8 July 1999 External T.I. 9909175 - EBP, EMPLOYER RECEIPT, CAPITAL GAIN

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: Is there a flaw in the application of 12(1)(n.1) where an EBP elects under 104(21) to treat an amount as a taxable capital gain?

Position: Not in our view.

Reasons: The intent was not to allow an EBP to pay an amount to the contributing employer in the form of a capital gain. 12(1)(n.1) is designed to include such amounts in the employer’s income as regular income and not as a capital gain.

XXXXXXXXXX 990917
M. P. Sarazin
Attention: XXXXXXXXXX

July 8, 1999

Dear Sirs:

Re: Employee Benefit Plan and Capital Gains

This is in reply to your letter dated April 6, 1999, wherein you asked us to investigate whether or not the results of the interaction of subsection 104(21) and paragraphs 12(1)(m), 12(1)(n.1) and 104(13)(b) of the Income Tax Act (the “Act”) were intended.

Your concern is illustrated in the following example:

(a) In 1999, an employer contributes $300 to an employee benefit plan (“EBP”) for the purposes of acquiring 30 of its shares on the open market at a price of $10 a share. Three shares are allocated to each of 10 employees. The EBP is a trust and the employees make no contribution to it.

(b) In 2000, the price of the employer’s shares increases to $15. One share vests for each beneficiary and a share is distributed to each of the beneficiaries. Consequently, each beneficiary would have an income inclusion of $15 under paragraph 6(1)(g) of the Act and the employer would be entitled to a deduction of $150 under paragraph 32.1(1)(a) of the Act.

(c) In 2001, the price of the employer’s shares increases to $20. One share vests for each beneficiary and a share is distributed to each of the beneficiaries. Consequently, each beneficiary would have an income inclusion of $20.00 under paragraph 6(1)(g) of the Act and the employer would be entitled to a deduction of $150 ($300 - $150) under paragraph 32.1(1)(a) of the Act.

(d) During 2002, one employee quits and forfeits his or her rights to one share. The EBP sells the share at that time for $25 and distributes the $25 to the employer. The provisions of paragraph 12(1)(n.1) apply to include the $25 received by the employer in its income.

Also, in 2002, the price of the employer’s shares increases to $30. One share vests for each remaining beneficiary and a share is distributed to each of the remaining beneficiaries. Consequently, each beneficiary would have an income inclusion of $30.00 under paragraph 6(1)(g) of the Act.

Where an EBP trust makes the distribution described in (d) above and also makes a designation under subsection 104(21) of the Act, the employer will have a capital gain of $15 ($25 - $10). You have pointed out that this results in double taxation as the full fair market value of the share ($25) has already been included in the income of the employer pursuant to paragraph 12(1)(n.1).

Comments

We agree with your analysis of the application of the Act to the illustration described above. However, we are of the view that this result was intended such that the EBP trust, in this example, should not make any designation pursuant to subsection 104(21). In our view, these provisions were designed so that payments received out of an EBP trust are employment income or business income, and that the nature of any income within the EBP trust is not preserved when a payment is made to a beneficiary of the EBP trust.

We trust these comments will be of assistance.

Yours truly,

Paul Lynch
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate