Principal Issues: [TaxInterpretations translation]
1. What is the tax policy underlying the requirement for an employee to report to work for a period at least equal to the duration of the leave under Regulation 6801 ITA?
2. Can an employee choose not to return to work after a sabbatical leave?
3. Can the employee decide to work part-time upon returning to work?
4. Can the employee delay the start of the unpaid leave?
5. What are the tax consequences of not returning to work after the leave?
Position:
1. To finance an employment leave;
2. No, otherwise there will be tax consequences;
3. No;
4. Yes, as long as all the other conditions of the plan are satisfied;
5. It depends on the circumstances.
Reasons: text of the Law.
March 11, 2003
Jonquière Tax Centre Headquarters
Income Tax Rulings Directorate
Attention: Ghyslaine Larouche
Michelle Desrosiers
Notary, M. Fisc.2002-018099
Salary deferral arrangement
This is in response to your letter of December 23, 2002, in which you asked for our interpretation of various issues relating to a salary deferral arrangement as described in Regulation 6801 of the Income Tax Regulations (the "Regulations"). The questions are as follows:
1. Why, under a salary deferral arrangement, is the employee required to report to work for a period at least equal to the period of leave?
2. With the employer's consent, can an employee not return to work following the leave?
3. If the employee is required to return to work, is it possible for the employee to work part-time rather than full-time?
4. Can the employee delay the start of the unpaid leave for six months by working those six months in order to avoid a return to work for one year?
5. If the employee does not return to work after unpaid leave, what are the consequences?
Our Comments
1. The provisions of the Regulations stipulate that a salary deferral arrangement must not be intended to provide benefits to employees who are members of the plan respecting their retirement, but must be intended primarily to fund a leave of absence from employment. Those provisions also stipulate that the employees concerned must return to their usual duties with their employer after their leave for a period at least equal to the duration of the leave. Those rules were enacted to allow a deferral of income tax paid to an employee in the year of an employee’s sabbatical leave without the application of the rules regarding salary deferral arrangements.
Deferred salary sabbatical leave plans are an exception to salary deferral arrangements. One of the purposes of a salary deferral arrangement is to defer taxes on salaries or wages that have been earned. Under a salary deferral arrangement, the deferred salary or wages are taxed in the year in which they are earned. The provisions of the Regulations ensure that a deferred salary sabbatical leave plan is aimed at taking a leave of absence and is not primarily intended to defer the tax payable on an amount earned as salary or wages. That tax treatment is possible as long as all the rules set out in section 6801 of the Regulation are complied with.
2. To avoid any negative tax impact, the taxpayer participating in a salary deferral arrangement must comply with all the conditions set out in section 6801 of the Regulations. Otherwise, the tax consequences described in item 5 below will apply.
3. Subparagraph 6801(a)(v) of the Regulations states that “the employee is to return to his regular employment with the employer … after the leave of absence for a period that is not less than the period of the leave of absence … .” The Canada Customs and Revenue Agency ("the Agency") is of the opinion that if, prior to the leave, an employee was working full-time, then upon the employee’s return to work, the employee must once again work full-time within the employer's business in order to be able to consider that the employee has returned to the employee’s regular employment. If the employee was working part-time before the leave, the employee may return to work part-time or on a busier schedule including a full-time schedule and still qualify under the rules of section 6801 of the Regulations.
4. Under subparagraph 6801(a)(i) of the Regulations, a leave of absence of three consecutive months, if the purpose of the leave is to enable the employee to attend an accredited educational institution on a full-time basis, or of six consecutive months, in any other case, must begin immediately after the deferral period and the deferral period must not exceed six years from the date on which the deferral period began.
Subparagraph 6801(a)(ii) of the Regulations requires that the amount deferred for services rendered to an employer during a taxation year under the plan and under any similar plan not exceed 33 1/3% of the amount of the salary or wages that the employee would have received in the year in respect of the services.
Subparagraph 6801(a)(iii) of the Regulations requires that the arrangement provides that throughout the period of the leave of absence the employee does 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, other than the amount by which the employee’s salary or wages under the arrangement was deferred or is to be reduced or, amounts that are based on a percentage of the salary or wage scale of employees of the employer, which percentage is fixed in respect of the employee for the deferral period and the leave of absence, and the reasonable fringe benefits that the employer usually pays to or on behalf of employees.
Finally, under subparagraph 6801(a)(vi) of the Regulations, the arrangement must provide that all amounts held 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.
Given the above, if all those conditions are satisfied, it is possible for the employee to delay unpaid leave by six months and take a six-month leave rather than a one-year leave, so that the employee would have to return to work for six months following the leave rather than having to return to work for a year. If the existing arrangement does not provide for such a postponement, it may be amended accordingly.
5. There is no penalty under the Income Tax Act for failing to comply with the conditions set out in section 6801 of the Regulations. However, the following tax consequences may result.
If all the conditions of the Regulations are satisfied at the time the arrangement between an employee and employer is entered into and it is not foreseen at that time that the employee will retire following the employee’s deferred salary leave, the employee will not be taxed on the amounts deferred before the leave, as long as the conditions are satisfied.
However, if the employee did not intend at the time the salary deferral arrangement was created to return to work after the leave for a period at least equal to the duration of the leave, the deferred amounts must be included in the employee's income in the taxation year in which they were deferred. A plan that made the start of retirement coincide with the leave would therefore not comply with the provisions of the Regulations.
In addition, if the employee decides during the course of the arrangement to retire at the end of the leave and does not return to work as initially provided for in the arrangement, the deferred amounts will be taxed in the year in which it is known that the above-described condition will not be satisfied. Consequently, if unforeseen situations arise when such an agreement is signed, such as the receipt and acceptance of an offer of retirement under a retirement incentive program, the employee may decide to retire with the tax implications described above.
Finally, where an employee retires after taking a leave of absence, we are of the view that such a situation will generally not affect the salary deferral arrangement where that situation was not otherwise provided for. That is the case if, on returning to work following the leave, the employee is informed of the option of retiring under a retirement incentive program or any other program.
For your information, unless exempted, 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.
Best regards,
Ghislain Martineau
Section Manager
Financing and Plans Section
Financial Industries Division
Income Tax Rulings Directorate