Principal Issues: [TaxInterpretations translation]
Tax treatment of an amount paid to an employee when the salary payment periods change and of the recovery of that amount from the last pay.
Position:
No definitive conclusion. There are arguments that it is prepaid wages. Prepaid wages are included in employment income in the year received. Where prepaid wages are recovered by a reduction in the wages for the last pay, it is our view that the amount received for the purposes of subsection 5(1) is the reduced amount.
Reasons:
Employment income is included in income where the amounts are received by the employee. The amount recovered is not received with the last pay, as the employee is not entitled to receive the same amount twice.
October 17, 2002
Mr. Marc Normand Headquarters Trust Accounts Division Sylvie Labarre, CA Policy and Technical Services Section (613) 957-8953 2002-015910
Prepayment of wages and repayment
This is further to your email of August 22, 2002 in which you asked for our opinion on the tax treatment of an amount received by an employee and of its repayment in the following circumstances.
Employees' wages are currently paid every two weeks. Those payments cover the working period from the previous pay day to the day before the payment day. For example, the payment made on July 25, 2002 covered the period from July 11 to July 24.
The employer wishes to change the pay system. Wages would be paid two weeks after the last day of a work period, i.e., two weeks later than at present. For example, pay covering the period from July 11 to July 24 would not be paid until August 8, 2002.
Without a transitional measure, the introduction of the new system would mean that employees would receive no money at the end of the first two weeks of implementation. Given that collective agreements stipulate that wages are paid every two weeks and that it would be unthinkable for employees to not receive any money for two weeks during the transition, an amount equivalent to normal pay could be paid during the transition. That amount would not refer to any period of work. The employer would recover that amount from the last pay issued under the new payroll system when the employee left employment. That amount would bear no interest.
You asked us what tax treatment should be accorded to the amount received at the time of the transition and to the recovery of the amount when the employee left.
Our Comments
In order to determine the tax treatment to be accorded to the amount received on the transition, it must be determined whether that amount constitutes a loan or debt owed by the employee to the employee’s employer, or whether it constitutes an advance payment of wages. Where an employee receives wages in advance, the amount received must be included in the employee’s income pursuant to subsection 5(1) of the Income Tax Act (the "Act") in the year it is received. On the other hand, an amount received as a debt or loan contracted with the employer is not included in income. However, where the amount is received as a debt or loan and does not bear interest, the employee must include, pursuant to subsection 6(9), the amount deemed to be a benefit received during the year pursuant to subsection 80.4(1).
Whether an amount constitutes a debt or an advance payment of wages is a question of fact and law. Based on the information provided, you have good arguments for concluding that the amount received by an employee is a payment in advance of wages rather than a debt. The fact that there is no note, acknowledgement of debt or document between the employee and the employer to establish the existence of a loan and the obligation to repay the amount, the absence of repayment terms within a reasonable period of time and the recovery of the amount received during the transition by reducing the wages paid in the last pay are indications that the amount received is not a debt. However, the fact that the amount does not bear interest is not in itself sufficient to conclude that it is not a loan or debt.
Subsection 5(1) provides that income from employment is the salary, wages and any other remuneration received by the employee during the year. Thus, wages paid in advance are included in income in the year received. Similarly, employment income does not include wages that have not been received.
In this situation, the amount paid to an employee at the time of the transition, as prepaid wages, should be included in computing that employee's income in the year of payment. On the other hand, in the year in which the employee leaves, the employee’s wages for the last pay will be reduced to recover the wages that were paid in advance (the employee is not entitled to receive wages twice). In our opinion, it is the reduced amount that will be received for the purposes of subsection 5(1), which will be reported in Box 14 of the T4 slip (as stated in your second scenario) and from which the employer will be required to deduct income tax at source.
You indicated that this scenario is not equitable and may create a prejudice in terms of, for example, computing earned income for the purposes of a registered retirement savings plan. Regarding earned income, as defined in subsection 146(1), we do not share your opinion since, at the time of the transition, the amount received, considered as an advance payment of wages, has already increased the amount of earned income since it was part of the employment income. Consequently, by not considering the amount of the reduction as employment income in the year of recovery, the same overall increase in earned income can be obtained as if the wages had not been paid in advance and subsequently recovered.
We do not comment on insurable earnings subject to CPP or QPP or on the amounts that should appear in Boxes 24 and 26 of the T4 slip, since this is the responsibility of the CPP/QPP Eligibility Division, which you have already consulted.
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's library. 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, the CRA library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy that has been severed in accordance with the Privacy Act will be sent to you for delivery to the client.
We hope you find these comments of assistance. Should you require any additional information regarding the content of this document, please do not hesitate to contact us.
Ghislaine Landry, CGA
for the Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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