8 May 1987 Income Tax Severed Letter 7-1483 - [Deregistration of Registered Employee's Pension Plans]

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.

May 8, 1987

Financial Industries Division Douglas Watson 957-8960 RE: Deregistration of Registered Employee's Pension Plans

This memorandum is in response to your enquiry of January 16, 1987. Since our first memorandum on the subject of a registered pension plan ("RPP") for which the registration is not renewed ("deregistered pension plans"), draft legislation for retirement compensation arrangements ("RCA") has been released. It is our opinion that this new legislation, when passed, will apply to deregistered pension plans as explained in this memorandum. As requested in your memorandum, we have added specific commentary on "insured pension plans" and have also included an explanation of section 254 of the Income Tax Act ("Act").

First, it must be stated that there are no specific provisions in the Income Tax Act ("Act") dealing with the deregistration of a pension plan. The tax consequences can only be determined after an examination of the facts and circumstances of each individual case. The following comments are restricted to the situation in which an employer ceases to make contributions to a RPP. If the plan is registered with the Ontario Pension Benefits Act ("Pension Act") the employer must file for a "windup" if they wish to terminate their involvement with the plan. In order to satisfy the requirements of the Pension Act we understand the employer must ensure that the fund is solvent and capable of meeting future obligations to the beneficiaries of the plan. It should be noted that only the requirements for plans registered in Ontario were examined. Other provinces may or may not have similar legislation.

Employers have several options when satisfying the requirements of a "wind-up". One alternative is to use the accumulated funds to purchase life annuities for each of the intended beneficiaries of the registered pension plan, thereby, guaranteeing that the employees and former employees are protected. In this case, or in any situation where "... a document has been issued or a contract entered into purporting to create, to establish, to extinguish or to be in substitution for, a taxpayer's right ... under a pension plan.." section 254 of the Act is applicable. Where the document or contract gives the taxpayer the same rights which were expected from the RPP, the beneficiary will be required to include in income pursuant to paragraph 56(1)(a) of the Act, payments out of the plan or replacement agreement as if those payments were out of a superannuation or pension plan.

Pursuant to paragraph 254(b) of the Act, where the document or contract alters the rights which were expected from the RPP, the beneficiary, at the time the document was issued or the contract entered into, will be deemed to have received and will be required to include in income, by virtue of subparagraph 56(1)(a)(i) of the Act, an amount equal to the value of the rights created by the document.

In a situation where there is no substituted agreement such as the case where funds are left on deposit to be paid out in the future, section 254 is not operative. As explained in our previous memo payments out of a deregistered plan, in these circumstances, would be regarded to be payments out of an employee benefit plan. However, based on a reading of draft legislation for RCA, it appears that deregistered pension plans will be treated as RCA, on the basis that the proposed legislation seems to be of sufficient scope to encompass virtually all conceivable forms of unregistered pension plans. This would include, for example, a life insurance policy, the purpose of which is to fund benefits for a taxpayer in contemplation of the retirement of the taxpayer. Consequently, payments out of such a plan will be included in income pursuant to proposed paragraph 56(1)(x) of the Act and, unlike in the case of RRP, will not be eligible for the pension income deduction or rollover to a registered retirement savings plan.

There is no provision in the Act which permits the earnings of a deregistered plan to be sheltered from tax. Assuming no further contributions the new rules for RCA will require that the custodian pay a 50% refundable tax on earnings of the fund in excess of payouts. The responsibility for the refundable tax, if any, will depend on the nature and terms of the fund including any specific agreement between the respective parties. For example, where the fund is held in the form of a segregated fund administered by a life insurance company the earnings determined pursuant to section 138.1 of the Act will be subject to the refundable tax. The earnings would be allocated to the policyholder which could be the employer or the trust established for the beneficiaries depending on the specific situation. Either of these parties would be liable for the refundable tax.

If the funds are held in the form of a deposit administration contract and the insurance company allocates earnings to the owner of the contract, which is the employer or a trust as the case may be, such owner would be liable to pay the refundable tax. Where earnings are not allocated there is a possibility that the insurance company as custodian of the funds, may be responsible for the refundable tax.

In the case of a life insurance policy or annuity contract, excluding prescribed annuities, held by a trust, the trust would be liable for the refundable tax on income calculated pursuant to the accrual rules of section 12.2 of the Act. Where these contracts are not held by a trust, the employer may be responsible for the refundable tax.

It would appear that your primary concern in writing us is to determine whether as a result of terminating registration upon notification of cessation of employer contributions there are any adverse tax consequences and whether terminating registration in such circumstances remains an appropriate measure. While the specific facts of each situation would have to be considered, as indicated above, there will be tax consequences where the registration of pension plans is not renewed. Whether termination is appropriate is your decision, however, it would seem to us that as long as a particular plan meets your requirements the fact that no further contributions will be made would not be a reason in itself to deny registration for a taxation year.

We hope that this general analysis is of assistance to you. If you wish our comments with respect to a specific situation, please provide the relevant documents evidencing the agreements between all parties.

for Director Financial Industries Division Rulings Directorate Legislative and Intergovernmental Affairs Branch