Principal Issues: [TaxInterpretations translation] What rules apply for a plan to qualify for the purposes of section 6801(a) of the Regulations and not be subject to the rules applicable to SDAs?
Position: General discussion
2008-029277 XXXXXXXXXX Mélanie Beaulieu (613) 957-9226 February 4, 2009
Dear Sir,
Re: Deferred Salary Leave Plan ("DSLP")
This is further to your email of September 11, 2008, in which you asked us whether a particular deferred salary leave plan or advance salary leave plan ("your Plan") qualified as a deferred salary leave plan ("DSLP"), pursuant to the requirements of paragraph 6801(a) of the Income Tax Regulations (the "Regulations"). For this purpose, you have provided us with a document entitled "Deferred or Advance Leave" and excerpts from the Collective Agreement of XXXXXXXXXXXX. We note that the information contained in the former document differs in some respects from the information contained in the excerpts from the Collective Agreement that you provided us. In order to avoid any ambiguity or imprecision, we have therefore chosen, in the event of any discrepancy, to comment on the information contained in the first document.
First, we wish to clarify that there is no requirement in the Income Tax Act (the "Act") or the Regulations that a DSLP be submitted to the Canada Revenue Agency (the "CRA") for review, approval, or other pre-registration mechanism. However, if the establishment of such a plan is contemplated, our Directorate may confirm in writing the tax consequences inherent in the plan through a response to an advance income tax ruling request. Relevant information on how to submit a request for an advance income tax ruling can be found in Information Circular 70-6R5, entitled "Advance Income Tax Rulings", dated May 17, 2002. This Information Circular, as well as the other CRA publications referred to herein, are available on our website at http://www.cra-arc.gc.ca/formspubs/menu-eng.html. If, on the other hand, you already have a DSLP in place, any questions relating to that particular DSLP should be directed to your Tax Services Office ("TSO") for its views. A list of TSOs and their contact information can be found on the "Contact Us" page of our website. While we are not in a position to comment on your particular plan, we are, however, prepared to provide the following general comments which may be of assistance to you.
Generally, the provisions of the Act applicable to salary deferral arrangements ("SDAs") require that any deferred salary or wages payment be included in the income of the employee concerned on an accrual basis (i.e., in the year in which the salary or wages are earned) although the salary or wages will not be received by the employee until a subsequent year. However, to the extent that a particular plan meets the conditions for the application of a DSLP, the rules applicable to SDAs will not apply and the deferred salary or wages will be taxed when actually received, and not in the year in which they are earned.
A DSLP is a mechanism or plan that allows an employee to defer salary or wages in order to finance a leave of absence from employment. The rules that govern DSLPs are set out in paragraph 6801(a) of the Regulations. This letter explains these rules and provides some additional information that may assist an employer who administers a DSLP for its employees. We have included references to the relevant provisions of the Regulations to allow you to refer directly, where necessary, to the specific provisions setting out the various specific requirements. For your convenience, we are also enclosing a copy of paragraph 6801(a) of the Regulations.
For the purposes of this discussion regarding DSLPs, it is essential to have a clear understanding of the meaning of certain terms. For example:
Deferral period: This expression refers to the period beginning with the first deferral of salary or wages and ending on the date on which the employee begins the employee’s leave and begins receiving benefits under the DSLP plan, which benefits result from the employee’s choice to defer the employee’s salary or wages.
Leave of absence: This term is used to describe the period during which the employee is absent from employment and receives benefits under the DSLP.
A DSLP must take the form of a written agreement between an employer and an employee. Whether an employer-employee relationship exists is a question of fact. If you would like more information on this topic to determine whether such a relationship exists in your situation, you can refer to CRA Guide RC4110, Employee or Self-Employed? The terms and conditions of the written agreement must clearly demonstrate that the main purpose of the plan is to allow the employee to fund, by deferring salary or wages, a leave of absence from employment [subparagraph 6801(a)(i)].
This main purpose implies that the content of a DSLP must satisfy certain conditions:
(i) the written agreement must clearly state that the DSLP is not intended to provide benefits to employees who are members of the plan upon retirement. Such a stipulation supports the conclusion that the plan is really intended to finance the taking of a genuine leave of absence by member employees and not to allow them to increase their pension benefits by deferring a portion of their employment income before retiring. It seems that your plan does not include such a stipulation. It should therefore be amended to clearly stipulate that it is not intended to provide benefits to participating executives on their retirement.
ii) the terms of the DSLP plan must not provide for the voluntary withdrawal from the plan by an employee who participates in it. A provision providing for such voluntary withdrawal would be contrary to the Regulation [s.6801(a)(i)] as it would mean that an employee may, at any time, access the funds held for the employee in the plan.
While a provision permitting voluntary withdrawal from the DSLP is problematic, a DSLP may, however, provide for early withdrawal from the plan in specific circumstances stipulated in the plan that would cause financial hardship to the employee.
Generally, such a withdrawal should be subject to the discretion of the employer. Your plan provides that certain rules apply "XXXXXXXXXX". As drafted, this statement appears to allow for voluntary withdrawal from the plan by participating executives. Your plan should therefore be amended to provide that early withdrawal from the plan may only take place in specific circumstances set out in the plan and subject to the employer's discretion. Where such a withdrawal occurs before the employee participating in the plan takes leave, all amounts previously deferred under the plan, as well as accrued and unpaid interest, are payable and taxable in the year in which the employee withdraws from the plan.
The deferral period
The plan should provide for the percentage of salary or wages otherwise payable to the employee that will be deferred, and for what period of time such percentage will be deferred. It is important to note that this percentage cannot exceed 33 1/3 % in a given year [subparagraph 6801(a)(ii)].
The deferral period may not exceed six years. This limit is imposed by Section 6801(a)(i) of the Regulations, which requires that the leave begin upon the expiry of a maximum period of six years following the date on which deferrals for the leave of absence commence. It is relevant to note that the deferral period may be less than six years. Your plan addresses the ability for participating executives to defer the option chosen. This is consistent with the rules applicable to a DSLP as long as the deferral period does not exceed six years and all amounts held under the DSLP are paid to the employee by the end of the first taxation year commencing after the deferral period. Your plan should therefore be amended to include this clarification.
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 salary or wages for a specified number of years and the receipt by the employee, during the leave of absence, of the accumulated deferred salary or wages. For example: deferring 20% of salary or wages for 4 years and receiving the salary or wages accumulated during the leave (i.e. 80%) in year 5.
ii) Alternatively, a DSLP may provide for the payment of a fixed percentage of the salary or wages or salary range in place for employees of the particular employer. The employee must then receive a specified percentage of salary or wages, or salary or wage scale, during the deferral period and also during the leave of absence. Please note that while the percentage must be fixed, the salary scale on which it is based may be variable. For example: a plan may provide that participants will receive 75% of their salary scale each year over a 3-year payout period and 75% of the salary scale applicable at the time of the leave of absence in year 4.
The agreement providing for the DSLP must describe the manner in which amounts deferred by the participating employee will be held. Clause 6801(a)(iv)(A) of the Regulations applies where the deferred amounts are paid by the employer to a third party to be held in trust, which trust is an employee benefit plan ("EBP") for purposes of the Act. Generally, an EBP is an arrangement under which contributions are made by an employer to another person and under which a payment or payments are to be made to or on behalf of employees or former employees. For more information about EBPs, 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 trust's income earned for the employee (on the deferred amounts) in that year. CRA has stated in the past that an EBP may deduct plan administration fees or expenses from its gross interest income. The employee participating in the DSLP will therefore only be taxed on the net interest amounts paid to the employee in the year.
If the deferred amounts are not paid into an EBP trust but are instead held in some other manner, clause 6801(a)(iv)(B) of the Regulations applies so that interest or any other amount that can reasonably be considered to have been earned for the benefit of the employee (on the employee’s deferred amounts) is paid to the employee concerned in the year in which it is earned. That would be the case, for example, where the salary or wages that would otherwise be payable to the participating employee are simply retained and invested by the employer.
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 income tax deductions at source.
CRA's position is that during the deferral period, EI premiums must be based on the gross salary or wages of the participating employee (i.e., the amounts that the employee would receive if there were no salary deferral). This means that deferred amounts paid during the leave will not be subject to EI deductions.
The leave of absence
Under paragraph 6801(a)(i) of the Regulations, the leave of absence must begin immediately after the deferral period. As noted above, the leave must begin no later than the expiry of six years following the date on which amounts begin to be deferred.
A leave of absence that is taken during the term of the master agreement (not just at the very end of the master agreement) would not prevent the application of paragraph 6801(a) of the Regulations if the leave is taken immediately after a deferral period. For example, an employee may take the leave in the second year of a 3-year master agreement. In such a case, the leave will be funded in part by deferred salary or wages (in the first year, being the deferral period) and in part by salary advances, which will be repaid in the third year, which we will refer to as the "payout period". During the period of the leave of absence, the employee will first receive an amount equal to the amount of salary deferred during the pay deferral period and subsequently an amount of salary paid in advance. The total of these two amounts must be included in the employee's income in the year of the leave, by virtue of subsections 6(3) and 5(1) of the Act. We note that your plan provides that an executive on leave without pay, disability or parental leave may participate in the plan, but the leave cannot begin until the date of return to work. It appears to us that an executive who participates in the plan in such circumstances would take the leave without first having had a deferral period. In such a case, the leave would be funded solely from salary advances and would not constitute a DSLP. Therefore, the rules applicable to a SDLP described herein would not apply in such circumstances. By virtue of subsections 6(3) and 5(1) of the Act, salary advances paid to the participating executive in such circumstances would have to be included in the participating executive's income in the year in which they are paid. With respect to the tax treatment applicable to the repayment of such advances, the relevant rules are described below under the heading "After the Leave".
The rules applicable to DSLPs provide that the leave must be for a minimum period of time, which depends on the purpose of the leave:
- If the purpose of the leave is to enable the employee to attend a designated educational institution on a full-time basis, the leave must be for a period of at least three consecutive months [clause 6801(a)(i)(A)].
The term "designated educational institution" is defined in subsection 118.6(1) of the Act. Generally speaking, a designated educational institution is an institution that offers courses at the post-secondary level and that has been accredited under the Canada Student Loans Act, the Canada Student Financial Assistance Act, or the Act Respecting Financial Assistance for Students of the Province of Quebec. The expression also refers to an educational institution certified by the Minister of Human Resources and Skills Development, which is intended to provide or increase the skills necessary to carry out an occupational activity. For more information on this subject, you may refer to Interpretation Bulletin IT-515R2, entitled "Education Tax Credit".
- A leave of absence for any other reason must be for at least six consecutive months [clause 6801(a)(i)(B)].
While the Regulations do not provide for a maximum length of leave of absence, the agreement must provide that amounts held on behalf of the employee under the plan 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 [subparagraph 6801(a)(vi)]. It is relevant to note that this comment is only applicable where the DSLP continues to exist and is operated in accordance with paragraph 6801(a) of the Regulations. If a DSLP fails to comply with any of the conditions of paragraph 6801(a) of the Regulation, then it will cease to qualify as a DSLP and all deferred amounts and accrued and unpaid interest, if any, less any applicable source deductions, must be paid to the employee and included in the employee's income for the year. During the leave of absence, the participating employee may not receive any salary or wages from the employer or from any other person or partnership not dealing at arm's length with the employer [subparagraph 6801(a)(iii)]. For a more detailed discussion of the meaning of the term "arm's length", refer to Interpretation Bulletin IT-419R2, Meaning of Arm's Length. The foregoing does not preclude the participating employee from receiving:
- The deferred salary or wages during the payout period or the percentage of the salary range established for the payout period and the duration of the leave [clause 6801(a)(iii)(A)];
- Salary advances that the employee will repay to the employer during the repayment period [clause 6801(a)(iii)(A)];
- Reasonable fringe benefits that the employer ordinarily pays to or on behalf of employees [clause 6801(a)(iii)(B)]; and
- Salary or wages from an entity that are in no way related to the employer for which the participating employee works during the leave.
Amounts paid during the leave (whether deferred amounts or salary advances) are subject to income tax deductions at source. As stated above, however, deferred amounts paid during the leave are not subject to EI premiums. However, employee advances paid during the leave are subject to EI premiums.
After the leave
The Regulation [subparagraph 6801(a)(v)] requires that the employee who is a member of the plan return to his or her regular duties with the employer for a period at least equal to the period of the leave. We note that your plan specifies that an executive who avails himself or herself of the plan must return to "XXXXXXXXXXXX" employment. In this sense, your plan does not appear to us to require the executive to return to employment if he or she takes the leave in the last year of the Master Agreement. This is contrary to the Regulations [subparagraph 6801(a)(v)], which requires the employee to return to his or her regular duties for a period at least equal to the duration of the leave, regardless of whether the leave is taken during the Master Agreement or at the end of the Master Agreement. Your plan should be amended accordingly.
As to what is meant by "his or her regular duties", our position is that if the employee is working full time prior to the leave, the employee will have to return to work full time for an equivalent period of time or the condition will not be satisfied. An employee working part-time prior to the leave will be able to return to work part-time, either at the same number of hours per week or for more, including a full-time schedule. In any event, an employee returning to work on a more demanding schedule must nevertheless return to work for a period equal to the leave of absence. For example, if an employee was working 20 hours a week before a six-month leave, it would not be sufficient for him or her to return to work for a period of three months at 40 hours a week. 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. It is relevant to note that the Regulations also allow a participating employee to return to work with an employer who participates in the same or similar DSLP.
Thus, if it was clear that an employee did not intend, at the time the employee entered into a DSLP, to return to work after the leave for a period at least equal to the length of the leave, the plan would not qualify as a DSLP and the deferred amounts would have to be included in the employee's income in the taxation year in which they were earned and deferred rather than in the year in which they are paid to the employee. In such a case, CRA may reassess prior years' tax returns if deferred amounts were not reported in respect of those prior years.
In addition, if an employee decides during the course of the plan that the employee will retire at the end of the leave and does not return to work as originally scheduled in the agreement, the deferred amounts will be taxed in the year in which it is known that the above condition will not be satisfied. Consequently, should unforeseen situations arise when signing such an agreement, such as the receipt and acceptance of an offer to retire under a retirement incentive program, the employee may decide to retire with the tax implications described above.
We are aware that certain events may occur during the leave that may make it impossible for the employee to return to work. In a situation where the employee has completed the period of leave and all amounts deferred under the DSLP have been paid to the employee, no negative tax consequences will result if, due to unforeseen circumstances, the employee is unable to return to work. In such a case, the deferred amounts will not be taxed in years prior to the year of leave.
Finally, as stated above, where the same master agreement provides for the funding of a leave of absence partly through a DSLP and partly through salary advances, a repayment period will follow the leave. Paragraph 6801(a) of the Regulations does not apply during the repayment period as there is neither a deferred amount nor a salary deferral arrangement 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 earned by the employee during that period (gross amounts, before deduction of repayment amounts) be included in the employee's income. However, paragraph 8(1)(n) of the Act also applies and allows the employee to deduct from employment income amounts withheld by the employer for the repayment of salary advances received by the employee during the leave. The total salary earned by the employee during this period is also subject to income tax deductions at source, as well as employment insurance premiums.
With respect to contributions to the Quebec Pension Plan and the Régie de l'assurance-maladie du Québec applicable to a DSLP, we invite you to contact the Ministère du Revenu du Québec, which administers the legislation applicable to them.
We hope you find our comments of assistance. If you wish to obtain more assurance that a DSLP you are considering is in compliance with the Regulations, we invite you to consult Information Circular 70-6R5 and to submit a request for an advance ruling.
Best regards,
Ghislain Martineau
Manager
Financial Sector and Exempt Entities Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
file Paragraph 6801(a) of the Income Tax Regulations