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. Whether the Taxpayer is entitled to a deduction for reimbursement payments made to its parent corporation under section 32.1 on the basis that the reimbursement payments are contributions to an EBP in respect of the Taxpayer's employees. 2. If not, is the Taxpayer entitled to a deduction for the reimbursement payments under any other provision of the Act?
Position: 1. No. 2. Yes.
Reasons: 1. The reimbursement payments are not EBP contributions. The payments are not a proxy for the contributions made to the EBP by the parent corporation (given the significant differences in the amount and timing), nor is the recharge agreement part of the EBP. 2. The reimbursement payments are deductible as an ordinary business expense in computing the Taxpayer's income under section 9, subject to the general limitations of the Act such as section 18, section 67 and subsection 78(4).
August 1, 2019
International and Large HEADQUARTERS
Business Directorate Income Tax Rulings
Leslie Bafia Directorate
Deductibility of reimbursement payments for performance share plan
This is in reply to your email of October 15, 2018 requesting our assistance in determining whether taxpayer requested adjustments (“TPRs”) for deductions by XXXXXXXXXX and its subsidiaries (collectively referred to as “Canco”) under section 32.1 (footnote 1) should be accepted. We also acknowledge the additional information subsequently provided by telephone and email.
XXXXXXXXXX (“Parentco”) offers a performance share plan (“PSP”) and other equity-based incentive plans to its XXXXXXXXXX employees. Canco and various entities within Parentco’s XXXXXXXXXX participate in the PSP. Parentco is responsible for administering and funding the PSP.
Canco makes reimbursement payments to Parentco pursuant to a recharge agreement for the value of shares distributed to Canco’s employees in satisfaction of vested PSP awards.
Canco originally filed its XXXXXXXXXX income tax returns without claiming a deduction for the reimbursement payments.
In XXXXXXXXXX, Canco filed TPRs for those taxation years requesting a deduction for the reimbursement payments. Canco submits that the PSP is an employee benefit plan (“EBP”) and that the reimbursement payments are contributions to the EBP that are deductible under section 32.1. Canco further submits that paragraph 7(3)(b) does not apply to prohibit the deduction as the PSP is not an agreement to which section 7 applies because it does not provide employees with a legally enforceable right to receive shares (per Transalta Corporation v R (2012 TCC 86)). In the alternative, if the reimbursement payments are not a contribution to an EBP, Canco submits that they are a deductible employee expense of Canco in the year the payments are made pursuant to section 9. You agree that paragraph 7(3)(b) does not apply to prohibit a deduction, but are uncertain whether the reimbursement payments are deductible under the EBP rules in section 32.1. You have asked for our views on this matter.
Our understanding of the facts is as follows:
1. Canco is XXXXXXXXXX subsidiary of Parentco. Parentco is a corporation headquartered in XXXXXXXXXX.
2. The terms of the PSP are outlined in the Parentco long term incentive plan. A PSP award recognizes and rewards an employee for their performance and value added to the corporate group. A PSP award is a conditional award of Parentco shares to be delivered upon vesting. Canco determines the number and class of Parentco shares to be awarded and the performance conditions attached to the award. The performance conditions are measured over a 3-year performance period. No consideration is paid for a PSP award or for shares acquired by an employee. Dividend equivalents may be payable to employees in respect of vested awards.
3. Canco has taken the position that the PSP does not constitute a salary deferral arrangement by virtue of paragraph (k) of the definition of a “salary deferral arrangement” in subsection 248(1). XXXXXXXXXX. We have not confirmed this position.
4. A vested award may be settled in either shares or cash equivalent, at the discretion of Canco or Parentco. The employee has no entitlement to or right to demand that the award be settled in shares.
5. From time to time, Parentco contributes cash to XXXXXXXXXX to purchase shares on the open market. The share purchases are conducted over time in a manner so as not to have an adverse impact on the market by having to purchase substantial numbers of shares at any given time. These shares are held in the XXXXXXXXXX and used to settle awards under the PSP as well as other equity-based incentive plans for employees of various entities within Parentco’s XXXXXXXXXX. When vesting occurs, Canco obtains shares from the XXXXXXXXXX and transfers them to the employee within XXXXXXXXXX days of the vesting date. The general rules governing the PSP and other equity-based incentive plans contemplate that Parentco may issue shares from treasury to the XXXXXXXXXX. Canco advised that this has never occurred.
6. Canco considers that the XXXXXXXXXX constitutes a trust for purposes of the Act, which is subject to the non-resident trust rules in section 94. The administrator of the XXXXXXXXXX filed an election pursuant to paragraph 94(3)(f) in order to deem only the portion of the trust relating to the Canadian employees to be resident in Canada. We have not done an entity classification for the XXXXXXXXXX to determine whether it is in fact a trust for Canadian income tax purposes or something else. Also, we are not providing any comments with regards to the validity of any election pursuant to paragraph 94(3)(f) for any of the trust taxation years or if the non-resident trust satisfies the conditions outlined in the definition of “electing trust” in subsection 94(1) for any of its taxation years.
7. Canco participates in the XXXXXXXXXX. The XXXXXXXXXX is a cost sharing agreement in which Canco agrees to pay a proportionate share of certain business support services provided by Parentco head office group. Such services include, but are not limited to, PSP expenditures with respect to Canco’s employees. The XXXXXXXXXX covers the allocation, invoicing and reimbursement of such costs and is referred to as the “recharge agreement” for purposes of this memo.
8. Pursuant to the recharge agreement, Parentco allocates and invoices Canco for an amount equal to the fair market value of the shares at the time the shares are distributed for the benefit of Canco’s employees. The cost is allocated to an entity based on the employee’s employer as at the grant date. The allocation method used by Parentco is described in Canco’s memo dated XXXXXXXXXX as follows: “XXXXXXXXXX.”
9. Canco calculates the employee’s taxable benefit based on the value of the shares or cash equivalent transferred to the employee in respect of the vested award. Canco reports the taxable benefit on the employee’s T4 information return in the year of transfer.
10. Canco’s explanation of its original filing position is that XXXXXXXXXX:
A. PSP award not an agreement to which section 7 applies
We agree that paragraph 7(3)(b) does not apply to prohibit a deduction for Canco’s PSP expenditures based on the reasoning set out in your email. Given the discretionary nature of the method for settling awards under the PSP, a PSP award is not a legally binding agreement to issue shares and thus not an agreement to which section 7 applies.
B. PSP is an employee benefit plan
Canco submits that the PSP constitutes an EBP in accordance with the definition in subsection 248(1):
There is an ‘arrangement’ (the PSP); under which contributions (cash) were made by a ‘person’ (Parentco) ‘with whom the employer’ (Canco) did not deal at arm’s length, to another person (the XXXXXXXXXX); and under which arrangement ‘payments’ (the distribution of shares) would be made for the benefit of employees of the ‘employer’ (Canco).
On the assumption that the XXXXXXXXXX is a trust, we agree with Canco’s reasoning that the PSP is an EBP.
C. Reimbursement payments are not deductible under section 32.1
Canco submits that the reimbursement payments it makes to Parentco pursuant to the recharge agreement constitute contributions made by Canco to an EBP in respect of Canco’s employees on the basis that the recharge agreement is part of the EBP and therefore the reimbursement payments are contributions to the EBP. Canco also put forward an argument that the reimbursement payments act as a “proxy” for the initial contributions made by Parentco to the XXXXXXXXXX for the purchase of shares in respect of Canco’s employees. Based on either line of reasoning, Canco states that it is entitled to a deduction for the reimbursement payments in accordance with section 32.1. Canco argues that the facts and decision in MNR v Chrysler Canada Limited et al (91 DTC 5526; 92 DTC 6346, FCTD) support its position.
We disagree with Canco’s position. It is our view that the reimbursement payments do not constitute contributions (as a proxy or otherwise) by Canco to the EBP and therefore no deduction is available to Canco under section 32.1.
i. Recharge agreement not part of the EBP
The recharge agreement is a general instrument used to ensure that Parentco is reimbursed for the cost of business support services it provides to Canco (such as the PSP) in order to properly reflect expenses incurred by Canco for financial statement and tax reporting purposes. We fail to see how it could be considered part of the EBP, as it contains none of the essential elements that make up the EBP, which are set out in the PSP, the XXXXXXXXXX and the individual award certificates.
ii. Reimbursement payment not proxy for Parentco’s contribution to EBP
The amount of Canco’s reimbursement payment is based on the value of shares distributed to Canco’s employees. Parentco’s contributions to the XXXXXXXXXX may occur long (possibly years) before Canco makes the reimbursement payment. Parentco’s contributions to the XXXXXXXXXX are also made for the benefit of employees of various entities within Parentco’s XXXXXXXXXX and are used to satisfy obligations under all of its equity-based incentive plans. As a result, if there is a surplus of shares in the XXXXXXXXXX because of greater than expected forfeitures in one plan or country (or for other reasons), those shares would be expected to be used to satisfy new awards, negating the need for Parentco to make additional contributions. This is reflected in the fact that no contributions were made to the XXXXXXXXXX. However, PSP awards and share distributions were still made to Canco’s employees for those years.
To be deductible under section 32.1, Canco’s reimbursement payment to Parentco would have to be considered to be a contribution to the EBP by Canco. Given the potentially significant differences in both the amount and timing of the reimbursement payment as compared to the actual contributions made by Parentco to the XXXXXXXX (that related to Canco’s employees), the reimbursement payments are not equivalent to Parentco’s contributions to the EBP, and thus cannot be considered to be a proxy for those contributions.
iii. Chrysler Canada
Chrysler Canada provides no support for Canco’s position and Canco’s description of the Court’s findings is inaccurate.
In Chrysler Canada, annual payments were made by Chrysler Canada to its U.S. parent to reimburse the parent for the value of the shares it issued to a trust for the benefit of Chrysler Canada’s employees. The Court concluded that the arrangement was subject to both the EBP rules and section 7, but held that section 7 had priority being the more specific of the two rules.
The Court did not comment on the nature of the reimbursement payment in its analysis of the EBP rules. Rather, it considered that the issuance of the shares by the U.S. parent to the trust constituted a contribution to an EBP on the basis that it was made to a trust for the benefit of an employer’s employees by a person not dealing at arm’s length with the employer. This is comparable to Canco’s situation, except that the shares were purchased on the open market not issued from treasury.
D. Reimbursement payments deductible under section 9
Canco’s alternative position is that the reimbursement payments are a deductible employee compensation expense in the year made pursuant to section 9, and the restrictions in paragraphs 18(1)(a) and 18(1)(b) do not apply.
We note that, in general, amounts are deductible for the purposes of section 9 if they are incurred in accordance with ordinary principles of commercial accounting and business practice, subject to any of the general limitations in section 18. The deductibility of any expenditure is also a question of fact subject to other rules, such as those respecting reasonableness in section 67 or unpaid employee remuneration in subsection 78(4).
In Imperial Tobacco Canada Ltd v The Queen (2008 DTC 2043 TCC), cash surrender chargeback payments were made by a Canadian corporation to reimburse its parent corporation for an amount equal to the cash payments made to its employees for the surrender of their employee stock options. The court held that the reimbursement payments were deductible as an ordinary business expense under section 9. Bowman CJ states the following at paragraph 22:
I start from the premise that in the ordinary course a payment made by an employer to an employee for the surrender of his or her option under a stock option plan to acquire shares of the company is a deductible expense to the company. This conclusion is not based on any specific provision of the Income Tax Act. It is simply part of employee compensation and is therefore a cost of doing business under section 9.
In the present case, the reimbursement payments are in respect of employee compensation for services rendered to Canco as part of its ongoing business activities and are required to be made pursuant to the recharge agreement. Accordingly, it is our view that the reimbursement payments are deductible as an employee compensation expense in computing Canco’s income under section 9, subject to the general limitations in section 18, section 67 and subsection 78(4).
As noted in fact #8, amounts invoiced by Parentco to a particular entity are based on the employee’s employer as at the grant date. Audit may wish consider whether an adjustment to the amount deductible by Canco is warranted in the event that one or more of Canco’s employees changed employers within the Parentco group during the grant-to-vest period resulting in the PSP awards not being fully attributable to services rendered in connection with Canco’s business. An adjustment may not be material or necessary if the movement of Parentco group employees into and out of Canada was comparable.
E. Accepting changes to a previously-filed return due to a change in position
We have not been asked to comment on whether to accept the TPRs as this is a matter of CRA administrative policy. However, we would like to make the following comments.
We understand that this question depends, in part, on whether the TPRs are due to an error or are due to a change in position resulting from the Transalta decision. If it is determined that the TPRs were due to an error, we understand that the TPRs for all of the taxation years could be accepted. However, if due to a change in position, we understand that only those TPRs for income tax returns originally filed after the Transalta decision (April 4, 2012) could be accepted. This question in turn depends on whether paragraph 7(3)(b) would have applied in respect of the PSP prior to the Transalta decision.
Subsequent to the Transalta decision, it is clear that the PSP award does not constitute an agreement for purposes of section 7 and therefore paragraph 7(3)(b) will not apply to prohibit a deduction for Canco’s expenditures relating to the PSP. Unfortunately, we do not have sufficient information on the XXXXXXXXXX to offer any determinative comments on whether paragraph 7(3)(b) would have applied in respect of the PSP prior to the Transalta decision. It is possible that the PSP awards would have been considered to be an agreement to sell shares for purposes of section 7. However, the opposite conclusion is also possible. In this regard, it is the CRA’s longstanding position that section 7 does not apply where an employer contributes to a trust and the trust uses the contributions to purchase employer shares (or shares of a corporation with which it does not deal at arm’s length) on the open market for eventual distribution to its employees. Instead, the arrangement is subject to the EBP rules. (footnote 2)
We are willing to consider this matter further if provided XXXXXXXXXX.
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We trust our comments will be of assistance.
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Unless otherwise stated, all statutory references in this document are to the Income Tax Act.
2 Advance Tax Ruling ATR-17 issued in 1987 and re-affirmed many times since in rulings (e.g., 2003-005304).
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