14 May 2019 External T.I. 2017-0737571E5 - SAR plan with dividend equivalents

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. Does the CRA’s general position on the non-application of the SDA rules to SAR plans apply where the plan provides for dividend equivalents? 2. Will the payment of dividend equivalents on an annual cash basis, rather than by way of additional units, cause the plan to fall outside of the CRA’s general position on SARs? 3. If so, will the plan be an SDA? 4. Is subsection 6(14) applicable to such an offside plan so as to provide partial relief for the main component of the plan?

Position: 1. Yes, provided that the dividend equivalents are credited in the form of additional units, and the eventual settlement is on the same basis and timeline as the whole of the unit. 2. Yes. 3. Question of fact, but not if the plan is exempt by virtue of the exception for three-year bonus plans in paragraph (k) of the SDA definition. 4. No.

Reasons: 1. The grant of the units is still considered to be solely for future services. 2. The right to an accelerated payment results in the award not being considered solely for future services. 3. A SAR unit with an accelerated dividend equivalent feature can be considered to be a bonus or similar payment and thus excluded from the SDA definition under paragraph (k) if paid within the 3-year window. 4. The dividend equivalent component is not separate enough from the main component to be a plan or arrangement in its own right.

XXXXXXXXXX							2017-073757
V. Pietrow
May 14, 2019

Dear XXXXXXXXXX:

Re: SAR plan with cash dividend equivalents

This is in reply to your email of December 14, 2017, in which you sought our views relating to a share appreciation rights (SAR) plan that provides for cash dividend equivalents. We apologize for the delay in responding, but your enquiry raised issues that required us to review the CRA’s position on dividend equivalents in various equity-based incentive plans from a broader perspective.

Your enquiry relates to a SAR plan of an employer corporation that provides for dividend equivalents on SAR units that are satisfied by way of cash payments made annually to employee participants. The vesting period for a SAR unit granted under the plan is set at three years. The corporation is contemplating extending the vesting period to five years, but is concerned that this might cause the salary deferral arrangement (SDA) rules to apply to the plan.

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (the “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 70-6R9, Advance Income Tax Rulings and Technical Interpretations.

An SDA is defined in subsection 248(1) of the Act as being a plan or arrangement under which an individual has a right in a taxation year to receive an amount in a subsequent 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 the Act by the individual in respect of an amount that is, or is on account or in lieu of, salary or wages for services rendered by the individual in the year or a preceding taxation year.

Several types of plans are specifically excluded from being an SDA. This includes three-year bonus plans described in paragraph (k) of the SDA definition under which a taxpayer has a right to receive a bonus or similar payment in respect of services rendered by the taxpayer in a taxation year to be paid within three years following the end of the year. SAR plans are not among the plans specifically excluded from the SDA definition.

However, it is the CRA’s longstanding position that a unit issued under a SAR plan that entitles the employee to receive only the increase in value of the underlying share from the date the unit is granted to the date it is redeemed will generally not be considered to be an SDA. Because the SAR unit has no intrinsic value when granted, it is considered to relate solely to the future services to be rendered by the employee and therefore falls outside of the preamble of the SDA definition. As a result, the value of the unit would generally not be included in the income of the employee until such time as the employee becomes entitled to redeem the unit. However, if after becoming entitled to redeem all or any portion of the unit the employee defers receipt of the remainder of the value of the unit, the SDA rules may be applicable from that point in time.

This general position also extends to SAR plans that include a dividend equivalent feature (i.e., additional rights equivalent to the dividends declared and paid on the underlying shares), provided that (i) the dividend equivalents are credited in the form of additional units, and (ii) the eventual settlement in respect of the dividend equivalents is on the same basis and timeline as provided for under the plan for the whole unit. (footnote 1)

If a SAR plan provides for dividend equivalents to be paid in cash on an accelerated basis (such as annually or after each dividend payment date) without the whole of the corresponding unit being redeemed, the CRA general position will cease to apply with effect from the time that the employee becomes entitled to receive the first such dividend equivalent payment. This is because, in such a case, the units would not be considered to be solely for future services.

While such a plan cannot rely on the general position for relief from the SDA rules, the exception for three-year bonus plans in paragraph (k) of the SDA definition may nevertheless apply. This would be the case where (i) the units granted constitute a “right to receive a bonus or similar payment” (which we would generally expect to be the case for a SAR plan), and (ii) the dividend equivalent component is redeemed within the same three-year window that applies to the main component of the unit to which the dividend equivalent relates. (footnote 2)

A SAR plan with an accelerated cash dividend equivalent feature and a redemption date beyond the three-year window in paragraph (k) does not meet any of the SDA exceptions. Consequently, it is a question of fact whether the SDA rules would apply to such a plan. In this regard, subsection 6(14) of the Act will not apply to such a plan to provide partial relief from the SDA rules for the main component of the award. The dividend equivalent feature is not separate enough from the main component to be a plan or arrangement within a larger plan or arrangement, as required by that subsection. (footnote 3)

We trust that these comments will be of assistance.

Yours truly,

Dave Wurtele
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 A deferred share unit plan that complies with the conditions of paragraph 6801(d) of the Income Tax Regulations to be excluded from being an SDA may provide for a dividend equivalent feature, as long as it reflects the same parameters described in this paragraph of the letter. The inclusion of an accelerated cash dividend equivalent feature would contravene the requirements of paragraph 6801(d).

2 This position also applies to other equity-based incentive plans (such as restricted share unit plans) that satisfy the conditions in paragraph (k).

3 The non-applicability of subsection 6(14) is also relevant for a deferred share unit plan that would otherwise comply with the conditions of paragraph 6801(d) but for the existence of an accelerated cash dividend equivalent feature in the plan.