Principal Issues: 1. Does a specific Deferred Salary Leave Plan comply with paragraph 6801(a) of the Regulations?
2. Whether an employee that becomes temporarily out of work during the summer period can participate in a paragraph 6801(a) Plan?
Position: 1. General comments and information.
2. Questions of fact. However, the fact that the employee becomes temporarily out of work during the summer period, should not, in and by itself, prohibit an employee to participate in a DSLP if at the time the arrangement is established it is clear based on the facts of the situation that the conditions of paragraph 6801(a) will be met.
Reasons: 1. Paragraph 6801(a) of the Regulations and previous positions. 2. Paragraph 6801(a) of the Regulations and previous positions.
XXXXXXXXXX 2016-064319 Lucie Allaire, LL.B CPA, CGA, D. Fisc. December 19, 2016
Dear Sir,
Subject: Deferred Salary Leave Plan (DSLP)
This is in response to your letter of April 18, 2016, asking whether a deferred salary leave plan qualifies as a salary deferral arrangement in accordance with the requirements of paragraph 6801(a) of the Income Tax Regulations (the "Regulations").
You also asked whether employees working 10 months a year who are temporarily laid off during the summer can participate in your plan. We understand that these are employees who are not placed on a recall list and have an assignment, before the summer period, for the next school year.
Unless otherwise indicated, all statutory references are references to the provisions of the Regulations.
Our comments
This technical interpretation provides general comments on the provisions of the Act and related legislation, where referenced. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
As a general rule, the provisions of the Act applicable to salary deferral arrangements ("SDA") require that any deferred payment of salary or wages be included in the income of the employee concerned in the year in which the salary or wages are earned although the salary or wages will be received by the employee only in a subsequent year. However, to the extent that a given plan meets the conditions for the application of the DSLPs, the SDA rules will not apply and the deferred salary or wage payments will be taxed when actually received, and not in the year in which they were earned.
A DSLP is an arrangement or plan that allows an employee to defer salary or wages in order to finance a leave of absence from his or her employment. The rules governing the DSLPs are set out in paragraph 6801(a). This letter explains these rules and provides some additional information that can assist an employer who administers a DSLP for its employees.
For the purposes of this letter regarding rules for a DSLP, it is essential to fully understand the meaning of the following terms:
Deferral period: The period beginning with the first deferral of salary or wages and ending on the date on which the employee begins his or her leave and begins to receive deferred amounts under the DSLP, which amounts result from his or her choice to defer salary or wages.
Leave: The period during which the employee is absent from employment and receives deferred amounts under the DSLP.
A DSLP must take the form of a written agreement between an employer and an employee. The terms and conditions of the DSLP written agreement must clearly demonstrate that the main purpose of the plan is to enable the employee to fund, through salary or wage deferrals, a leave of absence from employment [subparagraph 6801(a)(i)] . This main purpose implies that the attributes of a DSLP must meet certain conditions:
(i) The written agreement must clearly state that the DSLP is not intended to provide benefits upon retirement to employees who are members of the plan. Such a stipulation supports the conclusion that the plan in fact is intended to fund the taking of a genuine leave by employees and not to allow them to increase their pension benefits by deferring part of their employment income before taking their retirement.
(ii) The terms and conditions of the DSLP must not provide for voluntary withdrawal from the plan by a participating employee. A provision for such voluntary withdrawal would be contrary to subparagraph 6801(a)(i) since it would signify that an employee could at any times have access to funds held for him or her in the plan. However, a DSLP may provide for early withdrawal from the plan in special circumstances stipulated in the plan that would cause financial hardship to the employee. Generally, such a withdrawal from the DSLP should be subject to the discretion of the employer.
The deferral period
The plan should provide the percentage of salary or wages otherwise payable to the employee that will be deferred, and for what period of time such a percentage will be deferred. Under subparagraph 6801(a)(ii), this percentage may not exceed 33 1/3% of the salary or wages that the employee would reasonably be expected to be received in a year for the employee’s services.
The deferral period cannot exceed six years. This limit provided in subparagraph 6801(a)(i) requires that the leave begin by the expiry of a maximum period of six years after the date on which the deferrals for the leave of absence commenced. However, the deferral period may be for less than six years.
A DSLP is generally structured in one of the following ways:
(i) A plan may provide for the deferral of a certain percentage (not exceeding 33 1/3%) of annual wages or salary for a number of specified years and the receipt by the employee, during the leave, of the accumulated deferred salary or wages. For example, a DSLP may provide for the deferral of 20% of salary or wages during years 1 to 4 and for the receipt of the accumulated salary or wages (of 80%) during the leave in year 5.
(ii) Alternatively, a DSLP may provide for the payment of a fixed percentage of the salary or wages or existing salary or wage scale for employees of the particular employer. The employee accordingly receives a specified percentage of the salary, wages or existing salary or wage scale during the deferral period and also during the leave. Although the percentage must be fixed, the salary or wage scale on which it is based may be variable. For example: a DSLP may provide that participants receive 75% of their salary or wage scale each year over a 3-year deferral period and 75% of the salary or wage scale applicable at the time of the leave in year 4 .
The agreement providing for the DSLP must describe how the deferred amounts of the participating employee will be held. Clause 6801(a)(iv)(A) applies where deferred amounts are paid by the employer to a third party to be held in a trust which constitutes an employee benefit plan ("EBP") for the purpose of the Act. Generally, an EBP is an arrangement whereby contributions are made by an employer to another person under which one or more payments are to be made to or on behalf of employees or former employees. For additional information on EBPs, please refer to Interpretation Bulletin IT-502, Employee Benefit Plans and Employee Trusts. If the deferred salary or wages are held in this manner, the trust must, each year during the deferral period, pay to the employee the income that can reasonably be considered to be the income of the trust earned from the employee's deferred amounts in that year. We have stated in the past that an EBP can deduct administrative expenses or plan expenses from its gross interest income. As a result, the employee participating in the DSLP will only be taxable on the amount of net interest that will be paid to the employee in the year.
If the deferred amounts are not paid into a trust but are instead are held in another manner, clause 6801(a)(iv)(B) applies. In such case, interest or any other amount that may reasonably be considered to have been earned for the benefit of the employee on the deferred amounts must be paid to the employee concerned in the year in which it is earned.
The amounts of interest or income paid to an employee participating in a DSLP in a year during the deferral period are considered employment income and must be reported on the employee's T4 slip. These amounts are subject to source deductions.
During the deferral period, contributions to the Canada Pension Plan must be based on the employee's gross salary or wages less deferred amounts. On the other hand, EI premiums ("EI") must be calculated on the basis of the gross salary or wages of the participating employee (i.e., the amounts the employee would receive if there were no salary deferral). As a result, no EI premiums will be deducted from the deferred amounts paid during the leave of absence.
The leave
Under subparagraph 6801(a)(i), the leave must begin immediately after the deferral period and no later than the expiration of six years after the date on which the amounts began to be deferred.
Leave taken during the term of an agreement (and not only at its very end) would not preclude the application of paragraph 6801(a) if the leave is taken immediately after a deferral period. For example, an employee may take leave in the second year of a three-year agreement. In this instance, the leave is financed in part by deferred salary or wages (during the deferral period, i.e., the first year) and partly by advances of salary, which will subsequently be reimbursed in the third year, which we will refer to as the "repayment period". During the leave, the employee will first receive an amount equal to the amount of remuneration deferred during the deferral period and, subsequently, an amount of pre-paid salary. The total of these two amounts must be included in the employee's income in the leave year under subsections 6(3) and 5(1) of the Act.
In the situation where a plan allows a participating employee to take his or her leave without a deferral period, the leave would be funded solely by advances of salary or wages and the plan would not constitute a DSLP. By virtue of subsections 6(3) and 5(1) of the Act, advances of salary or wages paid to an employee in this case should be included in income in the year they are so paid. As regards the tax treatment applicable to the repayment of such advances, the rules described below under the heading "After the leave" apply.
The rules applicable to a DSLP provide that the leave must be of a minimum duration, which depends on the purpose of the leave:
- Under clause 6801(a)(i)(A), if the purpose of the leave is to allow an employee to attend a full-time designated educational institution, the leave must be for a period of at least three consecutive months.
The term "designated educational institution" is defined in subsection 118.6(1) of the Act. In general, a designated educational institution is an institution that offers post-secondary courses and has been approved under the Canada Student Loans Act, the Canada Student Financial Assistance Act, or the Act Respecting Financial Assistance for Education Expenses of the Province of Quebec. The expression also refers to an educational institution recognized by the Minister of Employment and Social Development, which furnishes or improves the skills required for the pursuit of an occupation. For more information, refer to the Income Tax Folio S1-F2-C1, Education and Textbook Tax Credits.
- Under clause 6801(a)(i)(B), a leave of absence for any other reason must be for a minimum duration of six consecutive months.
The Regulation does not provide for a maximum period of leave. However, under subparagraph 6801(a)(vi), the arrangement must provide that all amounts held for the employee’s benefit under the arrangement will be paid to the employee no later than the end of the first taxation year that commences after the end of the deferral period. This subparagraph is applicable only when the DSLP continues to exist and is operated in accordance with paragraph 6801(a).
During the leave, a participating employee is required by subparagraph 6801(a)(iii) to not receive any salary or wages from the employer, or from any other person or partnership with whom the employer does not deal at arm’s length. For the meaning of "dealing at arm's length," you may refer to the Income Tax Folio S1-F5-C1, Related Persons and Dealing at Arm's Length. The foregoing does not preclude an employee participating in a DSLP from receiving:
- The deferred salary or wages during the deferral period or the percentage of the salary or wage scale that was fixed for the employee in respect of the deferral period and the leave of absence (clause 6801(a)(iii)(A));
- The advances of salary or wages that the employee will repay to the employer during the repayment period (clause 6801(a)(iii)(A));
- Reasonable fringe benefits that the employer usually pays to or on behalf of employees (clause 6801(a)(iii)(B)); and
- The salary or wages from an entity that is not related to the employer for which the employee works during the leave.
As noted above, the amounts paid during the leave (whether deferred amounts or advances of salary or wages) are subject to source deductions and contributions to the Canada Pension Plan. However, only advances of salary or wages paid during the leave are subject to EI premiums.
After the leave
Subparagraph 6801(a)(v) requires that an employee who participates in a DSLP returns to his or her regular employment with the employer for a period not less than that of the leave. This requirement applies regardless of whether the leave is taken during the plan or at the end of the plan. In addition, this subparagraph also allows the employee participating in the plan to return to employment with an employer participating in the same or a similar DSLP.
With respect to the expression "his usual duties", if the employee works full time before the leave, he will have to resume his duties on a full-time basis for an equivalent period - otherwise this condition will not be fulfilled. An employee who works part-time before the leave may resume his or her duties on a part-time basis, either for the same number of hours per week or for a higher number of hours, which may be full-time hours. Nevertheless, an employee, even if resuming his or her usual duties at a higher number of hours than before the leave, must perform his or her duties for a period equal to that of the leave.
For example, if an employee worked 20 hours per week before a six-month leave and returns to work for a period of three months at 40 hours per week, the requirement in subparagraph 6801(a)(v) would not be satisfied. The purpose of this requirement is to ensure that the leave is a genuine leave followed by a return to work, and not a retirement.
Finally, as discussed above, where an agreement provides for the funding of a leave partly through a DSLP and partly through advances of salary or wages, a repayment period follows the leave. Paragraph 6801(a) does not apply during the repayment period, as there is no deferred amount or an EBP within the meaning of subsection 248(1) of the Act during that period. Subsections 6(3) and 5(1) of the Act require that the total salary or wages earned by the employee during that period (the gross amounts, before deduction of the repayment amounts) be included in income. However, paragraph 8(1)(n) of the Act applies so that the employee can deduct, from his or her employment income, the amounts deducted by the employer as repayment of the employee advances received by the employee during the leave. The total salary or wages earned by the employee during this period are also subject to source deductions, Canada Pension Plan contributions and EI premiums.
If a DSLP ceases to meet any of the requirements of 6801(a), it will cease to qualify as a DSLP. An agreement must therefore provide for the termination of the DSLP upon death or termination of the employee's employment, as the conditions in paragraph 6801(a) would cease to be met. In such a situation, all deferred amounts as well as any accrued and unpaid interest, less any applicable source deductions, must be paid to the employee and included in his or her income for the year.
Employees temporarily unemployed
The question of whether employees can participate in a DSLP where each year they are notified before the summer period that they have an assignment for the next school year but are temporarily out of work for the summer period, is one of fact.
In our view, the requirements of paragraph 6801(a) must be met at the time the arrangement is entered into with the employee and throughout the duration of the plan. If, at the time the agreement is made with an employee, the parties expect the employee to lose his or her employment during the plan, the plan would not qualify as a DSLP in respect of the employee and paragraph 6801(a) would not apply. In this case, deferred amounts should be included in the employee's income in the taxation year in which they are earned and deferred rather than in the year in which they are paid to the employee.
However if, at the time the agreement is made with an employee, it is clear from all the facts of the situation that the employee will meet all the requirements of paragraph 6801(a), being temporarily out of work during the summer period should not, in and of itself, prevent the employee from participating in a DSLP.
On the other hand, if an agreement complies with the provisions of the Regulation at the time it is established, but at a later point in time the employment relationship of an employee who participates in the plan ceases to exist, the plan will no longer satisfy one of the conditions of paragraph 6801(a) and it will then cease to qualify as a DSLP at that time.
In such a case, all deferred amounts and any accrued and unpaid interest, less applicable source deductions, must be paid to the employee and included in his or her income for the year in which the employer-employee relationship ceased.
We hope that our comments will be of assistance.
Louise J. Roy, CPA, CGA
Manager
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch