6 April 1993 External T.I. 9304245 F - Retirement Compensation Arrangement - Letter of Credit

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.

XXXXXXXXXX

Dear XXXXXXXXXX

This is in reply to your FAX transmission of February 9, 1993 concerning a retirement compensation arrangement ("RCA").

More particularly, you ask for our comments on your following views relating to an RCA that is secured by way of a third party guarantee such as a letter of credit ("LOC"):

1.     Where a non-registered pension plan is secured by way of a LOC, you believe it is the Department's position that the amount of the contribution to the RCA is the amount paid for the LOC.

2.     Where the LOC is supported by the employer pledging certain of its assets to the LOC issuer, you view this provision of security as a separate contribution to the RCA with the amount of the contribution being equal to the fair market value ("FMV") of providing the security. It is your further view that this FMV would be equal to the amount saved by providing the security. For example, if the cost to the employer for a $10,000 LOC would be

(a)     10% of its face amount where no security is provided (e.g., $1,000), or

(b)     1% of its face amount where security is provided (e.g., $100),

     it is your view that the amount of the contribution to the RCA related to the provision of security would be $900 (i.e., $1,000 minus $100).

3.     Where an employer agrees to pay an annual pension to an employee under a non-registered pension plan upon termination of his employment and the employer makes a single contribution of $100 to a trust in connection with the arrangement, it is your view that all pension payments under the arrangement are payments out of an RCA notwithstanding that a contribution of only $100 was made.

Our Comments:

A.      With respect to 1 above, where

(a)     the employer acquires the LOC, the FMV of the LOC would be a contribution to an RCA. The Department's position in this regard was explained at the 1988 Canadian Tax Foundation Conference ("CTFC"), and

(b)     where the employer establishes a trust and transfers cash to the trustee in an amount equal to the fee charged by the bank for issuing the letter of credit to the trust, that amount would be a contribution for the purposes of paragraph 20(1)(r) of the Income Tax Act (the "Act"). The Department's position in this regard was explained at the 1992 CTFC.

In each case, the total amount of the employer's contribution under paragraph 20(1)(r) would include the amount remitted to the Receiver General by the employer by reason of paragraph 153(1)(p) of the Act and subsection 103(7) of the Income Tax Regulations. For example, with respect to (b) above, the total amount of the employer's contribution to the RCA would be twice the amount paid by the trustee for the LOC.

B.      With respect to 2 above, the Department's position in this regard was also explained at the 1992 CTFC; i.e., that the pledging of property as security for an RCA could be a contribution to the RCA. The issue would be decided on a case-by-case basis.

We agree with you that the amount of the contribution to the RCA would be the FMV of providing the security. In the example cited, we also agree that it is possible that the FMV of providing the security would be $900. However, FMV is a question of fact. A well accepted definition of "fair market value" is that contained in Black's Law Dictionary, 6th edition, which reads as follows:

"the amount at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts".

The Department does not provide advance rulings on the FMV of a property nor does it as a general rule predetermine the FMV of a property in any other context. Rather, with respect to the concern you raise, the determination of the FMV of a property is the responsibility of the employer and the RCA trustee. The Department would become involved only after the fact and only if it considered the value assigned to a property to be unreasonable in the circumstances. Any such involvement would normally be by representatives of the relevant district taxation office.

C.      With respect to 3 above, we agree that during the time the arrangement constitutes an RCA, the related pension payments made to the employee would be payments out of the RCA and taxable in the employee's hands under paragraph 56(1)(x) of the Act, notwithstanding that a contribution of only $100 was made to the RCA.

This would not be the case, of course, where the LOC expired, no further LOC's were to be acquired and the RCA is wound up. Any related pension payment made other than under an RCA would be a superannuation or pension benefit taxable in the employee's hands under subparagraph 56(1)(a)(i) of the Act. Such winding up would not be feasible, however, where the employee wishes to have the LOC in place until his entitlement to the payments expires.

Our comments are an expression of opinion only and are not binding on the Department as explained in paragraph 21 of Information Circular 70-6R2. We trust, however, that they are of assistance.

Yours truly,

for DirectorFinancial Industries DivisionRulings Directorate7200-9