A Canadian public company (Employerco) proposed that the share appreciation right (SAR) units of its employees be converted into an equivalent value of deferred share units (DSUs), with the payout of the referenced number of shares on the retirement etc. of each employee participant to be taken care of by a an employee’s profit sharing plan (EPSP) trust (settled by Employerco at the time of the conversion into DSUs). The EPSP trust would use an interest-bearing loan from Employerco to fund its purchase of the matching number of Employerco shares and fund the loan interest with dividends on the shares and annual contributions from Employerco – both of which were taxable income to it but with an offsetting interest deduction, so that there would be no annual income inclusion to the participant under s. 144(3). On retirement, Employerco would make a further contribution (deducted by it under s. 144(5)) to enable the EPSP Trustee to repay the applicable portion of the loan, with that amount being included in the participant’s income under s. 144(3), and the EPSP trust would distribute the shares to the participant. Further similar features provided participants with dividend-equivalent DSUs and subsequent pay-out.
CRA found that this plan “failed on technical grounds,” i.e.:
The Proposed Transactions would result in immediate income tax consequences to the Participants on either one of the following bases:
- The conversion of the units from SARs to DSUs and adding dividend equivalents would represent a fundamental change to the Participant’s rights under the Plan, and therefore there would be an immediate disposition of the units. As a result, the Participant would be considered to have received an amount equal to the fair market value (FMV) of the Participant’s units and be required to include that amount in income from employment in the year in which the disposition occurs.
- The conversion of the units from SARs to DSUs would breach the post-amble of paragraph 6801(d) of the Income Tax Regulations, resulting in the Plan becoming a salary deferral arrangement (as defined in subsection 248(1) of the Act). In the circumstances, there would be an immediate income inclusion by virtue of subsection 6(11) and paragraph 6(1)(i) of the Act to the Participant for the FMV of the Participant’s units.
CRA went on to indicate that even if this structure were instead implemented on a prospective basis, it would refer it to the GAAR Committee as being abusive.