27 April 2006 External T.I. 2005-0149321E5 - SDA versus RCA

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: Whether a proposed employee incentive plan would be considered an RCA or an SDA?

Position: Question of fact

Reasons: The purpose for which a plan was established must be determined.

XXXXXXXXXX 							2005-014932
J. Gibbons, CGA
April 27, 2006

Dear XXXXXXXXXX:

Re: Retirement Compensation Arrangement ("RCA")

We are responding to your letter dated August 31, 2005, concerning an employee bonus plan as contemplated by a particular company XXXXXXXXXX In this regard, you have asked for our comments on whether the structure of the particular plan would satisfy the requirements of the definition of a "retirement compensation arrangement" ("RCA") or whether it would result in a "salary deferral arrangement" ("SDA"), within the meaning of the definitions of these terms in subsection 248(1) of the Income Tax Act (the "Act").

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and the subject matter of a request for an advanced income tax ruling submitted in the manner set out in Information Circular IC 70-6R5. However, we have provided some general comments below, which we hope will be of some assistance to you.

An RCA is defined in the Act as a plan or arrangement under which contributions (other than payments made to acquire an interest in a life insurance policy) are made by an employer or former employer of a taxpayer, or by a person with whom the employer or former employer does not deal at arm's length, to another person or partnership in connection with benefits that are to be or may be received or enjoyed by any person on, after or in contemplation of any substantial change in the services rendered by the taxpayer, the retirement of the taxpayer or the loss of an office or employment of the taxpayer (hereinafter simply referred to as "the termination of employment"). However, the definition of an RCA specifically excludes certain plans, including an SDA, from being considered an RCA.

An SDA is a plan or arrangement, whether funded or not, under which any person has a right in a taxation year to receive an amount after the year where it is reasonable to consider that one of the main purposes for the creation or existence of the right is to postpone tax payable under this Act by the taxpayer 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 (including such a right that is subject to one or more conditions unless there is a substantial risk that any one of those conditions will not be satisfied). However, paragraphs (a) through (l) of the definition of an SDA specifically excludes certain plans or arrangements from being considered SDAs.

Since the purpose or purposes of a plan must be determined in order to ascertain whether it is an SDA, this determination cannot be made by only reviewing the terms of a particular plan. Rather, all of the facts and circumstances involving the implementation of a particular plan would have to be reviewed before such a determination could be made. In this regard, the fact that a particular plan provides that benefits will be received thereunder by an employee only after the termination of his or her employment will not always lead to the conclusion that the plan or arrangement was an RCA, since such a plan may still have as one of its main purposes the deferral of tax.

In your letter, you questioned the significance of having the employer's contribution to the plan as discretionary only, and the fact that such discretionary contributions might have to be significant in order to be effective in helping the company retain its skilled workers. Although there is no requirement in the Act that contributions to an RCA be mandatory or non-discretionary, the employer would be denied a deduction for unreasonable contributions pursuant to section 67 of the Act. The issue of the reasonableness of any contribution is again a question of fact.

Another issue raised in your letter is the possibility that amounts contributed to the plan might be loaned back to the employer at the interest rate prescribed for the purpose of determining employee benefits under the Act. Presumably, you are referring to the interest rate prescribed by paragraph 4301(c) of the Income Tax Regulations. The Act does not specifically restrict the type of property that may be contributed to, held or acquired by an RCA, unless it is a share that was acquired as part of a dividend rental scheme, in which case Part XI.1 tax may apply. However, when amounts paid to an RCA are returned in one form or another to the employer, we would seriously question whether the contributions under the arrangement are truly made in connection with benefits that are to be received by the taxpayer on or after the termination of his or her employment or whether the contributions were made under the arrangement for other purposes.

Even if it is established that an arrangement is an RCA, an employer will be subject to an income inclusion in accordance with subsection 56(11) of the Act if a loan is made from the RCA to the employer at less than the rate that would, having regard to all of the circumstances (including the terms and conditions of the loan), have been agreed on at the time the loan was made between parties dealing at arm's length, i.e., fair market interest rates. This is a question of fact, and it is our view that the FMV interest rate cannot be approximated by the rate prescribed by paragraph 4301(c) of the Regulations.

Finally, with regard to your question whether it matters whether a participant of an RCA is a shareholder or related to a shareholder, it is noted that the RCA definition requires only that the contributions be made by an employer or former employer of a taxpayer or by a person with whom the employer or former employer does not deal at arm's length. Thus a shareholder is not prevented from participating in an RCA provided that he or she is also an employee or former employee of the employer. Nevertheless, the fact that a participant is a shareholder would certainly be taken under consideration, along with all of the other facts and circumstances, in determining whether a plan is an SDA or an RCA and whether contributions to the plan are reasonable.

Since it appears that you have an actual proposed transaction in mind, we wish to remind you that an advance income tax ruling may be obtained with regard to many of the issues raised in your letter, provided that all of the material facts are known and those facts can reasonably be expected to prevail. This is explained in paragraph 8 of Information Circular IC 70-6R5.

We trust that these comments will be of assistance.

Yours truly,

for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch