10 March 2011 External T.I. 2010-0383461E5 - Deferred Salary Leave Plans

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: What are the tax implications where an employee who is currently enrolled in a DSLP with their employer terminates the arrangement before taking their leave of absence and enrols in a new DSLP with the same employer, where the leave period under the new DSLP commences beyond the six year time limit allowed under the original DSLP

Position: Question of fact - general comments provided

Reasons: Such a determination would depend on the main purpose for establishing both the original DSLP and the new DSLP.

XXXXXXXXXX 					2010-038346
						Jason R. Ward
March 10, 2011

Dear XXXXXXXXXX :

Re: Deferred Salary Leave Plan ("DSLP")

This is in response to your email dated October 12, 2010 and further to our telephone conversation of October 14, 2010 (XXXXXXXXXX /Ward), wherein you requested our comments on the tax implications where an employee wishes to terminate their participation in an employer's DSLP (the "Original DSLP") before taking their leave of absence under that arrangement and subsequently enroll in a new DSLP (the "New DSLP") with the same employer.

In particular, you briefly describe a situation where one of your employees began making contributions under the Original DSLP in XXXXXXXXXX and was slated to commence their leave period under that arrangement in XXXXXXXXXX . In late XXXXXXXXXX , the employee advised you that they wish to terminate their participation in the Original DSLP without taking their leave of absence, and to have all deferred amounts paid to them at that time. The employee subsequently informed you that they wished to enroll in the New DSLP; under the terms of that arrangement, the employee would begin making contributions to the plan in XXXXXXXXXX and take a six month leave of absence commencing in XXXXXXXXXX .

The particular situation outlined in your correspondence appears to relate to a factual one, involving one or more specific taxpayers. It is not this Directorate's practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. We are, however, prepared to provide the following general comments which may be of assistance.

A DSLP is a plan or arrangement that permits an employee to defer salary or wages in order to fund a leave of absence from his or her employment. Generally, the salary deferral arrangement ("SDA") provisions in the Income Tax Act (the "Act") would 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, if an arrangement complies with the DSLP rules, the SDA provisions will not apply and the employee's salary deferrals will be taxed when actually received, rather than when earned.

The rules governing DSLPs are set out in paragraph 6801(a) of the Income Tax Regulations (the "Regulations"). In particular, subparagraph 6801(a)(i) of the Regulations requires that it is reasonable to conclude that the arrangement is established for the main purpose of permitting the employee to fund a leave of absence and not to provide benefits on or after retirement. All salary deferrals under the arrangement must be completed in a deferral period that commences on the date the deferrals begin and ends before the leave of absence occurs. The deferral period cannot exceed six years and the leave of absence must follow immediately after the deferral period. The period of leave under the DSLP may not be less than three months in the case where the participant will attend, on a full-time basis, a designated educational institution, and six months in any other case.

It is the CRA's position that where an arrangement satisfies the conditions of paragraph 6801(a) of the Regulations at the time it is established, but at some later time due to unforeseen circumstances either the employee or the employer cannot abide by those conditions, the arrangement will fail to meet the requirements of paragraph 6801(a) of the Regulations at that later time. Accordingly, the employer should immediately terminate the arrangement and all deferred amounts plus unpaid interest, if any, should be paid to the employee, less any applicable withholding tax. There is no additional penalty imposed by the Act and no need for the employer to notify the CRA in these circumstances. If the arrangement is not terminated, it would be subject to the SDA rules in the taxation year it is known that the arrangement ceases to satisfy the conditions of paragraph 6801(a) of the Regulations and the deferred amounts would be taxable employment income in that year. In addition, any further amounts that are deferred and any interest accrued after the time the arrangement becomes an SDA are taxable in the year of deferral.

On the other hand, if it is evident that an employee entered into a DSLP arrangement knowing at that time that they would be unable to abide by the provisions of the agreement, the arrangement would fail to comply with paragraph 6801(a) of the Regulations from the outset and would be an SDA. The employee would be liable for taxes, interest and perhaps penalties on the amounts deferred for the years the amounts were deferred. In such cases, reassessments of prior year income tax returns may be required for unreported deferred salary in those prior years. Deferred amounts and interest earned thereon are, by virtue of subsections 6(11) and 6(12) of the Act, included in the employee's income pursuant to paragraph 6(1)(a) of the Act for the year in which the amounts are deferred or the interest is earned. Any other amount received under an SDA would be included in the employee's income pursuant to paragraph 6(1)(i) of the Act.

As discussed with you in our telephone conversation of October 14, 2010, we have previously opined that if the CRA is able to prove that the employer and/or the employee knew at the time the agreement was entered into that the conditions in paragraph 6801(a) of the Regulations would not be met, a gross negligence penalty could be assessed in accordance with subsection 163(2) of the Act to either the employer or employee or to both of them (see document number 2008-0298261I7, dated April 15, 2009, a copy of which we have previously forwarded to you).

The determination of the main purpose for establishing a particular DSLP, and whether the penalty imposed under subsection 163(2) of the Act applies in a given case, involves questions of fact that must be resolved on the basis of the documents and circumstances in the particular case. Based on the limited information provided to us, we are unable to provide an opinion in respect of the specific situation outlined in your letter.

We trust the above comments will be of assistance.

Yours truly,

Mary Pat Baldwin, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch