16 December 2010 Internal T.I. 2010-0354101I7 - Salary Deferral Arrangement

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.

Principal Issues: Does the receipt of additional salary equal to 20% of usual wages from the employer violate subparagraph 6801(a)(iii) of the Income Tax Regulations?

Position: Yes.

Reasons: Pursuant to 6801(a)(iii) of the Income Tax Regulations an employee cannot receive any salary or wages from the employer (or anyone not dealing at arm's length with the employer) during the leave of absence, other than deferred amounts or regular fringe benefits.

								December 16, 2010

	Revenue Collections Directorate		HEADQUARTERS
	Trust Accounts Division				Income Tax Rulings
	25 McArthur Road, 9th Floor			  Directorate
	Vanier, ON   K1A 0L5				Lori Merrigan
								(613) 957-8979
	Attention: Lorraine Maisonneuve
								2010-035410
				

Salary Deferral Arrangement

This is in response to your memorandum of January 5, 2010, regarding the correct treatment of a salary deferral arrangement ("SDA") where the employee receives an additional salary payment in the year of the sabbatical. Unless otherwise stated, all statutory references in this letter are references to the provisions of the Income Tax Act (the "Act").

The employee entered into a special leave of absence arrangement with his employer for the years 2004 through to 2009. According to the terms of the arrangement, the employee received 80 % of his usual salary for four years, deferring 20% each year for four years to be received in the fifth year (the "Sabbatical Year"). However, in the Sabbatical Year, instead of receiving only the deferred salary amount equal to 80% of his usual salary, the employee also received additional salary from his employer equal to 20% of his usual wages.

The employer reported 100% of the employee's earned income in each of the deferral years (and not the 80% actually received by the employee), with the remaining 20% additional salary reported in the Sabbatical Year. The employee filed his 2004 and 2005 tax returns in accordance with the amounts that the employer reported on his T4, reporting 100% of his earned income for those first two years. However, in the 2006 and 2007 taxation years, the employee reported only 80% of the amount reported on his T4, which was 80% of the salary he had earned in those taxation years.

We understand that there is a dispute between the employer and the employee as to how this arrangement should have been reported for tax purposes. The employer has treated this arrangement as a SDA as defined in subsection 248(1) and issued the T4 returns on an accrual basis. However, the employee believes this arrangement qualifies as a deferred salary leave plan ("DSLP") under paragraph 6801(a) of the Income Tax Regulations (the "Regulations") and believes the amounts should have been taxed only when received.

Subsection 248(1) defines salary deferral arrangement as "a plan or arrangement..... in respect of an amount that is, or is on account or in lieu of, salary or wages of the taxpayer for services rendered by the taxpayer in the year or a preceding taxation year...". Generally, the SDA provisions require that salary deferrals be included in an employee's income on an accrual basis (i.e., in the year the salary is earned) notwithstanding that the salary may only be received in a subsequent year, however, there are some exclusions. One of those exclusions is a prescribed plan or arrangement.

Paragraph 6801(a) of the Regulations prescribes the conditions applicable to a DSLP that it must meet to qualify as a prescribed plan or arrangement that is excluded from being a SDA. One of those conditions outlined in subparagraph 6801(a)(iii) of the Regulations states that a DSLP must provide that throughout the leave of absence (the Sabbatical Year) the employee does not receive any salary or wages from the employer, or from any other person or partnership with whom the employer does not deal at arm's length, other than the deferral amounts and reasonable fringe benefits the employer usually pays. It is our opinion that the additional 20% of salary and wages that the employee received from the employer during the Sabbatical Year, over and above the deferred salary amount, would be considered to be additional salary or wages from the employer during the leave of absence. Therefore, in our view, this special leave of absence arrangement does not meet the prescribed conditions in paragraph 6801(a) of the Regulations, and is therefore not a prescribed plan or arrangement.

In our opinion, the employer has been correctly reporting the income on an accrual basis as a SDA pursuant to subsection 248(1). In each of the taxation years during the deferral period the employee should have been reporting 100% of his earned income on his tax return, as reported on his T4 slip that he received from the employer.

We trust that these comments will be of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Mary Pat Baldwin
Manager
Deferred Compensation Arrangements and Retirement Plans Section
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch