Principal Issues: Whether the CRA will continue to consider ruling requests on whether employee incentive plans with units the value of which are determined using a formula are SDAs?
Position: No, except for ATR-45 SAR plans and plans covered by one of the enumerated SDA exceptions.
Reasons: It is not possible to be reasonably certain, at the time of a ruling request, that a formula-based appreciation plan would never become a SDA at some point in the future due to changes in the relevant facts and circumstances specific to the employee, the employer or the business environment in which it operates.
FINANCIAL STRATEGIES AND FINANCIAL INSTRUMENTS ROUNDTABLE, OCTOBER 7, 2020
2020 APFF CONFERENCE
Question 7
Salary deferral arrangements and formula-based appreciation plans
It is not uncommon for a private corporation to have an equity-based incentive plan under which participating employees are granted units, the value of which is determined using formulas (“formula-based appreciation plans”). These formulas often involve various future oriented financial metrics of the corporation such as earnings before interest, taxes, depreciation, and amortization (“EBITDA”). Units granted under such plans generally do not have any intrinsic value at the date of grant, but may increase in value over the duration of the plan, depending on the measured results.
Question to the CRA
The CRA has, in the past, issued advance rulings to the effect that certain formula-based appreciation plans do not constitute a salary deferral arrangement ("SDA") within the meaning of the definition of that term in subsection 248(1). However, the CRA has recently indicated that it will no longer consider such requests for advance rulings (footnote 1). Can the CRA explain why it has changed its practice in this regard?
CRA Response
In reviewing a recent request for advance rulings on whether a formula-based appreciation plan was an SDA, the CRA encountered a number of issues that caused it to reconsider its policy of issuing advance rulings on such plans.
One of these issues was that the determination of whether a particular incentive plan is a SDA must be made on an annual basis, starting from the date of grant. That determination must be made from the perspective of each employee participating in the plan and in the context of each specific awards granted to that employee, taking into account all known facts and relevant circumstances to the end of the year under review. It has become clear to the CRA that it is simply not possible to be reasonably certain, at the time an advance ruling request is considered, that a formula-based appreciation plan will not qualify as a SDA at some point in the future due to changes in the facts and circumstances of the employee, the employer or the business environment in which the employee operates.
Another issue is that such plans are vulnerable to manipulation, which poses a risk to the CRA that cannot reasonably be accounted for in the context of a request for advance rulings. The CRA is therefore of the view that it is more appropriate for such a determination to be addressed at a later stage of the compliance process, when all the relevant facts and circumstances can be considered.
Consequently, the CRA will no longer consider requests for advance rulings on whether a formula-based appreciation plan is a SDA, unless the plan is a share appreciation rights plan as described in ATR-45 (footnote 2) or the ruling request pertains to whether one of the enumerated exceptions listed in the definition of SDA in subsection 248(1) applies.
This change in administrative policy does not mean that CRA considers all formula-based appreciation plans to be SDAs. On the contrary, the CRA accepts that it is quite possible that many such plans will not be SDAs where the underlying formula closely approximates the fair market value of the employer's shares over the duration of the plan. However, CRA will no longer make such a determination in the context of an advance ruling request.
You can refer to technical interpretation 2020-0850281I7 (footnote 3) for more details.
Nathalie Boyer
(450) 926-7039
October 7, 2020
2020-086434.
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 CANADA REVENUE AGENCY, Technical Interpretation 2020-0850281I7, July 10, 2020.
2 CANADA REVENUE AGENCY, Advance Rulings ATR-45 "Share Appreciation Rights Plan" 17 February 1992.
3 2020-0850281I7, supra note 1.