6 April 1994 Internal T.I. 9406086 - PENSION PLAN SURPLUS AND FORFEITURES

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.

Principal Issues:

1)Whether forfeitures under money purchase plan can be used to satisfy employer contribution obligations in year where there is a surplus.

2)Whether surplus in money purchase plan can be used to cover plan's operating expenses.

Position TAKEN:

1)Yes.

2)No.

Reasons FOR POSITION TAKEN:

1)Forfeitures must be allocated or paid out; if not paid out allocation is added to member's pension credit and therefore forces decrease in employer's contribution.

2)Surplus transferred to money purchase plan under 147.3(8) must be used to satisfy employer's obligations to make contributions; if surplus used to cover expenses, fails to meet 147.3(8) condition.

			April 6, 1994

	Head Office	Head Office
	Registered Plans Division	Rulings Directorate
	Stella M. Black	(613) 957-8953
	Director

	Attention:  Mike Bennett
			940608

Use of Plan Surplus/Forfeitures

This is in reply to your memorandum of March 9, 1994, in which you ask us two questions concerning the above-noted topic. You enclosed a copy of a letter from XXXXXXXXXX a copy of your letter of November 20, 1992, and a copy of a facsimile transmission of November 15, 1993, from XXXXXXXXXX for our further information.

The definitions of the terms "forfeited amount" and "surplus" are as follows:

"Forfeited amount" under a money purchase provision of a pension plan means an amount to which a member of the plan has ceased to have any rights, other than a portion thereof, if any, that is payable

(a)to a beneficiary of the member as a consequence of the member's death, or

(b)to a spouse or former spouse of the member as a consequence of the breakdown of their marriage or other conjugal relationship.

"Surplus" under a money purchase provision of a pension plan at any time means such portion, if any, of the amount held at that time in respect of the provision as has not been allocated to members and is not reasonably attributable to

(a)forfeited amounts under the provision,

(b)earnings of the plan that are reasonably attributable to forfeited amounts under the provision, or

(c)earnings of the plan (other than earnings attributable to the surplus under the provision before that time) that will be allocated to members as part of the regular allocation of such earnings.

(Subsection 8500(1) of the Income Tax Regulations - the "Regulations")

A.Employer Contributions When Both Surplus and Forfeitures Exist

You ask first whether forfeitures under a money purchase plan may be used to offset employer contributions where there is a surplus.

Employer contributions to a money purchase plan are governed by subsection 147.2(1) of the Income Tax Act (unless as otherwise stated all references to this statute are to the Income Tax Act S.C. 1970-71-72, c.63 as amended, consolidated to June 10, 1993 - the "Act"). Specifically, an employer contribution is deductible if it is made in accordance with the plan as registered. The relevant prescribed conditions for registration pertaining to employer contributions to a money purchase plan are contained in subparagraphs 8502(b)(i) and (ii) and paragraphs 8506(2)(a) through (c) of the Regulations. It is also a prescribed condition of registration that the pension adjustment limits set out in subsection 147.1(8) of the Act are respected, and these limits restrict the total employee and employer contributions in the year.

Where there are existing surpluses and forfeitures under a money purchase plan, the Act and Regulations prohibit or limit employer contributions in the following manner for years after 1990.

Subsection 147.1(8) of the Act restricts an individual's pension adjustment with respect to an employer (the total of all pension credits with respect to an employer in the year - subsection 8301(1) of the Regulations) to the lesser of the money purchase limit for the year and 18% of the individual's compensation from the employer. Subsection 8301(4) of the Regulations includes in an individual's pension credit for the year with respect to an employer both:

1)employer contributions in the year under the money purchase provision and

2)amounts allocated in the year to the individual attributable to forfeited amounts and earnings thereon.

The effect of this provision is that where there are amounts attributable to allocated forfeitures, the employer's contributions with respect to that individual may be prohibited or reduced. (Unless paid to the employer and unless an extension of time is granted by the Minister under subsection 8506(3) of the Regulations, forfeitures must be allocated to employees by the end of the calendar year following the year in which the amounts were forfeited - paragraph 8506(2)(f) of the Regulations. Forfeited amounts may be paid to an employer by virtue of subparagraph 8502(d)(vii) of the Regulations.) Unallocated forfeitures do not affect the individual's pension adjustment.

The only other provision dealing with the effect of forfeitures on employer contributions is contained in subparagraph 8506(2)(c)(ii) of the Regulations. Employer contributions are not permitted if there are unallocated pre-1990 forfeitures and earnings attributable thereto.

Subparagraph 8506(2)(c)(i) contains a prohibition against employer contributions where there is a surplus.

In our view, the provisions dealing with forfeitures and surplus are independent of each other, and the fact that there is a surplus does not mean that forfeitures cannot be allocated and thus reduce employer contributions.

The prohibition in paragraph 8506(2)(c) does not apply because the allocation of forfeitures is not a "contribution" by an employer. A required employer contribution under the plan might be reduced by the allocation of the forfeitures since the individual's pension credit is increased by the allocation. But the concomitant reduction in the required contribution is not equivalent to a de facto "contribution" of the same amount. (The wording of subsection 8507(3) of the Regulations lends support to this interpretation since it was considered necessary to deem allocations of surplus and forfeitures to be "contribution(s) made on behalf" of the member for purposes of paragraph (a) of that provision.) Furthermore, the employer is not entitled to a deduction for the forfeited amount when it is reallocated; the employer had a deduction for the contribution when it was made in the earlier year(s) with respect to the member who later forfeited the amount.

To conclude, forfeitures must be paid out to the employer or reallocated to employees; if reallocated, they may, depending on the terms of the plan, reduce the required employer contributions in the year notwithstanding the existence of a surplus in the year. The existence of unallocated forfeitures affects the member's pension credit thereby reducing either or both of the contribution components in the calculation of the pension credit.

(We note the comment in part 11.2.6 of the Registered Plans Manual that a reallocation of forfeitures can take the form of a cash refund to members, the refund being taxable in the hands of the members. The only provision specifically dealing with forfeitures, paragraph 8506(2)(f) of the Regulations, does not provide for cash refunds to members; we are not sure how such a payment can be made under the plan and still comply with the registration requirements concerning permissible distributions and permissible benefits. Although the pension adjustment definition in subsection 8301(4) excludes certain amounts "paid to the individual in the year" and the structure of the provision extends the exclusion to both surplus and forfeitures, we are not aware of any explicit provision in either the Act or the Regulations which authorizes payments of forfeitures to members.)

B. Plan Expenses Paid from Surplus

There is nothing specifically in the Act or Regulations dealing with the operating expenses of a registered pension plan. A comment in the Technical Notes to paragraph 8502(d) of the Regulations states that a plan may provide for payment of all reasonable administrative, investment and similar expenses incurred in connection with the plan. This would seem reasonable - the expenses associated with the plan should be paid for with plan funds. Alternatively, the Department considers such expenses to be a business expense to the employer, the deduction of which is provided for under subsection 9(1) and not prohibited by section 18 (see Interpretation Bulletin IT-105).

Surplus is an amount that is not attributable to employer or employee contributions (since these are amounts that must be allocated), nor to forfeitures, earnings on forfeitures, and earnings on plan assets. Generally, as you point out in your letter of November 20, 1992, surplus arises when a defined benefit plan with an actuarial surplus is replaced with a money purchase plan.

On the conversion of a defined benefit plan to a money purchase plan, if the actuarial surplus is transferred in accordance with subsection 147.3(8) of the Act, the surplus must be used to "satisfy employer obligations to make contributions" - the related provision in the Regulations is subparagraph 8506(2)(c)(i). We are assuming that this is the situation when XXXXXXXXXX inquires whether the surplus may be used to cover the plan's operating expenses (i.e. there is no right or intention to allocate the surplus to individual members in which case the transfer would have occurred under subsection 147.3(4.1) of the Act).

If the surplus is used to cover plan expenses, it would not be possible for the surplus to be used "to satisfy employer obligations to make contributions" in accordance with subsection 147.3(8) of the Act. It is our opinion that the plan's operating expenses must be paid out of plan earnings or covered by the employer by payment outside the plan.

We trust the foregoing comments are of assistance.

for Director
Financial Industries Division
Rulings Directorate