21 November 2016 Internal T.I. 2016-0641961I7 F - DSU Plan
Principal Issues: (1) Would a DSU plan providing for the redemption of units in the event of the termination of the plan upon a change in control of the employer or the termination of the plan upon a change in control consistent with the provisions of section 409A of the Internal Revenue Code comply with the requirements of paragraph 6801(d) of the Income Tax Regulations? (2) If not, to which taxation years will the salary deferral arrangement rules apply? (3) Would the grandfather rule provided in 2015-0610801C6 apply to the current situation?
Position: (1) No. (2) All amounts deferred in accordance with the plan, including dividend equivalents and all other additional amounts that accrued to, or for the benefit of the participants, will be included in the computation of income of the participants in the earliest non-statute-barred taxation year following the year in which the income should have been included based on subsection 6(11). (3) No.
Reasons: (1) The timing of payments further to the termination of the plan upon a change in control of the employer can be earlier than the time of the participant’s death, retirement or factual loss of office or employment required under paragraph 6801(d) of the Income Tax Regulations. (2) The Plan never qualified under paragraph 6801(d) of the Income Tax regulations. (3) The DSU plan does not respect the provisions of paragraph 6801(d) as it provides for the redemption of units in the event of the termination of the plan upon a change in control of the employer. Since this distribution event allows us to conclude that the Plan does not meet the requirements of paragraph 6801(d), it is our view that the grandfather rule established in document 2015-0610801C6 does not find application.
November 21, 2016
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Tax Services Office XXXXXXXXXX XXXXXXXXXX Attention: XXXXXXXXXX |
Headquarters Income Tax Rulings Directorate Marie-Claude Routhier, LL.B., D.D.N., M. Fisc. 2016-064196 |
Deferred Share Unit Plan
We are providing this memorandum to you in response to your e-mail sent on April 11, 2016 to the Tax Rulings Directorate (the "Directorate") in which you requested our views regarding the application of paragraph 6801(d) of the Income Tax Regulations (the "Regulation") in respect of a deferred share unit plan.
Unless otherwise indicated, all legislative references in this memorandum are to the provisions of the Income Tax Act (the "Act").
Definitions
In this memorandum, the following terms and abbreviations have the following meanings:
"Bonus" means any annual bonus to which an Officer is entitled under the Corporation's short-term incentive plan, including any discretionary bonus granted by the Board of Directors of the Corporation for the previous taxation year of the Corporation ;
"Clause" means any clause of the Plan;
"Compensation" means any compensation payable to a Director for services rendered as a member of the Board of Directors of the Corporation;
"Corporation" XXXXXXXXXX;
"Deferred Compensation" means the portion of the Compensation or Bonus that a Participant elects to defer, as the case may be, or that the Board of Directors of the Corporation elects to pay in the form of Units;
"Director" means any person who is a member of the Board of Directors of the Corporation;
"Election" means the election described in paragraph 3 of this memorandum;
"Former Participant" means any Participant whose Units have been redeemed by the Corporation as of the date hereof, following the occurrence of any of the events described in paragraph 11 of this memorandum;
"Officer" means any senior employee of the Corporation or any of its Canadian or US subsidiaries, XXXXXXXXXX as determined by the Board of Directors for the purposes of determining the eligibility of a Plan Participant;
"Participant" means any Director and any Officer who participates in the Plan;
"Plan Year" means any 12-month period commencing on January 1 and ending on December 31 of any year;
"Plan" means the deferred share unit plan authorized by the Board of Directors of the Corporation on XXXXXXXXXX and the final version of which was approved on XXXXXXXXXX;
"Retirement" means, in the case of a Director, the termination of his or her office as a Director of the Corporation, pursuant to Clause XXXXXXXXXX. In the case of an Officer, the term "retirement" means the retirement of the Officer from the Corporation or any of its Canadian or US subsidiaries as defined for the purposes of the Corporation's pension plans. Notwithstanding the foregoing, in the case of a US Participant, the term "retirement" has the meaning provided for in section 409A of the US Code, as set out in Clause XXXXXXXXXX;
"SDA" means a salary deferral arrangement, as defined in subsection 248(1);
"Shares" means the common shares in the capital stock of the Corporation;
"Unit" means a deferred share unit granted to a Participant in accordance with the Plan;
"US Code" means the US Internal Revenue Code;
"US Participant" means any Participant who is a US citizen or resident in the United States (Clause XXXXXXXXXX);
"Value of Units" means the average closing price of the Shares of XXXXXXXXXX of XXXXXXXXXX immediately preceding the time at which the value of the Units is to be determined for the purposes of the Plan.
Facts
Our understanding of the facts provided by you and of the principal terms of the Plan is as follows:
1. The Plan was established for the benefit of the Participants, who are primarily Canadian residents.
2. In accordance with Clause XXXXXXXXXX, the Plan came into effect on XXXXXXXXXX for Directors in respect of their Compensation and on XXXXXXXXXX for the Officers in respect of any Bonus payable to them in XXXXXXXXXX for the Corporation's XXXXXXXXXX taxation year and for any Bonus payable for a taxation year subsequent thereto.
3. Under Clause XXXXXXXXXX, the Plan allows Participants to make an annual irrevocable election to receive all or part of their Compensation or Bonus, as the case may be, in the form of Units.
4. For the first year of participation of a Participant in the Plan, Clause XXXXXXXXXX states that the election, to be valid, must be completed, signed and sent to the Corporation within XXXXXXXXXX days following the notice of designation of the Participant to the Board of Directors of the Corporation or within XXXXXXXXXX days following notice of his or her eligibility under the Plan, as the case may be.
5. For subsequent years, under Clause XXXXXXXXXX, the Election must be sent to the Corporation before the end of the Plan Year preceding the Plan Year for which the election is made. If no election notification is given to the Corporation in respect of a Plan Year, the most recent election made by the Participant remains in effect.
6. The Plan provides in Clauses XXXXXXXXXX and XXXXXXXXXX a mandatory Minimum Election for certain Officers equal to XXXXXXXXXX% or XXXXXXXXXX% of the value of their Bonus. In the event that no Election notification is given to the Corporation by any of them, the Canadian Officers are deemed to have made the required Minimum Election, while the last Election made by a US Participant subject to the Minimum Election remains until it is amended.
7. Clause XXXXXXXXXX allows an Officer to receive a number of Units which corresponds to the quotient obtained by dividing the value of his Deferred Compensation payable by the Unit Value as of the date of the meeting of the Directors during which the corresponding Bonus was approved.
8. The Plan allows each Director to receive a number of Units which corresponds to the quotient obtained by dividing the value of his Deferred Compensation earned during the XXXXXXXXXX of a given year by the Unit Value at the end of XXXXXXXXXX. This method is provided for in Clause XXXXXXXXXX.
9. Where a cash dividend is paid by the Corporation in respect of the Shares, Clause XXXXXXXXXX states that a number of Units, equivalent to the dividend, is to be granted to the Participants, based on the number and value of the Units held at the moment of the payment of the dividend.
10. Units have been granted to Participants under the Plan effective from XXXXXXXXXX.
11. Pursuant to Clause XXXXXXXXXX, Units must be redeemed by the Corporation:
a) as soon as practicable following the occurrence of any of the following events:
(i) the termination of employment of an Officer;
(ii) the termination of the Plan following a change of control of the Corporation, as set out in Clause XXXXXXXXXX;
(iii) the termination of the Plan in respect of US Participants who are affected by a change of control of the Corporation under section 409A of the US Code and the corresponding Regulations;
b) XXXXXXXXXX days following the death of a Participant;
c) XXXXXXXXXX following the Retirement of a Participant.
12. Under Clause XXXXXXXXXX, upon a redemption of Units, the Corporation will remit or cause to be remitted to the Participant or its estate, if any, a cash amount equivalent to the Value of Units credited in his or her favour on the redemption date, less any applicable withholding tax. Following the redemption and full payment of the Value of Units, the Units redeemed are automatically canceled.
13. The value of the amount of money equivalent to the Value of Units of the Former Participants that were redeemed was included in computing their income for the year in which the amount was received.
14. Pursuant to Clause XXXXXXXXXX, the Plan may be amended or terminated at any time by the Board of Directors of the Corporation provided that such modification or termination does not prejudice the rights of the Participants with respect to the Units that were previously credited to their account. In the event that the Plan is terminated, the Units will remain in effect until an event provided for in Clause XXXXXXXXXX occurs, unless there has been a change of control of the Corporation and its Board of Directors determines that it is appropriate to proceed with the redemption of the Units.
15. An office or employment held by a Participant would not necessarily terminate with a change of control.
16. In general, US Participants who are Directors travel to Canada to attend meetings of the Board of Directors of the Corporation.
17. Officers who reside in the United States or are US citizens do not render any service in Canada.
Your questions
You wish to know whether the Plan is a plan described under paragraph 6801(d) of the Regulation, as required by paragraph (l) of the definition of "SDA" in subsection 248(1).
If the plan does not constitute a plan referred to in paragraph 6801(d) of the Regulation, you wish to confirm the tax consequences that apply to the particular situation. In particular, if the Plan is an SDA, you have requested our views regarding the application of the new position set out in Document 2015-0610801C6 of the Directorate, as well as our comments regarding taxation years that may be subject to a a reassessment pursuant to subsection 6(11).
Your position
You are of the view that the Plan does not comply with the conditions set out in subparagraph 6801(d)(i) of the Regulation and is an SDA. In particular, you note that the Plan, in Clauses XXXXXXXXXX, provides for two redemption events that do not comply with the wording of subparagraph 6801(d)(i) of the Regulation.
These two events concern the termination of the Plan as a result of a change of control of the Corporation as set out in Clause XXXXXXXXXX, and the termination of the Plan in respect of US Participants when they are affected by a change in the control of the corporation referred to in section 409A of the US Code and the corresponding Regulations. You are of the view that Document 2015-0610801C6 of the Directorate supports your position and its principles for the taxation of SDAs apply to the particular situation.
Consequently, you have concluded that deferred amounts received in the form of Units and the Value of Units received as dividend equivalents must be included in computing the Participants' income for the calendar year during which the Units were granted, pursuant to subsection 6(11) and paragraph 6(1)(a). You indicated that these amounts will generally be deductible in computing the Corporation's income under paragraph 20(1)(oo), in the taxation year of the Corporation that ends in the taxation year of the Participants concerned. You are also of the view that subsection 6(13) is inapplicable and that no tax consequences apply with respect to Units allocated to US Participants, as no service is rendered in Canada by the latter.
Our comments
Subsection 248(1) generally provides that an SDA is a plan or arrangement 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 the 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.
The plans described under paragraph 6801(d) of the Regulation are excluded from the definition of an SDA under paragraph (l) of that definition. Specifically, paragraph 6801(d) of the Regulation includes any plan or arrangement between a corporation and an employee of the corporation or a corporation related thereto under which the employee may receive an amount that may reasonably be attributable to duties of an office or employment performed by the employee on behalf of the corporation or a corporation related thereto where:
(i) all amounts that may be received under the plan or arrangement are received after the time of the employee’s death or retirement from, or loss of, the office or employment and no later than the end of the first calendar year commencing thereafter, and
(ii) the aggregate of all amounts each of which may be received under the plan or arrangement depends on the fair market value of shares of the capital stock of the corporation or a corporation related thereto at a time within the period that commences one year before the time of the employee’s death or retirement from, or loss of, the office or employment and ends at the time the amount is received.
We understand that the Plan allows Participants to receive an amount that is reasonably attributable to duties of an office or employment performed by them on behalf of the corporation or its affiliates. The condition set out in the preamble to paragraph 6801(d) of the Regulation is therefore met.
Furthermore, the total of all amounts that may be received under the Plan is based on the fair market value of the Shares as required under subparagraph 6801(d)(ii) of the Regulation. However, all amounts that may be received under the Plan will not be received only after the date of death, retirement or loss of office or employment of a Participant, as required by subparagraph 6801(d)(i) ) of the Regulation. In particular, under Clauses XXXXXXXXXX of the Plan, the Participants could receive an amount under the Plan following a change of control of the Corporation. In addition, the Units must be redeemed XXXXXXXXXX following the Retirement of a Participant in accordance with Clause XXXXXXXXXX and, under Clause XXXXXXXXXX, "retirement" as provided under section 409A of the US Code. The US Participants would therefore be entitled to receive an amount prior to any of the periods provided for in subparagraph 6801(d) of the Regulation, under Clause XXXXXXXXXX.
Since all the conditions set out in paragraph 6801(d) of the Regulation are not met, the Plan cannot be excluded from the definition of SDA under paragraph (l) of that definition. We are of the view that the Plan is an SDA as of XXXXXXXXXX since at that time it gave Participants in a taxation year the right to receive an amount after the year and it is reasonable to consider that the existence or creation of this right had, among other main purposes, the purpose of deferring the tax payable under the Act on an amount for which they were entitled to salary or wages for services Participants have rendered during the year or a previous taxation year.
In Document 2015-0610801C6, the Directorate stated its position regarding the application of paragraph 6801(d) of the Regulations in respect of a deferred share unit plan that allowed its participants to receive an amount in accordance with section 409A of the US Code. Under this provision, a participant could receive an amount before death, retirement or loss of office or employment. The Directorate therefore concluded that a deferred share unit plan providing for a distribution to its participants pursuant to all the triggering events set out in section 409A of the US Code could not comply with the provisions of paragraph 6801(d). As an advance ruling had been made in the past to the contrary, it was decided that this position would only apply to units of deferred share unit plans that were credited to a participant's account after November 24, 2015. It should be noted that this grandfathering rule only applies where the only reason the plan does not meet the requirements of paragraph 6801(d) of the Regulation is that it contains a clause allowing Participants to receive an amount prior to any of the times specified in subparagraph 6801(d) of the Regulation in accordance with section 409A of the US Code.
We have determined above that the Plan does not comply with the provisions of paragraph 6801(d) of the Regulation because, pursuant to Clause XXXXXXXXXX, Units of a Participant are to be redeemed when the Plan ceases to exist as a result of a change of control of the Corporation. Since this Clause, by itself, allows us to conclude that the Plan does not meet the requirements of paragraph 6801(d) of the Regulation, we are of the view that the grandfathering rule set out in 2015-0610801C6 does not apply in this case.
Pursuant to subsection 6(11), where at the end of a taxation year any person has a right under a SDA in respect of a taxpayer to receive a deferred amount, an amount equal to the deferred amount shall be deemed, for the purposes of paragraph 6(1)(a), to have been received by the taxpayer as a benefit in the year. For the purposes of subsection 6(11), subsection 6(12) provides that where at the end of a taxation year any person has a right under a salary deferral arrangement in respect of a taxpayer to receive a deferred amount, an amount equal to any interest or other additional amount that accrued to, or for the benefit of, that person to the end of the year in respect of the deferred amount shall be deemed at the end of the year, to be a deferred amount that the person has a right to receive under the arrangement. A deferred amount is defined in subsection 248(1) as any amount that a person has a right under the arrangement at the end of the year to receive after the end of the year.
In this case, subsection 6(11) applies to any Bonus, Compensation, dividend equivalent, and any increase in the Value of Units that a Participant, at the end of each taxation year, was entitled to receive after the end of each year. For example, if an Election has been made by a Participant in the 2014 taxation year in respect of a Bonus earned and payable in 2015 and Units have been credited to his or her account in the year 2015 in respect of the election, the Participant shall include in the computation of his or her income for the year 2015 the Value of Units received in respect of the deferred Bonus and any dividend equivalents to which the Participant was entitled at the end of 2015 pursuant to subsections 6(11) and 6(12) and subparagraph 6(1)(a)(v).
It should be noted that the value of any right that a Participant may receive after a taxation year must be included in computing the Participant's income for the year under subsection 6(11) to the extent that the amount of deferred income has not otherwise been added in computing the Participant's income for the year or a preceding taxation year. Consequently, if the taxation year in which an amount under 6(11) and 6(12) is to be included is statute-barred, that amount will be included in the first year subsequent to the barred year.
We understand that since the Plan was established, Units held by Former Participants have been redeemed by the Corporation following the occurrence of one of the events described in paragraph 11 of this memorandum. These Former Participants accordingly included in the computation of their income for the year in which they received the payment an amount equivalent to the Value of Units credited in their favour on the date of the redemption. We are of the view that the provisions of subsections 6(11) and 6(12) will apply to the Former Participants, as discussed above, and that their income tax return for the year of payment will have to be amended in order to exclude the amount previously included in computing their income under the Plan in accordance with subparagraph 6(1)(a).
Any deferred SDA amount will be deductible in computing the Corporation's income under paragraph 20(1)(oo), for a particular taxation year, to the extent that the amount corresponds to services rendered by a Participant to the Corporation and that it has been added as a benefit under subparagraph 6(1)(a)(v) in computing the Participant's income for the Participant's taxation year that ends in the particular taxation year of the Corporation.
It should be noted that the US Participants are subject to the above-mentioned SDA rules to the extent that the deferred amounts are taxable income earned in Canada under section 115. Subject in particular to the application of paragraph 115(1)(d) and subparagraph 110(1)(f)(i), income derived from the duties of an office or employment performed in Canada by a person not resident in that country at any time in the year is included in computing the taxpayer's income for the purposes of the Act under paragraph 2(3)(a) and subparagraph 115(1)(a)(i). In addition, since the Plan Participants are primarily Canadian residents, we are of the view that subsection 6(13) is not applicable.
Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.
We hope that our comments will be of assistance.
Best regards,
Louise J. Roy, CPA, CGA
Manager
for the Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
c.c. Leslie Bafia
Legislative Services Application Section and Audit Policies
Large Business Audit Division
International and Large Business Directorate
Directorate General for the International Sector, Large Businesses and Investigations