1 November 1994 Internal T.I. 941600A - COST OF LIVING PAYMENTS

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:

A foreign allowance paid to expatriate employees by a Canadian employer. The foreign allowance is paid as a consequence of higher personal or living costs in Canada. The issue is whether the foreign allowances are subject to tax in the hands of the employees.

Position TAKEN:

The allowances would be taxable.

Reasons FOR POSITION TAKEN:

The position is based on previous correspondence issued by this Directorate and the recent Phillips decision (94 DTC 6477).
	                 		  		   		  941600
XXXXXXXXXX	        M. Eisner

Attention: XXXXXXXXXX

November 20, 1994

Dear Sirs:

Re: Employees Compensation

This is in reply to your letter of June 16, 1994 in which you requested our views on whether or not certain amounts paid to employees who relocate to Canada are taxable. We regret our delay in responding.

The situation which has been set out in your letter appears to relate to an actual set of circumstances. Confirmation of the tax consequences of proposed transactions will only be provided in response to a request for an advance income tax ruling following a review of the relevant facts and documentation. The procedures for requesting an advance income tax ruling are set out in Information Circular 70-6R2 and the related Special Release dated September 30, 1992. On the other hand, if the transactions have already occurred, you may wish to submit the relevant information to your local District Taxation Office. We are, however, prepared to provide you with the following general comments.

Our Comments

You are concerned with the type of situation where a corporation (the Employer) which is a wholly-owned subsidiary of a foreign corporation, carries on business in Canada. The Employer has several employment positions staffed by employees from the foreign parent corporation. These expatriate employees generally work in Canada for a period of three to five years.

While employed in Canada, the compensation package of expatriate employees provides for the payment of a foreign allowance. 40% of the total allowance consists of a mobility allowance (15%), a hardship allowance (15%), and a cost of living allowance (10%). The purpose of the foreign allowance is to reimburse the employee for costs expected to be incurred as a result of his or her move to Canada from the home country.

The concern with the above situation is whether payments made in respect of these three components of the foreign allowance are taxable as employment income.

In commenting on the above situation, the first point we wish to make is that it is a question of fact whether an amount paid to an employee constitutes an allowance or a reimbursement. However, helpful comments on allowances were made in Attorney General of Canada v. Roland M. MacDonald 94 DTC 6262 (FCA). In this regard, the Court stated on page 6264 that an allowance (i) "is an arbitrary amount in that it is a predetermined sum set without specific reference to any actual expense or cost"; (ii) "will usually be for a specific purpose"; and (iii) "is in the discretion of the recipient in that the recipient need not account for the expenditure of the funds towards an actual expense". On the other hand, a reimbursement is considered to be a repayment made to a person with respect to an expense or loss incurred.

Where an amount is regarded as being an allowance, the consideration is whether the amount is subject to tax under paragraph 6(1)(b) of the Income Tax Act (the Act). On the other hand, where an amount is regarded as being a reimbursement, the consideration is whether it constitutes a benefit under paragraph 6(1)(a) of the Act. On the basis of the information set out above, although the payments would appear to be structured as allowances, it is not possible to determine with certainty whether the payments in question (or a part thereof) would be viewed as allowances or reimbursements. We have accordingly proceeded to provide comments on the basis that both reimbursements and allowances may be involved.

The second point we wish to make is that we have made the assumptions that

(a) the amounts in question are paid to the expatriate employees as a consequence of the higher personal or living costs that will be incurred by them as a consequence of their employment at the new work location in Canada, and

(b) the sole issue with respect to reimbursements is whether a taxable benefit has been received by the employees for the purposes of paragraph (6)(1)(a) of the Act.

In the event that payments in respect of the three components are considered to involve reimbursements, our comments are as follows:

(a) The Department has accepted that the circumstances in Cyril J. Ransom v. M.N.R. 67 DTC 5235 (Exchequer Court), involved a reimbursement rather than an allowance. However, the decision in Ransom has only been accepted in so far as it relates to the actual loss incurred on the disposition of a personal residence. In this regard, you may wish to refer to paragraph 37 of Interpretation Bulletin IT-470R "Employee Fringe Benefits". In the case of other reimbursements, it is necessary to review the relevant details before it can be determined whether an employee has received a taxable benefit.

The limited scope of the Ransom decision is also supported by the Federal Court of Appeal decision in the Queen v. William R. Phillips 94 DTC 6177. In this case, the employer paid an amount to a relocated employee as a subsidy in respect of the higher cost of acquiring a residence at the new work location. In deciding that the amount was taxable, the Court confined the Ransom decision to its own particular facts and indicated that the amount paid in that case was in the nature of a reimbursement of a capital loss. In addition, on page 6183, the Court stated that "While I support the rule in Ransom, it has no application in a case concerning an expenditure as opposed to a capital loss".

As consequence of the above comments, it is our view that the Ransom decision is not relevant for the purposes of determining whether reimbursements made in respect of the three components constitute taxable benefits.

(b) In Richard D. McNeill v. the Queen 86 DTC 6477 (FCTD), the Treasury Board authorized the payment of an amount that was categorized as an "Air Traffic Linguistic Relocation Allowance". This allowance was comprised of two components. The first was termed an "Accommodation Differential" and the second was referred to as a "Social Disruption Allowance". Although the latter was held to be taxable, the "Accommodation Differential" allowance was held to be non-taxable. Even though the compensation was based on the difference in mortgage costs taking into account the appraised value of property at the old location and the assessed value of similar accommodation at the new location, the Court's conclusion was based on the premise that the payments were made primarily for reasons unrelated to the employment relationship; namely public and labour relations. Accordingly, the tax treatment of the "Accommodation Differential" allowance set out in the McNeill decision was considered unique on its facts and is not considered relevant for the purposes of determining whether or not the reimbursements in this case constitute taxable benefits.

(c) In R. Orrin J. Splane v. the Queen 92 DTC 6021 (FCA), the employee relocated at the employer's request. He received from his employer mortgage interest differential payments to reimburse him for the increased mortgage payments he had to make when he purchased a residence at the new work location. The Court held that the payments in question were not taxable. While the Department has accepted the outcome of this case, the Department does not consider the decision to be a precedent in any situation except where the facts are substantially the same (i.e., where payment is made in respect of a mortgage interest differential). Accordingly, this decision is not considered to be relevant for the purposes of determining the tax treatment of the payments in question since a mortgage interest differential does not appear to be involved.

For clarification purposes, we also note that it is the Department's view that a mortgage interest differential payment is non-taxable in the amount by which the interest cost increased as a result of the increase in the interest rate that was assumed directly as a result of the relocation. For example, where the principal amount of a mortgage at the old location was $150,000 at 10% and the first mortgage at the new location was $150,000 at 12% while the second mortgage at the new location was $25,000 at 15%, any subsidy on the first mortgage would be accepted as non-taxable while the subsidy on the second mortgage is taxable.

The Court, in the course of considering the circumstances of the Phillips case reviewed the Splane decision and concluded that the judge in that case must have felt, in the face of more ambiguous facts, that it was dealing with a capital loss as contemplated in the Ransom decision and that the taxability or non-taxability of a mortgage interest differential should be determined in the above manner.

(d) In the Phillips decision, it was indicated that the employee had increased his net worth as a consequence of the payment of $10,000. While such a circumstance may not be present with respect to the foreign allowance, other comments made in the Phillips decision at page 6184 suggest that relying on the Ransom reasoning to treat other allowances or payments as non-taxable would be inappropriate.

It is the Department's general position that reimbursements made to employees to compensate an employee for increases in personal or living costs are taxable as a benefit under paragraph 6(1)(a). It would, accordingly, seem that reimbursements made in respect of the three components would be taxable.

In the event that amounts received in respect of the three components were to be regarded as being allowances, paragraph 6(1)(b) of the Act would be relevant. Under this provision, allowances for personal or living expenses or for any other purpose are required to be included in income unless they are specifically excluded in that paragraph. On the assumption that none of the excluding subparagraphs apply, it is our view that the allowances would be taxable under paragraph 6(1)(b) of the Act.

A further issue in respect of the situation set out above is the tax treatment of a rent subsidy. A rent subsidy, which is not available to employees in the home country, is paid to all expatriate employees with respect to the difference in rent prices in Canada and the home country. The amount of the subsidy is calculated as being the difference between actual rent paid and 20% of foreign gross income. The expatriate employees are expected to live in central locations in order to be able to make business contacts on behalf of the Employer.

The rent subsidy is not made available to the employee until a lease agreement has been provided to and has been approved by the Employer. The employee must sign a contract with the Employer stating that he or she will use the rent subsidy for the purpose of paying rent only.

Subject to the comments in the following paragraph, it is our view that the rent subsidy would taxable under either paragraph 6(1)(a) or (b) of the Act, depending on whether it is paid as a reimbursement or an allowance. In this connection, we also refer you to the comments on living expenses set out on page 6184 of the Phillips decision.

A consideration in respect of the rent subsidy may be the provisions of subsection 6(6) of the Act in relation to a "special work site" referred to therein. This provision excludes allowances from income that were received in respect of (or the value of) certain personal or living expenses such as lodging which would otherwise be included in income. There are two main requirements that must be satisfied in order for this provision to be applicable; (1) the temporary nature of the duties performed by the relocated employee and (2) the requirement to maintain and have available for the employee's occupancy a principal residence at the place from which he/she was transferred. These requirements are set out in subparagraph 6(6)(a)(i) of the Act. The Department views that phrase "...the duties performed by the taxpayer were of a temporary nature..." as referring to the duration of the duties performed by the individual. Where the duties are expected to provide the individual with continuous employment beyond two years, as determined at the outset, those duties are generally not considered to be of a temporary nature, although the facts of each case must be considered before a final determination can be made. In the case at hand, where the duration of continuous employment well exceeds two years, the prime factor to be considered is the ongoing nature of the duties being performed.

We trust our comments will be of assistance to you.

Yours truly,
J.A. Szeszycki
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch