Principal Issues:
Whether a penalty can be assessed under subsection 163(2) of the Act if at the time the employer and the employee entered into a Deferred Salary Leave Plan ("DSLP"), the conditions in paragraph 6801(a) were not all met?
Position:
Yes, if the CRA is able to prove that the employer and/or the employee did, knowingly or under circumstances amounting to gross negligence, make a false statement.
Reasons:
There is an argument that the employee and/or the employer is making, knowingly or under circumstances amounting to gross negligence, a false statement when they know that the employee does not qualify for the exclusion in the SDA definition and a T4 slip and/or income tax return is prepared as if the employee qualified.
April 15, 2009
Edmonton Tax Services Office Headquarters Client Services Division I. Landry, M. Fisc.
Attention to: Carol Sayre
Senior Business Services Agent
2008-029826Salary Deferral Arrangement
This is in response to your email of October 29, 2008 in which you requested our comments regarding the possibility to assess a penalty in accordance with subsection 163(2) of the Income Tax Act (the "Act") when an employer and an employee enter into a Deferred Salary Leave Plan ("DSLP") with the knowledge that conditions stated in paragraph 6801(a) of the Income Tax Regulations ("Regulations") will not all be met.
Unless otherwise stated, all statutory references in this letter are references to the provisions of the Act.
You described a situation where an employer and an employee entered into a written agreement in order to defer salary with the knowledge that the employee would not return to work and the Salary Deferral Arrangement ("SDA") tax consequences would not be applied.
Comments
Where an arrangement complies with paragraph 6801(a) of the Regulations, the SDA provisions do not apply and the employee's salary deferrals are taxed when actually received, rather than when earned.
Paragraph 6801(a) of the Regulations requires that a number of conditions be satisfied at the time the agreement is entered into. Among other things, subparagraph 6801(a)(i) of the Regulations requires that the arrangement to defer salary be established to permit the employee to fund a leave of absence from employment and not to provide benefits on or after retirement. Subparagraph 6801(a)(v) of the Regulations states that the arrangement must provide that the employee return to regular employment with the employer after the leave of absence for a period equal to the leave of absence.
It is the CRA's position that where an arrangement meets the conditions required under paragraph 6801(a) of the Regulations at the time it is established, but at some later date due to unforeseen circumstances either the employee or the employer cannot abide by the provisions of the agreement, the arrangement between the employer and the employee will fail to meet the requirements of paragraph 6801(a) of the Regulations. Generally, when this happens, the employer should terminate the agreement and all deferred amounts plus interest, if any, should be paid to the employee less the applicable withholding tax. There is no additional penalty imposed by the Act and no need for the employer to notify the CRA in these circumstances. If the arrangement is not terminated, it would be subject to the SDA rules in the taxation year it is known that the arrangement ceases to satisfy the conditions of paragraph 6801(a) of the Regulations and the deferred amounts would be taxable employment income in that year. In addition, any further amounts that are deferred and any interest accrued after the time the arrangement becomes an SDA are taxable in the year of deferral.
Where it is reasonable for the employer to expect an employee to fulfill a commitment but the employee reneges on that commitment, the Act does not impose any penalty on employees who fail to comply with the agreement with their employers. The employee is to comply with the tax consequences mentioned above.
On the other hand, if it is evident that an employee had entered into an agreement with the intention of retiring following his/her leave of absence or with no intention to return to employment, the agreement would fail to comply with the Regulations and would be an SDA. The employee would be liable for taxes, interest and perhaps penalties on the amounts deferred for the year(s) the amounts were deferred. In such cases, reassessments of prior year income tax returns may be required for unreported deferred salary in those prior years. Deferred amounts and interest earned thereon are, by virtue of subsections 6(11) and 6(12), included in the employee's income pursuant to paragraph 6(1)(a) for the year in which the amounts are deferred or the interest is earned. Any other amount received under a SDA would be included pursuant to paragraph 6(1)(i).
Subsection 163(2) provides a penalty, commonly referred to as "gross negligence penalties" that is applicable when a person "knowingly or under circumstances amounting to gross negligence" makes, or is otherwise involved in the making of, "a false statement or omission" in a return or in providing information. Whether the subsection 163(2) penalty applies in a given case is a question of fact that can be determined only after a review of all the facts.
It is our view that when the employee and/or the employer know at the time the agreement is entered into that the employee will not respect all the conditions of paragraph 6801(a) of the Regulations and they knowingly apply the provisions of the Act as if the agreement complied with paragraph 6801(a) of the Regulations, they are knowingly or under circumstances amounting to gross negligence, making a false statement to the CRA. It would be the case where the employer produces the T4 slip and the employee files his/her income tax return as if he/she qualified for the exclusion of the SDA.
In such a situation, if the CRA is able to prove that the employer and/or the employee knew at the time the agreement was entered into that the conditions in paragraph 6801(a) of the Regulations would not be met, a penalty could be assessed in accordance with subsection 163(2) to either the employer or employee or to both of them.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the CRA's mainframe computer. A severed copy will also be distributed to the commercial tax publishers 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 your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.
We trust that these comments will be of assistance.
Yours truly,
Louise J. Roy, CGA
Manager
for Acting Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch