24 January 2008 Internal T.I. 2007-0263291I7 - US based Deferred Income Plan

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: Is a particular arrangement a salary deferral arrangement?

Position: Based on the information provided we concur with the TSO that the employee received her salary and directed a portion of it be deferred under the arrangement. We note that the plan would be an SDA had it been determined that the taxpayer's employer contributed the deferred amounts to the plan and the employee had not received the amounts.

Reasons: The provisions of the plan permit her to request a portion of her remuneration to be withheld and contributed on her behalf to a trust governed by the plan. There is no evidence that the employer made any contributions to the trust on its own behalf. There is no issue concerning constructive receipt since the employee effectively received and directed the amount to be withheld on her behalf.

								January 24, 2008

	Windsor Tax Services Office  			HEADQUARTERS
	Appeals Officer					W.C. Harding
								613 957-8953
	Attention : Ms. Janet Ciurysek
								2007-026329

U. S. Deferred Income Plan

This is in reply to your email of December 21, 2007 and our telephone conversation of January 8, 2008 (Ciurysek/Harding) concerning the participation of a Canadian resident employee in a U.S Deferred Income Plan (DIP) of her U.S. Employer. We acknowledge receipt of the additional information provided.

Background:

The employee immigrated to Canada from XXXXXXXXXX in XXXXXXXXXX and has been a Canadian resident ever since. The employee was first employed with the U.S. based employer in or about 2002 and started contributing to the DIP in 2003.

In completing her 2003 T1 income tax return, the Canadian resident employee reported employment income of $XXXXXXXXXX US ($XXXXXXXXXX CDN) as reported in box 1 of her 2003 W2 slip. The W2 also reported $XXXXXXXXXX U.S in box 14 as "Non-Qualified Retirement Plan" contributions and the total of the two amounts, $XXXXXXXXXX US, was reported in Box 5 as the amount on which U.S. Medicare tax was payable.

The individual's 2003 T1 was reassessed on XXXXXXXXXX, to include the contribution of $XXXXXXXXXX ($XXXXXXXXXX CDN) that had not been included in employment income. This assessment was confirmed in your letters of November 15, and December 7, 2005. We also note that in your letter of November 15, 2005, you specifically noted that an employee's contribution to such a plan is not deductible under the Income Tax Act (the "Act").

It is our understanding that the employee has continued to contribute to the DIP since 2003. However, the returns for those years are not currently under appeal.

The DIP is a non-qualified plan as defined under the U.S. Internal Revenue Code and permits participants to defer receipt of between 2 to 50% of their remuneration. The remuneration that is deferred is invested in various funds as selected by each participant. All of the amounts held in a participant's account are 100% vested at all times and participants may revoke the deferral election or change the investments held in their account at any time. Participation in the DIP will end if a participant's employment is terminated or if the participant is no longer eligible to participate in the DIP. On termination of employment or at age 65, a participant will receive the amount held in the participant's account in a lump sum, in instalments or as a combination of both.

The employer transfers the remuneration that is deferred by the employee each year into an irrevocable "grantor trust" where it is invested as requested by the participant. A grantor trust is an inter vivos trust for Canadian tax purposes. However, in the US, funds held in a grantor trust may be used to fund benefits but are also available to general creditors of the employer if the employer becomes insolvent. The plan is therefore considered to be unfunded for U.S. tax purposes. The DIP also provides that participants and beneficiaries have no right, other than the right of unsecured general creditors, against the employer or the trust, with respect to any portion of the amounts held in a participant's account.

Taxpayer Representations:

From the information provided, we understand that the taxpayer and her representatives were initially concerned that the reassessment would result in double taxation of the amounts she contributed under the DIP since the Canadian taxes incurred as a result of the income inclusion could not be offset by the US taxes that will be withheld on payment of the amounts out of the plan. We note that CRA's Competent Authorities Services Division in its memorandum of June 26, 2007, addressed these representations.

The representative of the taxpayer has now taken the position that, as the individual does not have control of the funds held within the trust, she has not constructively receive these funds. Accordingly, she should not be taxed on the amount held within the trust until the amount is paid out to her. In this respect, the representative quoted Income Tax Rulings' document E9727725, dated November 13, 1997, on salary deferral and constructive receipt which states, in part:

"In its response to Question 13 at the 1984 Revenue Canada Round Table published in the Report of the Thirty-Sixth Tax Conference, 1984, the Department stated that '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 any restriction concerning its use. Where at any particular time, a plan or arrangement does not provide an employee with such access to funds held under the arrangement, we would not generally consider constructive receipt to exist at that time even though the employee may give directions as to the form of investment in which the funds are to be held."

The representative further represents that a substantial risk of forfeiture of the amount exists in that should the employer become insolvent or subject to litigation funds in the DIP would be fully accessible to creditors.

Our position

The representatives' comments on constructive receipt relate primarily to the taxability of the amounts held within the DIP after the amounts have been contributed. I.E., the comments focus on the ability or inability of the employee to receive property held within the DIP. However, in the particular case you are considering, the assessment is based on the receipt of the employment income before it is contributed to the DIP. In other words, did the employee have receipt of the remuneration she earned and did she direct the employer to withhold and invest a portion of this remuneration in the DIP?

In our file 983278 dated February 23, 1999, we addressed this issue with respect to Canadian resident employee contributions to a U.S. 401(k) plan and stated in part:

"Canadian residents are required to report their gross income from employment when filing their Canadian income tax returns. When an American employer withholds an amount from your employment income and contributes it to a 401(k) plan the employer is doing it on your behalf. This is similar to a Canadian employer withholding employee contributions to a Canadian registered pension plan. However unlike contributions to a registered pension plan, an employee cannot deduct contributions to a 401(k) plan under the provisions of the Income Tax Act."

We also note that this position has been maintained in the courts in several decisions and in particular Bussey v The Queen (1998) 147 ETC, A Kamil v The Queen (1998) 148 ETC, and Raymond Brilla v The Queen 98 DTC 1502).

Based on the available information, it is our view that the reassessment is consistent with the decisions reached in these cases and was correctly made. It is our view that the employee received her full remuneration and directed the employer to withhold and contribute a portion of that remuneration into the DIP on her behalf. Accordingly, the amount deferred was properly reassessed in the year in which it was deferred.

We also note that since the amount deferred was withheld from the employee's remuneration it follows that the contribution was an employee contribution and not an employer contribution. Accordingly, if there were no other employer contributions to the DIP (in respect to the particular employee) the arrangement is not an employee benefit plan as defined in subsection 248(1) of the Act, nor a pension plan, but is a form of employee savings or thrift plan. Furthermore, the trust governed by the plan is a non-resident inter vivos trust for the purposes of Canadian taxation; the employee is taxable on any income of the trust that is payable to her; and the trust may be subject to the provisions of section 94 of the Act.

The Competent Authorities Services Division noted in its memorandum that the DIP might be a salary deferral arrangement as defined in subsection 248(1) of the Act (an "SDA"). We note that this would be the case if the employee's remuneration had been reduced by the deferred amount and this amount was contributed to the DIP as an employer contribution.

Had the DIP been an SDA the amount deferred would be subject to taxation in accordance with the SDA provisions of the Act. The DIP would not be an employee benefit plan as defined in subsection 248(1) of the Act as SDAs are specifically excluded from that definition. However, the trust would be an inter vivos trust for the purposes of Canadian taxation and the employee would be taxable on any income of the trust that is payable to her. The trust could also be subject to the provisions of section 94 of the Act. However, many types of employment-based trusts are excepted from the provisions of section 94 of the Act (or will be excepted under draft legislation) and a determination cannot be made on the application of this provision based on the information provided to us.

It should be noted that whether the plan is a thrift plan or an SDA the deferred amount must be included in the employee's income in the year of deferral.

Additional Comments:

As noted above, if the deferred amount had not been received by the employee but was contributed to the DIP by the employer, the plan would be an SDA. The following information is provided here to clarify the application of the SDA provisions that would apply in this event.

Subject to certain specific exceptions, an SDA is defined in subsection 248(1) of the Act as a plan or arrangement, whether funded or not, 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 this 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 taxation 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).

In the particulars of your situation (had there been no receipt by the employee of the amount contributed to the plan) the DIP would be an SDA as it clearly satisfies the provisions of the SDA definition. We note in particular:

• For an SDA to exist a participant must have a right to receive an amount after the end of the year where the amount is in respect of services rendered in the year. In your situation, the amount was earned in respect of the taxpayer's employment with the employer and the employee has a fully vested unsecured right, as a general creditor of the employer and/or the trust, to receive the amounts held for her account.
• A plan or arrangement will not be an SDA where a right to receive an amount is subject to one or more conditions unless there is a substantial risk that any one of those conditions will not be satisfied. In your situation the employee's right is fully vested and is not subject to any conditions save that it will only be paid on her termination of employment.
• In this respect, the representative of the employee suggests that as a general creditor the individual has a substantial risk that the amount will not be paid if the employer becomes insolvent or a bankrupt. First, the right to receive the amount is not subject to a condition that the employer is solvent and not bankrupt at the time of payment. The right will exist at that time although it may not be fully satisfied should the employer be insolvent. Second, no convincing evidence has been provided to support a position that there is a substantial risk that the employer may become insolvent or bankrupt in this particular case. It should also be noted that paragraph 8(1)(o) of the Act provides a deduction where a taxpayer forfeits benefits that were previously included in income under the SDA provisions of the Act.
• With respect to the file referred to by the representative (our file E9727725), the arrangement being discussed was excluded by paragraph (k) of the SDA definition and was not an SDA. Since the plan was not an SDA, the doctrine of constructive receipt was applicable with respect to the amounts held under the plan as discussed in that letter.
• An SDA will not exist where one of the main purposes for the creation or existence of the right to receive the amount after the end of the year is to postpone tax payable under the Act by the taxpayer. It is often argued that a foreign plan is designed to provide retirement benefits to residents of the foreign jurisdiction and is not designed to defer taxation under the Canadian Income Tax Act. In this respect, it should be noted that the provision refers to the creation or existence of the right of the taxpayer, and not to the purpose of the plan in general. In your situation, it would be our view that one of the main purposes for the creation of the Canadian employee's rights under the plan was to postpone the tax otherwise payable under the Act.
• As noted in the preceding bullet, an arrangement may not be an SDA if it is established to provide retirement or pension benefits. In our view, the DIP allows employees to defer amounts until they retire but it does not otherwise contain any of the provisions that are typical of a pension plan. In particular, a pension plan must be at least partially funded by an employer. Furthermore it would normally be considered unreasonable for a pension plan to permit employee contributions of between 2% and 50%. Hence, we are of the view the DIP would not be a pension plan.
• The Plan documentation indicates that an objective of the DIP is to help participants to accumulate money for retirement. Given this description it may be arguable that the DIP is a retirement compensation arrangement in accordance with the provisions of subsections 207.6(5), (5.1) and 248(1) of the Act. First, this could only occur if there were employer contributions and the contributions were used to fund retirement benefits. Second, the definition of an RCA in subsection 248(1) of the Act excludes salary deferral arrangements. Accordingly, since it is our view that the DIP is an SDA, the plan could not be an RCA.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. 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 electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client. We trust these comments will be of assistance to you. Please contact Wayne Harding if you would like to discuss any of the points made in this memorandum.

Mary Pat Baldwin, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch