20 January 1994 External T.I. 9400745 - SECTION 7 EMPLOYEES PROFIT SHARING 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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

RULINGS DIRECTORATE
CORRESPONDENCE SUMMARY

DOCUMENT TYPE:

Opinion

Principal Issues:

Does section 7 apply to an EPSP which uses employer contributions to purchase treasury shares?

Position TAKEN:

Yes

Reasons FOR POSITION TAKEN:

See Review Committee submission 930689.

LEGAL:

FINANCE OPINION:

JURISPRUDENCE:

RCT PUBLICATIONS:

HAA NUMBER:

HAA 4735-1

XXXXXXXXXX 940074

Attention: XXXXXXXXXX

January 20, 1994

Dear Sirs:

Re: Employees Profit Sharing Plans

This is further to your letter of June 9, 1993, and our reply of July 12, 1993 (931756), concerning the applicability of the decision in Placer Dome Inc. v. The Queen (92 DTC 6402, FCA) in relation to employees profit sharing plans (EPSP's) where treasury shares are purchased using employer plan contributions. We have now concluded our study of both Placer Dome and MNR v. Chrysler Canada Ltd. et al. (92 DTC 6346, FCTD) and their impact on the interpretation of section 7 and section 144 of the Income Tax Act (the "Act"). Our comments follow.

We intend to treat EPSP's in the same manner as employee benefit plans (see ATR-17). That is, if employer contributions can be used to purchase treasury shares, section 7 of the Act will apply and the employer will be denied a deduction pursuant to paragraph 7(3)(b) of the Act.

You provided several arguments as to why an EPSP should only be subject to section 144 of the Act. Our analysis of the issues follows. (Note the discussion of the taxation of employer and employee is general and not intended to be comprehensive.)

An EPSP is a profit sharing plan set up to benefit employees, but the employer contributions, property income, and capital gains and losses of the plan are taxable in the employees' hands each year as they arise. Accrued gains may, upon election by the trustee, also be allocated. If the employee forfeits an amount already allocated, there is a tax credit of 15% awarded in the year of forfeiture. (Proposed amendments would provide the employee a deduction equal to the amount previously included in income.) There is a flow-through of the income type so that the capital gains deduction, foreign tax deduction and dividend tax credit can be claimed by the employees. The employer is entitled to a deduction for the year for all contributions, but the employee contributions, if any, are non-deductible.

There are no restrictions on the type of investments which can be made by an EPSP; the total of the plan property could, therefore, be invested in employer shares (including shares of a corporation with which the employer does not deal at arm's length).

An employees profit sharing plan may be structured as a profit sharing plan but have as a purpose the sale or issuance of employer shares. An employees profit sharing plan is not subject to special taxing provisions that give preferential treatment to the receipt of employer shares by the employee (as compared, for example, to a deferred profit sharing plan). In an EPSP there is immediate taxation and no special deduction relating to employer shares. If the employer were a Canadian-controlled private corporation (CCPC), taxation under section 144 would be especially detrimental to the employee - the tax deferral under subsection 7(1.1) would be inapplicable. There is no apparent tax reason an EPSP set up to purchase employer shares at a discount cannot be treated as a section 7 stock option plan.

In our view, an EPSP can be structured to be an agreement by an employer to sell or issue shares of the employer or a non-arm's length corporation and, in such circumstances, section 7 of the Act would be more specific than section 144 of the Act in its application.

Although the foregoing comments are not binding on the Department, we trust they satisfactorily explain our position.

Yours truly,

for Director
Financial Industries Division
Rulings Directorate