17 July 1995 External T.I. 9500075 - VACATION BUYING & SELLING IN A FLEX PLAN

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:

whether a flexible benefit plan which permits the purchase of vacation will be considered a salary deferral arrangement

Position TAKEN:

question of fact

Reasons FOR POSITION TAKEN:

if a plan permits the carryforward of purchased vacation, such a plan could be a SDA depending on whether the potential tax deferral associated with such a carryforward can be considered one of the main purposes of the arrangement & thus we will not rule or offer an opinion.

A. Humenuk
XXXXXXXXXX 950007

Attention: XXXXXXXXXX

July 17, 1995

Dear Sirs:

Re: Health Care Plans

We are replying to your letter of January 3, 1995 concerning flexible benefit plans. We apologize for the delay in our response.

You describe a flexible benefit plan in which an employee is allocated flex credits equal to 4% of the employee's gross pay. The source of the flex credits is a 2% reduction in the employee's pay and a 2% contribution by the employer. Prior to the beginning of the plan year, the employee allocates the flex credits to various benefits available under the plan, including medical and dental plans which are intended to be private health services plans as defined in the Act. Any flex credits not so allocated are paid to the employee in cash. One of the benefits that may be acquired with the flex credits is additional vacation days. The additional leave is considered to be used prior to any regular vacation entitlement and must be used within the plan year. You ask for confirmation of the Department's position with respect to the tax consequences associated with the conversion of salary entitlement to flex credits and with the purchase of vacation by means of flex credits.

Where employees forego amounts to which they are otherwise entitled in order to obtain or increase the amount of credits available under a flexible benefit plan, the Department considers any such additional credits to be taxable under section 5 of the Income Tax Act at the time that they are credited to the plan. This applies for example, to credits obtained in exchange for salary bonuses, other increases in remuneration, vacation or other leave credits, notwithstanding that the flex credits so acquired may be applied to a plan which provides benefits which would otherwise have been non-taxable to the employee.

It is the trading of the entitlement to salary or other taxable amount by the employee which triggers a taxable event and not the use of the flexible credits so obtained. The exclusion from employment income for benefits described in subparagraph 6(1)(a)(i) of the Act applies in respect of benefits received or enjoyed by an employee from his or her employer's contribution to the specified plans. The exemption does not apply in a situation where an employee purchases coverage under a plan mentioned in subparagraph 6(1)(a)(i) of the Act, either through payroll deductions or through the forfeiture of an amount to which the employee was otherwise entitled (such as vacation, salary, right to an increase in salary or bonus) since such a contribution is not made by the employer.

In our view the conversion of salary or other taxable amounts to flex credits represents a payment in kind and as such the employee is taxed on the value of the amount converted to flex credits at the time of the conversion. Accordingly, in the situation you describe, the employees would be taxed on the gross amount of salary to which the employee is entitled without regard to the 2% reduction for flex credits in the year in which the flex credits are allocated.

You also asked us to confirm that additional vacation purchased must be used in the calendar year in which it is purchased and that it be used only after all other vacation entitlement has been exhausted in order for the arrangement not to be considered a salary deferral arrangement as that term is defined in the Act.

As stated at the 1991 Corporate Management Tax conference, a plan which permits the rollover or cash out of purchased vacation leave may be a salary deferral arrangement. In order to determine whether any particular arrangement is a salary deferral arrangement, we must consider the definition found in subsection 248(1) of the Act. Briefly stated, a salary deferral arrangement is:

• a plan or arrangement (whether funded or not),
• between an employer and,
• an employee who has a right to receive an amount under the arrangement, and
• one of the main purposes for the creation or existence of the right is to postpone the tax payable under the Act by the employee in respect of salary or wages for services rendered in the year or a preceding year.

From this definition, it can be seen that an arrangement which permits an employee to purchase vacation for use in a future year could be a salary deferral arrangement since the deferral of the vacation postpones the tax payable which would otherwise be payable on that vacation. However, it is a question of fact as to whether the deferment of tax is one of the main purposes of the arrangement. The existence of other purposes does not itself support a finding that tax deferment is not one of the main purposes of the arrangement. Accordingly, we cannot provide you with a ruling or an opinion concerning a plan which permits a carryforward of the purchased vacation beyond the end of the plan year since the employee who has purchased vacation has a right to receive an amount and it is not possible to determine if the main purpose for the creation of that right was to postpone tax otherwise payable at that time.

We trust our comments will be of assistance to you.

Yours truly,
P.D. Fuoco
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch