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: When transferring from a "current" payroll system to a "payment in arrears" system, is a transition payment made to employees subject to income tax?
Reasons: See response
April 26, 2016
Re: One-time transition payment
We are writing in response to your email dated December 17, 2015, and our conversation of February 18, 2016 (Waugh/XXXXXXXXXX), concerning whether a one-time transition payment is considered an interest-free loan or salary advance to be included in an employee’s income.
In the situation you described, an employer is considering changing its payroll system to a payment-in-arrears system. Currently, the pay received by employees is for work completed up to and including the day of payment. Under the new system, employees’ pay will be calculated and processed after the work has been completed (employees will be paid for work that was done two weeks previously). The employer will pay existing employees a one-time transition payment (TP), at the date of conversion (with all payroll deductions being made at the time of the payment), instead of having a gap in pay (i.e., no pay) for existing employees for the pay period which is moving to arrears. The employer will adjust its pay system on the date of conversion so that existing employees’ pay statements for the first pay period following the conversion shows a period ending two weeks prior; in effect, existing employees will have two pay statements reporting the same pay period. Upon termination of employment, an adjustment payment will be made for the difference between an employee’s gross pay at the date of termination and his or her gross pay at the date of conversion. If the difference represents a positive amount, the employer will make a payment to the employee, subject to all payroll deductions. If the difference represents a negative amount, the employee will make a payment to the employer (the employer may choose to take the money from a payment being made to the employee).
It is our understanding that the migration to the payment-in-arrears payroll system will be mandatory and employees will not be able to refuse the TP. No agreement will be signed between the employer and employees for the TP.
This technical interpretation provides general comments about the provisions of the Income Tax Act (Act) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
Subsection 80.4(1) of the Act generally deems an employee to have received a benefit from employment where the employee receives an interest-free or reduced-interest loan because of or as a consequence of a previous, a current, or an intended office or employment. A loan is generally defined as delivery by one party, and receipt by another party, of a sum of money upon agreement, express or implied, to repay with or without interest. The amount of the benefit is calculated as the difference between the interest actually paid by the employee and the interest computed at a prescribed rate on the outstanding balance of the loan. The prescribed interest rate is determined in accordance with sections 4300 and 4301 of the Income Tax Regulations.
However, where an employer makes a payment to an employee that is an advance on account of the employee’s future earnings, the amount received is generally not considered to be a loan to which subsection 80.4(1) of the Act applies. Generally, the term “advance” means “pay” or “pay money before it is due” and, therefore, has a broad meaning. A salary advance is a payment for salary, wages, or commissions that an employee is expected to earn by the performance of future services.
Normally, an employee is not required to repay a salary advance as long as he or she continues to perform the services (i.e., remains employed). The fact that an employer is entitled to recover some part of the advance if an employee ceases employment before he or she has provided services in respect of which the advance was made, does not change the nature of the payment. Such advances are generally included in an employee’s income under subsection 5(1) of the Act in the year the advance is received. Based on the information you have provided, it is our view that the TP would likely be considered a salary advance which should be included in the employees’ income in the year it is received. The employer is required to withhold and remit payroll deductions (e.g., income tax, CPP premiums, EI premiums.)
Generally, under paragraph 8(1)(n) of the Act, an employee may claim a deduction from employment income for any repayment of all or part of a salary advance that was previously included in the employee’s income and that was for a period which he or she did not perform the duties of employment. This deduction is available in the tax year in which the repayment is made and cannot exceed the advance that was previously included in the employee’s income from employment. For more information regarding the repayment of a salary advance, see “salary overpayments” in chapter 6 of CRA Guide RC4120, Employers’ Guide – Filing the T4 slip and Summary.
We trust these comments will be of assistance to you.
Nerill Thomas-Wilkinson, CPA, CA Manager Business and Employment Income Section Business and Employment Division Income Tax Rulings Directorate
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