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.
After finding that this plan “failed on technical grounds,” i.e., the conversion of the units from SARs to DSUs and addition of dividend equivalents triggered an immediate income inclusion to the participants, CRA went on to indicate that even if this structure were instead implemented on a prospective basis, it would refer such a plan to the GAAR Committee as being abusive, stating:
[T]he structure is highly artificial, provides significant tax deferral and rate reduction benefits on employment compensation, and represents an abuse of the EPSP rules. Here, there is no profit-sharing in purpose or effect. …
Furthermore, we note that the favourable tax results under the Proposed Transactions are similar, in large part, to those available under the employee stock option rules in subsections 7(1) and (1.1) and paragraphs 110(1)(d) and (d.1) of the Act, even though the Plan is not an employee stock option agreement, Employerco is not a Canadian-controlled private corporation, the Participant might not necessarily be dealing at arm’s length with Employerco, and the requirements of paragraph 110(d) or (d.1) are not satisfied. Although the Participant would have an income inclusion in the year of Retirement for the cost of the Shares, taxation on the amount by which the Shares appreciated while held by the EPSP Trust would be deferred until the year in which the Participant disposes of the Shares.