8 March 1988 Income Tax Severed Letter 5-5347 - [Prepaid Leave 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.

XXXX

Peter Lee (613)957-2746

March 8, 1988

Dear Madam:

Re: Prepaid Leave Plan of XXXX ("PLP")

We are writing in reply to your letter of December 8, 1987 wherein you requested our views on the effect of the following proposed changes to the PLP pursuant to the Income Tax Act ("Act") and the Income Tax Regulations ("Regulations"):

XXXX

Your request is more properly the subject of an advance ruling since the proposed Section 6801 of the Regulations became law on February 4, 1988. However, we would provide the following general comments.

The Act requires amounts of salary that are deferred by way of a "salary deferral arrangement" (an "SDA"), as that term is defined in subsection 248(1) of the Act, to be taxed in the employee's hands on an accrual basis rather than when received, effective after February 25, 1986. An SDA does not include a prescribed plan or arrangement which is described in section 6801 of the Regulations. There are two general types of prescribed plans described: an arrangement in writing that is established before July 28, 1986 (paragraph 6801(1)(b)), and an arrangement in writing that is established after July 27, 1986 (paragraph 6801(1)(a)).

In our opinion, the proposed changes to the terms of the written PLP dated June 4, 1984 are material changes and would constitute a new arrangement. Therefore, the grandfather provisions in 6801(1)(b) would not be applicable to the new arrangement. The new arrangement may not be an SDA however, if it were to meet the definition of a "prescribed plan or arrangement" in 6801(1)(a).

A prescribed plan or arrangement in 6801(1)(a) is a legal arrangement in writing between an employer and employee that meets the following tests:

1. The arrangement must not be established to provide benefits to the employee on or after retirement but rather to fund, through salary or wage deferrals, a leave of absence from employment.

2. The leave of absence must not be less than 6 consecutive months and must commence immediately after a deferral period not exceeding 6 years after the date on which the deferrals for the leave of absence commence.

3. The amount of deferral for a given taxation year cannot exceed 33 1/3 percent of the employee's normal salary or wages.

4. During the period of leave of absence the employee must not receive any salary or wages from the employer (or persons or partnerships not dealing at arm's length with the employer) other than

(a) amounts of salary or wages deferred before that period, or a fixed percentage of salary or wages (such percentage being fixed both for the deferral and the leave periods) or

(b) reasonable fringe benefits usually paid on behalf of the employees by the employer.

5. The amounts deferred must be held by or for the account of a trust governed by a plan that is an employee benefit plan within the meaning of the definition thereof in subsection 248(1) of the Act or are held by or for the account of any person, other than the aforementioned trust. In both cases all income earned for the benefit of the employee must be paid in the year to the employee (or be payable to the employee at the end of the year where the plan is governed by a trust).

6. After the leave of absence, the employee will re-commence regular employment with the employer or an employer that participates in the same or a similar arrangement after the leave of absence for a period that is not less than the length of the period of the leave of absence.

7. Subject to 5 above, all amounts held for the employee's benefit must be paid to him no later than the end of the first taxation year that commences after the end of the deferral period.

In our opinion, the new arrangement would not meet all the above tests. Under the PLP, all income earned on the deferred salary would be paid or payable at the commencement of the period of leave rather than in the year earned. In addition under the PLP, there is no requirement for the employee to re-commence regular employment for a period that is not less than the length of the period of the leave of absence. As a result, the PLP with the proposed changes may fall within the definition of an SDA, as in our opinion, it would not be a prescribed plan or arrangement.

We hope these comments are helpful. They represent our opinions only and are not advance rulings and accordingly are not binding on the Department.

Yours truly,

for Director Financial Industries Division Rulings Directorate