7 February 1996 Internal T.I. 9601717 - DEFERRED SALARY LEAVE 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:

1.Whether plans meet requirements of section 6801 of the Regulations.

2.What are the tax consequences when the arrangement is cancelled.

Position:

Situation 1 - 1. Depends of the contract. 2. SDA rules applicable if condition in section 6801 not met from the beginning. Otherwise, tax in the year of cancellation.

	Situation 2 - 1. No.  2. Application of subsection 6(3) 	and paragraph 8(1)(n).

						February 7, 1996

MONTREAL TAX SERVICES OFFICE HEADQUARTERS
Source Deduction L. Roy
(613) 957-8953
Attention: Denis Hébert
7-960171

Deferred Salary Leave Plan

This is in reply to your memorandum of December 21, 1995 forwarded to us from the Policy and Technical Services Section for reply. The memorandum concerns a letter sent to your office on November 28, 1995, wherein a technical interpretation is requested on salary deferred leave plans ("DSLP") in the following situations.

Situation 1

An employee enters into a deferred leave contract for 5 years. The employee contributes 20% of his salary for the first 4 years and in the 5th year, is expected to take a leave of absence and receive 80% of his salary. However, the contract is cancelled at the end of the third year.

Situation 2

An employee enters into a deferred leave contract for five years but the leave is taken in the first year and repayment is made in the following 4 years. In year one, the employee received 80% of his salary while on leave and in years two and three, he is back at work and pays back 20% of his salary in each year. At the end of the third year, the employee cancels his contract and wants to repay the balance left.

Our comments

In order to determine the tax treatment of an amount received under a DSLP, it is necessary to establish if the DSLP meets the requirements of paragraph 6801(a) of the Income Tax Regulations (the "Regulations").

Subparagraph 6801(a)(i) of the Regulations requires that the arrangement to defer salary be established to permit the employee to fund a leave of absence from employment and not to provide benefits on or after retirement. The leave of absence to be taken by the employee must be of three consecutive months if it is for the purpose of permitting his full-time attendance at a designated educational institution, or six consecutive months in any other case. Also, the leave of absence must commence immediately after the deferred period and the deferred period must not exceed 6 years from the date on which the deferral commence.

Subparagraph 6801(a)(v) of the Regulations states that the arrangement must provide that the employee return to regular employment with the employer after the leave of absence, for a period equal to the leave of absence.

Subparagraph 6801(a)(vi) of the Regulations requires that deferred amounts must be paid out no later than the end of the calendar year commencing after the deferral period ends.

Given these conditions, it is our view that to satisfy the requirements of paragraph 6801(a) of the Regulations, an arrangement must prohibit an employee from withdrawing from the plan at will. However, if the plan terms permit withdrawals in extenuating circumstances, such as in the case of financial or other hardship, and only with permission of the employer, it would not prevent the plan from being a prescribed plan under subsection 6801(a) of the Regulations.

In the first situation you have described, assuming that the plan meets all of the requirements in paragraph 6801(a) of the Regulations, it our view that, if the employer terminates the arrangement, all deferred amounts plus unpaid interest less the applicable withholding tax, should be paid to the employee and included in his income for the year of withdrawal. There is no additional penalty imposed by the Income Tax Act (the "Act") in these circumstances.

However, if the arrangement does not prohibit the employee from withdrawing at will, it is our view that the arrangement between the employer and the employee may not be a prescribed plan pursuant to subsection 6801(a) of the Regulations and that such an arrangement could be subject to the salary deferral arrangement rules from its inception. Therefore, the consequences would be the reassessment of tax for the years in which the salary was deferred.

In the second situation you have described, it is our view that the arrangement does not meet the condition under paragraph 6801(a)(i) of the Regulations, since the leave of absence commenced before any deferral. Therefore, it is our view that the amount paid to the employee during the first year is deemed pursuant to subsection 6(3) of the Act, for the purpose of section 5, to be remuneration for the employee's services rendered during the period of employment.

In this regards, paragraph 4 of Interpretation Bulletin IT-196R2 states that subsection 6(3) of the Act will apply where a person receives a payment pursuant to a contract of employment which provides that part of his remuneration will be payable on a deferred basis.

Pursuant to paragraph 8(1)(n) of the Act, a taxpayer may claim a deduction against income from an office or employment for any required reimbursement of amounts paid to the taxpayer for a period in which the taxpayer did not perform the duties of the office or employment. This deduction is available for the taxation year in which the reimbursement is made. The deduction would be limited to amounts paid to the taxpayer for the period in which the taxpayer did not perform the duties of the office or employment and which were included in computing the taxpayer's income from an office or employment. In addition, the amount reimbursed cannot exceed the total amount received by the taxpayer over that period.

Therefore, in the situation you have described, it is our view that if the employee reimburses the balance outstanding in year three, he will be eligible for a deduction under paragraph 8(1)(n) of the Act in that year.

Section Chief
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch