2002 Ruling 2001-0112123 - EMPLOYEE PROFIT SHARING 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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Does the proposed arrangement qualify as an employee profit sharing plan?

Position: Yes, provided a valid election is made and provided the contributions are reasonable.

Reasons: The plan is correctly structured as an EPSP.

XXXXXXXXXX 		2001-011212

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letters of XXXXXXXXXX, in respect of your request for an advance income tax ruling on behalf of the above-noted corporation.

Definitions and Abbreviations

In this letter, the following terms have the meanings specified:

(a) "Act" means: the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof;

(b) "CCRA" means: the Canada Customs and Revenue Agency;

(c) "Corporation" means: XXXXXXXXXX, incorporated under the laws of Canada on XXXXXXXXXX and renamed on XXXXXXXXXX,
XXXXXXXXXX

CCRA account number XXXXXXXXXX ,
XXXXXXXXXX Tax Services Office, and
XXXXXXXXXX Tax Centre;

(d) "Employees" means: the employees of the Corporation, including the Shareholder;

(e) "Fiscal Year" means: the financial year of the Corporation as determined by the board of directors of the Corporation, for tax purposes, from time to time;

(f) "Investors" means: XXXXXXXXXX, a private, taxable, Canadian corporation incorporated in XXXXXXXXXX, and XXXXXXXXXX, XXXXXXXXXX;

(g) "Member" means: an Employee who participates in the Plan;

(h) "Plan" means: the proposed XXXXXXXXXX, which is the subject of this ruling, a draft copy of which was provided by you;

(i) "Profits" means: the net income before taxes of the Corporation as determined by the Corporation's auditors according to generally accepted accounting practices;

(j) "Regulations" means: The Income Tax Regulations;

(k) "Shareholder" means: XXXXXXXXXX;

(l) "Target "A"" means XXXXXXXXXX; and

(m) "Trust" means: the trust governed by the Plan, formed under the laws of XXXXXXXXXX, whose trustees (the "Trustees") will all be residents of XXXXXXXXXX and will include XXXXXXXXXX.

Facts

1. The Corporation is a taxable, Canadian-controlled private corporation as defined in subsection 125(7) of the Act.

2. XXXXXXXXXX.

3. XXXXXXXXXX. These services extend, in some cases, to assisting business development and strategic planning for the business that is the recipient of the investment (the "Target").

4. The Corporation's private placement activities include the following:

XXXXXXXXXX.

5. The Investors wish to make various venture capital investments and have retained the services of the Corporation to recommend, structure and manage these venture capital investments on their behalf.

6. In consideration for the services rendered by the Corporation, the Investors have agreed to pay a management fee to the Corporation equal to $XXXXXXXXXX, plus an annual monitoring fee equal to XXXXXXXXXX % of the amount of the investments made by them and not written off. In addition, the Investors have agreed to provide the Corporation with an option (the "Investor Option") to acquire XXXXXXXXXX % of the Investors' investments in the Targets for an exercise price equal to the Investors' respective cost of their interests in the Targets. The Investor Options are exercisable at any time from the date that the Investors make an investment in a Target.

7. In addition to the management fees received from the Investor, the Corporation may also receive stock options, warrants or rights in the Targets (the "Target Options"). The Target Options if granted, will be granted directly by the Target to the Corporation and will generally provide for an exercise price equal to the fair market value of the shares that are the subject of the Target Options on the date the Target Options are granted.

8. On XXXXXXXXXX, on the recommendation of the Corporation, one of the Investors acquired approximately XXXXXXXXXX shares in the capital stock of Target "A" for a total acquisition price of $XXXXXXXXXX (or approximately $XXXXXXXXXX per share). In consideration for this recommendation, the Corporation received from the Investor an annual management fee of $XXXXXXXXXX and an option to acquire up to XXXXXXXXXX% of the Investor's investment in Target "A" at a price equal to approximately $XXXXXXXXXX per share (the "Investor "A" Option").

9. In addition to the management fees and Investor "A" Option received from the Investor described in 7 above, the Corporation also received an option to acquire XXXXXXXXXX voting and participating shares in the capital of Target "A" for a price of $XXXXXXXXXX per share (the "Target "A" Option"). Because the current estimated value of such shares of Target "A" is $XXXXXXXXXX per share, the Target "A" Option currently have a nominal value.

10. In order to reward its Employees who contribute towards its business, the Corporation desires to implement the Plan.

11. The Corporation currently has XXXXXXXXXX Employees. No Employee is related to any other Employee.

Proposed Plan

12. The Corporation will establish the Plan under which funds will be held in trust for the benefit of the Members.

13. All of the Corporation's current Employees will become Members of the Plan.

14. In accordance with the Plan, in each Fiscal Year in which the Corporation realizes profits or within XXXXXXXXXX days thereafter, the Corporation will pay to the Trustees for such Fiscal Year out of Profits a contribution equal to the lesser of:

(a) a specified amount of the aggregate salaries paid to the Members by the Corporation for the year, such amount to be determined by the board of directors of the Corporation, provided that the specified percentage shall not be less than XXXXXXXXXX% and shall not be greater than XXXXXXXXXX%; and

(b) the Corporation's Profits for the Fiscal Year.

15. The Corporation will file an election under subsection 144(10) of the Act such that the contributions it makes out of the Corporation's Profits will be deemed to be payments computed by reference to the Corporation's Profits.

16. Members will not be entitled to contribute under the Plan.

17. The Trustees will allocate contributions, profits of the Plan, and any capital gains and capital losses incurred, realized, received or accrued by the Plan among member accounts ("Member's Account"). Each Member will have a Member's Account. Subject to 18, 19, 20 and 22 below, the Trustees will determine at what time and upon the happening of what contingency the profits of the Plan, and any capital gains and capital losses incurred, realized, received or accrued by the Plan will be allocated to each Member's Account. Each Member's Account shall be a complete record of:

(a) all contributions allocated to the Member;

(b) all income (including dividends), capital gains and capital losses incurred, realized, received or accrued by the Plan to the extent that such income, capital gains or capital losses have been allocated to the Member;

(c) all amounts allocated to the Member under 20(d) below;

(d) all amounts or property distributed to the Member or to a beneficiary of the member as defined in the Plan; and

(e) all expenses allocated to the Member which have not been deducted for the purpose of determining the income allocated to the Member pursuant to 17(b) above.

18. A Member's Account will be maintained for the Member until a full distribution is made to the Member or a beneficiary of the Member, in accordance with the provisions of the Plan.

19. Immediately upon receipt thereof, and in no case later than the end of each taxation year of the Trust, the Trustees will, according to their own discretion, allocate the contributions received during the taxation year of the Trust to the Members.

20. No later than the end of each taxation year of the Trust, the Trustees shall, according to their own discretion, allocate the following amounts to or among a Member's Account or Members Accounts:

(a) all income of the Trust (including dividends and foreign income) realized by the Trust in the taxation year of the Trust;

(b) capital gains of the Trust for the taxation year of the Trust;

(c) capital losses of the Trust for the taxation year of the Trust;

(d) the total of all amounts each of which is an amount that may be deducted under subsection 144(9) of the Act in computing an individual's income because that individual ceased to be a Member in the year; and

(e) such other property or amounts that the Trustees determine are payable out of the Trust to a Member out of that particular Member's Account.

21. At any time, or from time to time, the Trustees may make an election, pursuant to and in accordance with subsection 144(4.2) of the Act, to treat any capital property as having been disposed of. When the election is made, the Trust will be deemed to have disposed of the capital property for proceeds of disposition equal to the amount designated in the election and to have reacquired the property immediately thereafter at a cost equal to those proceeds. Any resultant deemed capital gain or loss of the Trust will be allocated to or among a Member's Account or Members' Accounts at the discretion of the Trustee.

22. For greater certainty, the Trustees may allocate the amounts described in 17, 19, 20 and 21 above, entirely according to their own discretion and need not allocate such amounts on a pro rata or any other basis among the Members.

23. In the event that a Member's employment with the Corporation is terminated for cause, the Corporation shall advise the Trustees in writing and thereupon all amounts contained in or allocated to that Member's Account shall be forfeited and the amounts thereof shall be reallocated to the remaining Members' Accounts no later than the end of the Fiscal Year. Such reallocated amounts shall be divided in such shares and proportions between the remaining Members' Accounts as the Trustee in his discretion shall determine.

24. An employee whose employment has been terminated (either voluntarily or involuntarily) may be entitled to receive an allocation from the Plan for the year in which the termination occurred even though the allocation may occur subsequent to the termination. For these purposes, a termination is deemed to occur on the date that the employee is no longer entitled to receive salary from the Corporation (i.e., at the end of the agreed notice period).

25. The Trust will generally acquire investments in marketable securities using the funds contributed to it by the Corporation. The Trust may acquire some or all of the Investor Options and any Target Options referred to in 6 and 7 above from the Corporation. The purchase price for each Investor Option (the "Investor Option Purchase Price") or Target Option (the "Target Option Purchase Price") will be its fair market value at the time of the sale of the relevant Investor Option or Target Option by the Corporation to the Trust.

26. The Trust will specifically acquire from the Corporation, the Investor "A" Option and the Target "A" Option described in 8 and 9 above, using the funds contributed to it by the Corporation. The purchase price for the Investor "A" Option (the "Investor "A" Option Purchase Price") and the Target "A" Option (the "Target "A" Option Purchase Price") will be their respective fair market values at the time of the sale of the Investor "A" Option and the Target "A" Option to the Trust. For greater clarity, the determination of the Investor "A" Option Purchase Price and the Target "A" Option Purchase Price will be based on the best available information at the time of the acquisition of the Investor "A" Option and the Target "A" Option and will not take into account any specific accretion in value that, in fact, occurs subsequent to the date of acquisition by the Trust or the value of the shares of Target "A" on the date that the Target "A" Option or the Investor "A" Option is exercised, if such options are in fact exercised, to the extent such accretions in value would not normally be considered in the determination of the fair market value of such options and shares using generally accepted valuation principles.

27. It is the intention of the Corporation to continue the Plan in effect indefinitely but the Corporation reserves the right to amend, modify or discontinue the Plan, in whole or in part, at any time, provided, however, that:

(a) any such amendment or modification which may affect the rights, duties and responsibilities of the Trustees shall not become effective until the Corporation has received the written consent of the Trustees thereto;

(b) no amendment or modification to the Plan shall adversely affect the rights of the Members up to the date of such amendment or modification; and

(c) if the Plan is terminated, the Corporation shall not recover any amounts paid into the Trust up to the date of such termination and all of the property of the Trust must and shall be used for the sole benefit of the Members and/or their beneficiaries.

Purpose of the Proposed Plan and Related Transactions

28. The purpose of the proposed transactions is to provide an incentive to the Corporation's Canadian Employees, to reward their efforts, and to attract high-quality new employees, by providing a direct financial reward linked to the success of both the Corporation and the companies in which the Corporation's clients invest.

Additional Information

29. To the best of your knowledge, none of the issues involved in this ruling are:

(a) in an earlier return of the Corporation, the Employees, or any person related to the Corporation or the Employees;

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the Corporation, the Employees, or any person related to the Corporation or the Employees;

(c) under objection by the Corporation, the Employees, or any person related to the Corporation or the Employees;

(d) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; nor

(e) the subject of a ruling previously issued by the Directorate to the Corporation, the Employees, or any person related to the Corporation or the Employees.

Rulings

Provided that:

(a) the preceding statements constitute a complete disclosure of all relevant facts, the proposed plan and transactions, and the purpose of the proposed plan and transactions;

(b) the Plan is implemented as proposed;

(c) the election under subsection 144(10) of the Act (referred to in 15 above) is made in accordance with the provisions of the Act; and

(d) if the Plan is amended as provided in 27 above, it will be amended in such a manner that the Plan continuously satisfies the provisions of the Act or any successor provisions thereto upon which these Rulings are provided,

we rule as follows:

A. The Plan will be an employee profit sharing plan as defined in subsection 248(1) of the Act.

B. Depending on the proper characterization of the Investor "A" Option by the Corporation at the time of the disposition of the Investor "A" Option by the Corporation to the Trust as discussed in 26 above, the Corporation will, as determined at the time of the disposition, realize either a capital gain, computed in accordance with subdivision c of the Act, or income, as computed under subdivision b of the Act.

C. Depending on the proper characterization of a Target "A" Option by the Corporation at the time of the disposition of the Target "A" Option by the Corporation to the Trust as discussed in 26 above, the Corporation will, as determined at the time of the disposition, realize either a capital gain, computed in accordance with subdivision c of the Act, or income, as computed under subdivision b of the Act.

The above rulings, which are based on the Act in its present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001, and are binding on the CCRA provided that the proposed Plan is implemented, and the proposed transactions are initiated by XXXXXXXXXX.

Comment:

Except as expressly stated, these rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly the reasonableness or fair market value of the management fees, monitoring fees or any of the outlays or expenditures referred to in this letter.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch