of Canada for purposes of the Act. The beneficiaries of the Trust will be the Employer and the Participants. The trustees will not elect to qualify the Trust as an employee trust.

13. The Employer will make cash contributions to the Trust to enable the trustees to purchase Shares on the open market or from third parties with whom the Employer and the Corporation deal at arm's length in order to satisfy its obligations to provide Shares to the Participants. It is anticipated that most of the Shares required to fund the Plan will be purchased throughout the performance year in which the services are rendered by the Participants that will give rise to the bonus and prior to the award of DSUs. The trustees will use the cash contributions made by the Employer exclusively to purchase the Shares in satisfaction of the benefits to be provided under the Plan and pay the expenses incurred by the trustees in discharging of their obligations under the Plan. The trustees will have no discretion to use the funds contributed to the Plan by the Employer for any other purposes.

14. The number of DSUs to be allocated to a Participant will be determined by dividing the amount of the bonuses to be deferred by the average cost of the Shares acquired throughout the year by the Trust. For example, if a Participant is entitled to a deferred bonus of $XXXXXXXXXX and at the time the bonus would otherwise be payable, the average cost of the Shares acquired by the Trust, during the year, is $XXXXXXXXXX, the Participant will be allocated XXXXXXXXXX DSUs. The formula for determining the number of DSUs that will be allocated to Participants may be modified from time to time. The Employer will maintain an account, to be known as a "DSU Account", for each Participant to record the number of DSUs awarded and the vesting of DSUs.

15. Participants will not be entitled or required to make contributions to the Plan. Accordingly, the adjusted cost base ("ACB") of the Participant's interest in the Trust will be equal to nil.

16. Unless otherwise provided in the terms of the Award Agreement with the Participant, the DSU Plan will provide that the DSUs will vest in three equal installments on each of the first, second and third anniversaries of the Effective Award Date for a particular Award. In no event shall the vesting of the last installment of the DSUs take place later than the third anniversary of the Effective Award Date which is the end of the taxation year in which the service period ended to which the bonus relates (the "Third Anniversary Date"), in accordance with paragraph (k) of the definition of "salary deferral arrangement" in subsection 248(1).

17. Unless otherwise provided under the Award Agreement, the DSUs will vest or be forfeited in accordance with the Plan, as follows:

(i) upon death, all unvested DSUs will vest immediately;

(ii) upon disability, termination of employment by the Employer without cause, retirement or other voluntary termination of employment, the DSUs will continue to vest in accordance with the terms of the Plan as if the disability, termination of employment without cause, retirement or other voluntary terminations of employment had not occurred; and

(iii) upon termination of employment for cause, the unvested DSUs will be forfeited.

However, if the Participant terminates employment and is subsequently employed by an entity that the Employer views as a competitor, all unvested DSUs allocated to the Participant may be forfeited.

18. Subject to the terms of the Award Agreement, the Shares will be distributed to the Participant by the trustees at the time that the DSUs vest.

19. Under no circumstances will the distribution of the Shares under the Plan be deferred beyond the Third Anniversary Date.

20. Prior to the time that the Shares are distributed from the Trust, the Participant will have no rights to the Shares and no rights as shareholders of the Corporation in respect of the Shares. In particular, the Participant will have no legal or beneficial ownership interest in the Shares by virtue of the allocation of the DSUs and no rights to vote the underlying Shares, no entitlement to dividends or entitlement on liquidation until such time as the Shares have been distributed. Title and all incidents of beneficial ownership of the Shares will remain with the trustee while the Shares remain in the Trust.

21. All dividends paid on the Shares held by the Trust prior to their vesting and distribution, as described in 16 and 17 above, will be paid to the Trust.

22. The Trust Agreement will provide that the trustees shall allocate, distribute and pay to the Employer, in its capacity as income beneficiary of the Trust, the income of the Trust for the year, including all dividends received by the Trust on the Shares, prior to their vesting, by the end of the taxation year in which the Trust received the income. The Employer will not be required to recontribute to the Trust that income that was previously paid to it by the Trust.

23. The Employer may pay, annually to the Participants, an amount as additional remuneration, equal to the dividends received in respect of the Shares by the Employer, which will be equal to the dividend that the Participants would have received had they held the underlying Shares directly.

24. From time to time the Employer may, in addition to its powers under the Plan, add to or amend any of the provisions of the Plan or terminate the Plan provided, however, that:

(i) any approvals required under applicable law or stock exchange rules are obtained,

(ii) no such amendment or termination shall be made at any time, which has the effect of adversely affecting the existing rights of a Participant under the Plan without the Participant's consent.

(iii) no such amendment shall cause the Plan to cease to be subject to paragraph (k) of the definition of "salary deferral arrangement" in subsection 248(1) or result in the invalidation of any of the Rulings provided.

25. In the event that a corporate reorganization, a stock dividend or other fundamental event results in a change to the underlying Shares, the number of DSUs allocated to the Participant's DSU Account will be appropriately adjusted in order to preserve the benefits allocated under the Plan.

26. All forfeited Shares will be retained within the Trust and used to reduce the Employer's funding requirements. In the event that the Trust holds forfeited Shares at the time the Plan is terminated, the forfeited Shares will be sold and the cash proceeds paid to the Employer.

PURPOSE OF THE PROPOSED TRANSACTIONS

27. The purposes of the proposed transactions are to:

(i) encourage the XXXXXXXXXX to focus on practices that will increase the profits of the Employer and the Corporation.

(ii) encourage the most successful XXXXXXXXXX to remain with the Employer and attract successful XXXXXXXXXX who are currently employed by competitor firms by increasing the compensation paid to the most successful XXXXXXXXXX.

(iii) reduce the risk that successful XXXXXXXXXX will leave the Employer to become employees with competitor firms by deferring the payment of the bonus and linking the bonus to the value of the Shares.

ADDITIONAL INFORMATION

28. We understand that, to the best of your knowledge and that of the taxpayers, none of the issues involved in the Ruling request:

(i) is in an earlier return of the Corporation, the Employer or a related person,

(ii) is being considered by a Tax Services Office or a Taxation Center in connection with a previously filed return of the Corporation, the Employer or a related person,

(iii) is under objection by the Corporation, the Employer or a related person,

(iv) is before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has expired, or

(v) is the subject of a Ruling previously issued by the Directorate to the Corporation, the Employer or a related person.

29. The Corporation and the Employer file their tax returns at the XXXXXXXXXX Taxation Centre and deal with the XXXXXXXXXX Tax Services Office. The head office of the Corporation and the Employer is XXXXXXXXXX.

RULINGS GIVEN

Provided the preceding statements constitute a complete and accurate disclosure of all the relevant facts, the proposed transactions and the purpose of the proposed transactions, provided that the proposed agreements (the DSU Plan, the Trust Agreement and the Award Agreement) reflect the proposed transactions described above and provided that the transactions are carried out as described above, our Rulings are as follows:

A. The Plan will not constitute a salary deferral arrangement ("SDA") by virtue of paragraph (k) of the definition of SDA in subsection 248(1).

B. The Trust will not constitute an employee trust as that term is defined in subsection 248(1).

C. The Plan will not constitute a retirement compensation arrangement as that term is defined in subsection 248(1).

D. The Plan will constitute an employee benefit plan as that term is defined in subsection 248(1).

E. Such part of the amount that would, but for subsection 104(6) be the income of the Trust for the year, as was paid in the year to the Employer as a beneficiary of the Trust as described in 22 of the proposed transactions, will be deductible from the income of the Trust pursuant to paragraph 104(6)(a.1).

F. At the time the Trust distributes the Shares to the Participants as described in 18 of the proposed transactions, in satisfaction of all or any part of their interest therein, the Trust shall be deemed to have disposed of the Shares for proceeds of disposition equal to its cost amount, immediately before that time, in accordance with subparagraph 107.1(b)(i).

G. At the time described in ruling F above, the Participants will be deemed to have disposed of their interest or part thereof, as the case may be, for proceeds of disposition equal to the ACB to the Participant of that interest or part thereof, immediately before that time, in accordance with subparagraph 107.1(c).

H. At the time described in ruling F above, the Participants will be deemed to have acquired the Shares at a cost equal to the greater of their fair market value at that time and the ACB to the Participant of the Participant's interest or part thereof, as the case may be, immediately before that time, in accordance with subparagraph 107.1(b)(ii).

I. An amount equal to the fair market value of the Shares distributed by the Trust to a Participant will be included in the Participant's income under paragraph 6(1)(g), in the year in which DSUs vest and Shares are distributed as described in 16, 17 and 18 of the proposed transactions. The fair market value of the Shares will be determined as of the day on which the Shares are distributed.

J. Any amount paid in the year to a Participant, as described in 23 of the proposed transactions, will be included in the Participant's income under section 5.

K. Except as provided in rulings I and J above, no amount will be included in the income of a Participant under subsection 5(1) or paragraph 6(1)(a) of the Act as a result of allocating DSUs to a Participant's DSU Account as described in 11 and 14 of the proposed transactions or by virtue of the contributions made by the Employer to the Trust as described in 13 of the proposed transactions.

L. The Plan will not constitute an investment contract as defined in subsection 12(11) and no amount will be included in a Participant's income pursuant to section 12.

M. Subject to section 67, the Employer's contribution to the Trust as described in 13 of the proposed transactions will be deductible by the Employer to the extent provided in subsections 32.1(1) and (2) in the taxation year in which DSUs vest and Shares are distributed to the Participants in accordance with 16, 17 and 18 of the proposed transactions. For the purposes of subsection 32.1(2), payments out of or under the Plan in a particular year will be equal to the fair market value of the Shares distributed by the Trust to the Participants in that year under the Plan.

N. The amount paid to the Employer as described in 22 of the proposed transactions will be included in its income pursuant to paragraphs 104(13)(b) and 12(1)(m).

The Rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 and are binding on the CRA provided that the Plan is implemented before XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
Section Manager
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch