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.
Dear Sirs:
Re: Prepaid Leave Plan
Your letter of October 2, 1990 to the Sudbury District Office, regarding the prepaid leave program implemented by the XXX has been forwarded to us for reply.
Your questions regarding penalties on termination can best be answered by giving some background on the purpose of these prepaid leave plans as defined in theIncome Tax Act(the “Act”). A salary deferral arrangement (“SDA”) is defined in the Act as an arrangement giving a person a right to receive wages in a later year with one of its main purposes being a postponement of taxes payable. If an employee has a right under a SDA to receive an amount in a later year the Act deems him/her to have received it in the year earned and he is taxed on it in that year.
Various arrangements, which would otherwise qualify as a SDA, are specifically excluded from the definition. One of these exclusions is a prepaid leave plan as defined in Regulation 6801 of the Act. Therefore, such plans must meet the requirements of Regulation 6801 or they may be considered a SDA resulting in the employee being taxed on the deferred amounts in the year earned instead of the year received.
Among other things Regulation 6801 states that the plan must not be established to provide benefits on retirement and that its main purpose must be to fund a leave of absence from work. A provision permitting arbitrary withdrawal by an employee may indicate that the plan is not intended to fund a leave of absence but to defer taxes. Accordingly, it is the Department's position that withdrawals should only be permitted in unusual circumstances, such as financial or other hardship. If it is determined that an employee did not enter the arrangement to fund a leave of absence from work, he/she could be reassessed during his/her years of deferral to include the deferred amounts in income in those years.
XXX We have also reviewed the tax related provisions in the XXX plan and our comments are referenced to the Headings in the plan.
Government Requirements for Prepaid Leave Plans
The minimum leave is six months but there is no maximum leave.
The plan document is incorrect in stating that the leave may be postponed for up to seven years. Regulation 6801 limits the deferral period to six years, after which the leave is to commence.
All amounts deferred must be paid out by the end of the first taxation year commencing after the end of the deferral period. A taxation year for individuals is a calendar year. Therefore, if a deferral period ends on August 31, 1995, all amounts would have to be paid out by December 31, 1996.
Beneficiary Designation
On the death of the participating employee the deferred amounts must be reported on his/her final return to the date of death, and not by the estate. The deferred amounts are considered to be rights or things pursuant to subsection 70(2) of the Act and can be reported an a separate return.
Registered Retirement Savings Plan (“RRSP”)
The statement is basically correct. RRSP contributions are based on earned income which includes wages. The interest earned on the deferred salary is also considered wages but interest on interest is not wages and would not be part of earned income.
Worker's Compensation
This is not administered by Revenue Canada.
Maternity Leave and Sick Leave
The Department does not have a policy specifically for these situations. If an employee is still receiving a salary he/she can continue to defer up to the maximum stated in Regulation 6801. There is no minimum deferral required. Although each situation would be determined on its specific facts, generally, long term disability or maternity leave would appear to be sufficient reason to withdraw from the plan.
Salary Payment During Leave
Both the employer and the employee portion of CPP contributions must be paid during the leave period. If the employee is required to pay both portions of CPP contributions the employer portion will not form part of the employee's gross salary.
We trust that these comments are satisfactory to you.
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© Her Majesty the Queen in Right of Canada, 1991
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© Sa Majesté la Reine du Chef du Canada, 1991
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