Personal Tax Planning

Transcription

1 caadia tax joural / revue fiscale caadiee (2013) 61:2, Persoal Tax Plaig Co-Editors: Pearl E. Schusheim* ad Gea Katz** A Fresh Look at Retiremet Compesatio Arragemets: A Flexible Vehicle for Retiremet Plaig Jim Kahae,** Uros Karadzic,** ad Simo Létoureau-Laroche** The retiremet compesatio arragemet (rca) provisios were first itroduced i 1986 as a ati-avoidace mechaism relatig to various tax-deferral strategies. They have sice become a importat tool i employee pesio plaig. The authors provide a historical perspective, a overview of the pesio-plaig ad icome tax cosideratios, ad several scearios illustratig the applicatio ad utility of rcas. The authors coclude with a overview of the ew pealty provisios ad advatage tax rules eacted i 2012 i respose to certai strategies adopted by private compaies that the Departmet of Fiace felt uduly exploited the rca tax regime. Keywords: Deferred compesatio retiremet plaig employee compesatio pesio plas executive compesatio Cotets Itroductio 480 Defiitio 480 Historical Backgroud 482 The Need for a RCA 484 Tax Cosequeces Relatig to RCAs 485 Refudable Tax Accout 485 Tax Implicatios for Employers ad Employees 486 Treatmet of RCAs o Retiremet or Death 488 Implicatios for Custodias 489 Fudig the RCA Letter of Credit Arragemets 489 Iteratioal Cosideratios 490 Taxatio of Retiremet Beefits to No-Residets 492 Other Plaig Implicatios 495 Providig Superior Retiremet Beefits 495 Case Study 1: Mid-Career Executive Hire 496 * Of Couzi Taylor LLP, Toroto (affiliated with Erst & Youg LLP). ** Of Erst & Youg LLP, Toroto. 479

2 480 caadia tax joural / revue fiscale caadiee (2013) 61:2 Facilitatig Purchase ad Sale of a Busiess 497 Fudig of Severace Paymets 497 Case Study 2: Severace Paymet 497 Attractig ad Retaiig Key Employees Compariso with Other Retiremet Plas ad Arragemets 498 Who Beefits from RCAs? 498 Recet Developmets Eforcemet ad Pealty Provisios 499 CRA Audits ad Assessmets 499 New Prohibited Ivestmet ad Advatage Rules 499 Coclusio 502 Itroductio Retiremet compesatio arragemets (rcas) are a importat Caadia pesioplaig vehicle that allows employers to set aside fuds to provide for employee retiremet beefits ad defer the icome recogitio to the employee. These retiremet beefits are typically pesio promises made to employees istead of, or i additio to, registered pesio plas (rpps). From the employee s perspective, a fuded rca ca provide security related to the pesio promise, i the evet that the employer would otherwise be uable or uwillig to make the related retiremet paymets i the future. rcas have bee part of the Caadia retiremet-plaig ladscape sice 1986, but are gaiig promiece as a viable meas of plaig for retiremet. rcas provide flexibility i retiremet plaig beyod what ca be achieved with rpps. I additio, employers cocers with the high cost of rpps, especially defied beefit plas, have drive may to look for pesio alteratives. While the use of rcas has bee costraied i the past by a ivestmet disadvatage amely, oly oe-half of the assets i the pla are available to produce returs this factor may be viewed as less sigificat i the curret low iterest rate eviromet. rcas are particularly relevat to seior-level employees. They may restore the pesio paymets that would have bee provided for uder a rpp if it were ot for the related tax limits, or they may provide for fudig of a separate pesio promise urelated to a rpp, or a ew pesio where o rpp beefit exists. This article focuses o the icome tax ad plaig aspects of rcas, ad provides a update o recet chages to the tax rules. Defiitio Retiremet compesatio arragemet is a defied term uder the Icome Tax Act. 1 It is a arragemet uder which a employer, a former employer, or a perso ot dealig at arm s legth with the employer or former employer makes cotributios 1 RSC 1985, c. 1 (5th Supp.), as ameded (herei referred to as the Act ). Uless otherwise stated, statutory refereces i this article are to the Act. The defiitio is cotaied i subsectio 248(1).

3 persoal tax plaig 481 (other tha paymets for the purpose of acquirig a life isurace policy) 2 to a third party (referred to as the custodia ) with respect to beefits that are to be received or ejoyed by a perso i the followig circumstaces: 3 the retiremet of the perso, the loss of a office or employmet of the perso, or a substatial chage i the services redered by the perso. While retiremet ad loss of office or employmet are evets that are geerally clear, a substatial chage i services is a questio of fact that must be determied o the basis of all the relevat circumstaces. The Caada Reveue Agecy (cra) will cosider that there has bee a substatial chage i services for the purposes of the defiitio of a rca whe the perso retires or is termiated but cotiues to reder differet services tha the oes formerly redered to the employer. For example, a seior executive providig traiig as a part-time employee after termiatio would be cosidered to have experieced a substatial chage i services. 4 A provisio i a deferred compesatio arragemet that provides for paymets to a employee who is still employed with o substatial chage i services redered will likely disqualify the arragemet from rca characterizatio. 5 The rca defiitio is very broad but excludes a umber of retiremet or deferred compesatio plas or arragemets specifically covered by other provisios of the Act i particular, rpps ad pooled rpps; deferred profit-sharig plas ad employee profit-sharig plas; registered retiremet savigs plas (rrsps); disability, group sickess, ad accidet isurace plas ad policies; employee trusts ad employee life ad health trusts; vacatio trusts; salary deferral arragemets (sdas); arragemets to defer salary or wages of professioal athletes; arragemets maily kept for the beefit of o-residets of Caada with respect to services provided outside Caada; ad statutory pesio plas, such as the Caada Pesio Pla. 6 2 By virtue of subsectio 207.6(2), where a employer acquires a life isurace policy, icludig a auity, i coectio with a retiremet compesatio arragemet, the life isurace policy will be cosidered subject property of the RCA. 3 Subsectio 248(1), the defiitio of retiremet compesatio arragemet. 4 Caada Reveue Agecy guide T4041, Retiremet Compesatio Arragemets Guide. 5 CRA documet o , March 1, These prescribed plas or arragemets are listed i regulatio 6802.

4 482 caadia tax joural / revue fiscale caadiee (2013) 61:2 Historical Backgroud I 1980, the Departmet of Fiace itroduced the employee beefit pla (ebp) rules to couter certai icome-deferral arragemets that allowed a immediate deductio to the employer while deferrig the icome iclusio to the employee/ beeficiary util the icome was received. The ebp rules sychroized the timig of the employer deductio with the iclusio of the deferred compesatio i the employee/beeficiary s taxable icome. 7 Despite these provisios, certai compesatio arragemets cotiued to provide udue deferral of icome. 8 As a result, provisios dealig with two specific forms of compesatio deferral were itroduced i 1986: the sda rules 9 ad the rca rules. 10 These provisios effectively made the ebp the residual characterizatio for icome-deferral arragemets ot otherwise covered by the Act. 11 The sda rules take priority over the rca provisios. 12 Accordigly, whe assessig whether a arragemet is a rca, oe must first determie whether the arragemet is a sda. A sda is a pla or arragemet (fuded or ot) uder which a perso has a right i a taxatio year to receive a amout after the year, where it is reasoable to cosider that oe of the mai purposes for the creatio of the right is to postpoe tax payable i respect of a amout that relates to services redered i the year or i a prior year, uless, where the right is subject to coditios, there is a substatial risk that ay oe of the coditios will ot be satisfied. 13 The Departmet of Fiace idicated i the techical otes released with the draft sda legislatio that [a]s a geeral rule, a substatial risk of forfeiture would arise if the coditio imposes a sigificat limitatio or duty which requires a meaigful effort o the part of the employee to fulfill ad create a defiite ad substatial risk that forfeiture may occur. 14 Vestig coditioal o the employer s achievemet of specified, substatial, ad challegig reveue goals without certaity of attaimet durig the vestig period may costitute a substatial risk of forfeiture Sectio Caada, Departmet of Fiace, Release o Caada, Departmet of Fiace, 1986 Budget, Budget Papers, Notice of Ways ad Meas Motio To Amed the Icome Tax Act, February 26, Caada, Departmet of Fiace, Notice of Ways ad Meas Motio To Amed the Icome Tax Act, October 9, See subsectio 248(1), the defiitio of employee beefit pla. 12 See subsectio 248(1), the defiitio of retiremet compesatio arragemet. 13 See subsectio 248(1), the defiitio of salary deferral arragemet. 14 Caada, Departmet of Fiace, Techical Notes to Bill C-23 (Ottawa: Departmet of Fiace, November 1986), at paragraph 5 of the SDA sectio. 15 It is uderstood that the CRA, as a matter of policy, will ot rule o whether a particular coditio costitutes a substatial risk of forfeiture.

5 persoal tax plaig 483 The defiitio of a sda is sufficietly broad to iclude may uregistered retiremet arragemets. Oe might argue that a retiremet arragemet was ot established to defer tax where the fudig of the retiremet beefits was ot i lieu of regular compesatio or bous, ad therefore such a arragemet would ot be a sda. However, Fiace is of the view that tax deferral could be oe of the mai purposes of a retiremet arragemet, ad accordigly that arragemet would ot be precluded from beig a sda simply because it provided for pesio or superauatio beefits. The fact that Fiace explicitly excluded rpps from the sda defiitio is a clear demostratio of the departmet s itetio, sice taxes o wages that would otherwise have bee received are effectively deferred. 16 Therefore, taxpayers must ot rely solely o this purpose test to determie whether a retiremet arragemet is a sda. I determiig whether a arragemet is a sda, the cra will look carefully at variatios i compesatio. A sudde decrease i salary or bous occurrig i the same year as a paymet to a retiremet pla may be relevat i determiig whether the pla is a scheme to defer compesatio. 17 However, the cra typically excludes a retiremet arragemet from beig characterized as a sda where the arragemet has the characteristics of a uregistered or supplemetary pesio pla (that is, the terms of the arragemet are substatially the same as those of the rpp that applies to the beeficiary) ad the amouts that may be paid uder the pla ca be cosidered to be reasoable superauatio or pesio beefits. 18 What might be cosidered a reasoable pesio beefit is a questio of fact that will be determied with referece to the employee s specific circumstaces. The cra has provided the followig guidelies to assist i the determiatio of whether a retiremet arragemet provides reasoable pesio beefits: The reasoableess of the beefits provided uder the retiremet arragemet i compariso to the provisios of the registered pla that applies to the particular employees; The history of the employer i providig pesio beefits; The comparability of the beefits provided to other employees of the employer or related employers uder other arragemets; ad The history of the employees remueratio ad ay variatios i that icome as a cosequece of the establishmet of the arragemet. 19 If it is determied that a retiremet arragemet does provide excessive beefits, it will be cosidered a sda eve if it otherwise meets the coditios set out i the rca defiitio. While there are o quatitative guidelies to determie what costitutes 16 CRA documet o C6, Jue 21, CRA documet o , May 8, CRA documet o E5, April 23, CRA documet o C6, Jue 21, 2007.

6 484 caadia tax joural / revue fiscale caadiee (2013) 61:2 a reasoable beefit, a actuarial evaluatio could help to support the level of cotributios made to the rca. If a pla is characterized as a sda, adverse tax cosequeces result. The amouts cotributed to the pla would be cosidered to be deferred icome, taxable immediately to the employee i the taxatio year i which the cotributios are made by the employer. 20 Although the employee would be immediately subject to icome tax o the cotributed amout, the cash would ot be available sice it would remai with the custodia of the pla. Fially, where a fuded uregistered arragemet is either a sda or a rca, it will likely costitute a ebp where the arragemet ivolves a custodia. I the case of post-employmet compesatio, a ebp may be used to deliver icetive awards or provide beefits to former employees. The ebp rules allow the tax to be deferred util the employee receives the beefit paymet. I this way, the ebp rules may be viewed as less harsh tha the sda rules, which require immediate icome recogitio eve where the amout has ot bee received. However, the rca offers more flexibility i providig beefits tha either a ebp or a sda. The Need for a RCA Whe a employer makes a promise to provide pesio beefits to a employee, that promise ca be delivered through a umber of arragemets. rpps are ofte used to provide beefits to a broad base of employees. A rpp ca be either a defied beefit pla (where the pesio amout is determied by a formula based o earigs ad years of service, ad the cotributios are actuarially determied) or a defied cotributio pla (where the cotributio level is fixed ad the beefit is limited to the amout of assets that accumulate i the employee s accout). I both cases, the rpp must be fuded, typically through a trust, ad the cotributios to the pla will be tax-deductible as log as they are withi certai limits. 21 A rpp may ot always be a desirable approach to providig pesio beefits. It may ot provide adequate flexibility if the employer wishes to provide a pesio beefit oly to a selected group of employees, such as seior maagers or executives. The admiistrative costs of providig a rpp also may be sigificat. Whe a rpp is ot desired but the employer wats to provide a pesio beefit, aother approach might be to establish a o-registered pla. A o-registered pesio pla, sometimes referred to as a supplemetary executive retiremet pla (serp), ca be either fuded or ufuded. Whe a serp is fuded, it is always fuded through a rca. Therefore, rcas ca be used to provide fudig for o-registered pesio plas. I some istaces, a serp is established to provide beefits that caot be offered uder rpps owig to the maximum pesio tax limits uder the Act. I these cases, the serp beefit would mirror the terms of the beefit uder the rpp, but 20 Subsectio 6(11). 21 Subsectio 147.2(1).

7 persoal tax plaig 485 would cover the earigs i excess of the statutory limits for rpps. If a employer agrees to fud this beefit, the fudig must be facilitated through the rca. The fudig cotributios to the rca ca be determied o either a defied beefit or a defied cotributio basis. I the case of a defied beefit pla, the employer may eed to obtai a actuarial report idicatig the level of cotributios required to provide for a defied pesio. For a defied cotributio arragemet, the cotributio could simply be calculated as a percetage of the employee s earigs. Oe key purpose of usig a rca to fud retiremet beefits is to safeguard employees beefits from the employer s creditors. Assets held i a rca are separate from the employer ad are out of reach of the employer s creditors. I the evet of bakruptcy, the employees whose beefits are secured through the fuded rca would likely receive greater beefits tha employees who were provided with oly a ufuded promise ad who would eed to stad alogside other creditors. Similarly, a rca ca provide security i the evet of a chage of cotrol followig a merger or a acquisitio. Tax Cosequeces ReLATig to RCAs Refudable Tax Accout Whe the employer makes a cotributio to a rca, oe-half of the cotributio must be remitted to the cra 22 ad placed i a refudable tax accout (rta). Similarly, oe-half of the retur geerated by the ivested portio of the assets must be trasferred to the rta. 23 Whe beefits are paid from the pla, the fuds are refuded from the rta to the rca at the rate of $0.50 for each $1 of beefit paid. 24 I the evet of termiatio of the pla, the assets i the rta are refuded to the rca. 25 Table 1 provides a illustratio of how a rca ad rta would work over a period of four years. As oted above, the balace at the ed of the year i the rca ad the rta are equal, sice oe-half of all cotributios ad ivestmet icome must be remitted to the cra. Upo termiatio of the rca, the assets remaiig i the rta (if ay) are refuded to the pla. However, the terms of the pla will dictate whether such surplus assets belog to the employer or to the pla members. Ofte it is the employer who is etitled to reclaim ay pla surplus followig termiatio, but i some istaces, the terms of the pla will dictate that all assets, icludig those that remai after the promised beefit is settled, accrue to the pla members. This may also have a impact o the employer s reportig of the asset o the balace sheet for 22 Subsectio 207.5(1), the defiitio of refudable tax, paragraph (a). 23 Ibid., paragraph (b). 24 Ibid., paragraph (c). 25 Subsectio 207.7(2).

8 486 caadia tax joural / revue fiscale caadiee (2013) 61:2 Table 1 Impact of Refudable Tax o Assets Held i a Retiremet Compesatio Arragemet over the Life of the Pla (Four Years) Year 1 Year 4 (pla iceptio) Year 2 Year 3 (pla termiatio) dollars RCA balace (begiig of year)... il Employer cotributio il Employee cotributio il Ivestmet icome il Beefit paymets... il (20) (20) (400) Trasfer to RTA (1/2 of all cotributios ad ivestmet icome) a Trasfer from RTA to RCA (1/2 of all beefits paid)... il RCA balace (ed of year) il Retur of assets to employer.... a a a 24 RCA = retiremet compesatio arragemet. RTA = refudable tax accout. accoutig purposes specifically, for employers who report uder iteratioal fiacial reportig stadards 26 sice the employer may ot ow the surplus. The rta is a o-iterest-bearig accout. Therefore, i effect, oly oe-half of the assets set aside to provide for the beefit ca be ivested. This is the major drawback of the rca as a retiremet plaig tool. Sice the employer caot rely o the icome from the assets i the rta to fud retiremet beefits, the employer cotributios required to provide the beefits will be somewhat higher. However, as oted earlier, this is of less cocer i a low iterest rate eviromet, sice the forgoe retur i the rta is ot as sigificat as it would otherwise be. Tax Implicatios for Employers ad Employees The first resposibility of the employer is to register the rca trust ad apply for employer ad custodia trust accout umbers, so that refudable tax ad withholdigs ca be remitted. 27 Cosistet with cotributios to other pesio arragemets, employer cotributios to a rca are deductible i the year they are paid. 28 Retiremet beefits are taxable to the employee at the time of receipt Iteratioal Accoutig Stadards Board, Iteratioal Fiacial Reportig Iterpretatios Committee, Iterpretatio IFRIC 14, IAS 19 The Limit o a Defied Beefit Asset, Miimum Fudig Requiremets ad Their Iteractio, July 4, Guide T4041, supra ote Paragraph 20(1)(r). 29 Paragraph 56(1)(x).

9 persoal tax plaig 487 It should be oted that the deductio is permitted oly for cotributios made with respect to services redered by a employee or a former employee. Accordigly, eve though the defiitio of a rca allows cotributios to be made by a perso ot dealig at arm s legth with the employer, 30 such cotributios would ot be deductible uless the employee had redered services to that perso. 31 The provisio goverig the employer deductio 32 does ot specify whether the employer cotributio is limited to a amout i respect of services redered i the curret year. It seems to be acceptable to the cra that a deductio is available with respect to past services, icludig services redered prior to the year i which the rca is established, provided that the cotributios are reasoable ad there is a employer-employee relatioship. 33 Employee cotributios may also be deductible if the followig coditios are met: 34 the employee cotributios were paid to a Caadia-residet custodia; the employee was required uder the terms of employmet to cotribute to the rca; ad the total amout cotributed by the employee is ot more tha the total amout cotributed by a employer or by ay other perso i respect of the employee durig the year. I cases where a employee s cotributio does ot meet these coditios for example, because the employee is ot legally required to cotribute to the rca the employee may be etitled to a deductio at a later time whe there is a icome iclusio from the rca, such as whe the employee retires or dies. 35 This provisio allows the employee to recover udeducted cotributios to the rca, plus ay amout paid or received to acquire or dispose of a iterest i the rca. 36 The deductio is limited to the amout of the beefit icluded i icome for a give year. Practically speakig, several years could elapse before the employee is etitled to a full deductio of the cotributed amouts, so i certai situatios, it may ot be appropriate to make such cotributios. The cra has stated that the provisio allowig the deductio of employee cotributios is ot iteded to provide a deductio for cotributios that are cosidered ureasoable if paid i full by the employer. The cra challeged a situatio where 30 Subsectio 248(1), the defiitio of retiremet compesatio arragemet. 31 CRA documet o I7, Jauary 10, Paragraph 20(1)(r). 33 CRA documet o E5, Jauary 5, Paragraph 8(1)(m.2). 35 Paragraph 60(t). 36 Caada, Departmet of Fiace, Explaatory Notes Relatig to Icome Tax (Ottawa: Departmet of Fiace, December 1997), at subclause 99(6).

10 488 caadia tax joural / revue fiscale caadiee (2013) 61:2 a employer, i additio to his ow cotributios to the rca, paid a amout to a employee who the made a cotributio to the rca, ad the total amout cotributed exceeded a reasoable amout. 37 I additio, a lack of evidece that cotributios were made i accordace with the terms of the retiremet arragemet may disqualify the arragemet as a rca, especially if a o-arm s-legth relatioship exists betwee the employer ad the employee. A arragemet providig ureasoable beefits to a employee would likely be cosidered a sda. Treatmet of RCAs o Retiremet or Death There is geerally more flexibility upo the retiremet of a employee etitled to beefits uder a rca tha uder other registered plas. I particular, the withdrawal requiremets are more flexible i the case of a rca compared to those applicable to a rpp, a idividual pesio pla (ipp), or persoal tax-deferred savigs i relatio to timig ad pesio amouts. The pla member is taxed as fuds are withdraw, ad the rca receives the refudable tax from the cra i the amout of oe-half of the beefit paid. The custodia is required to withhold icome tax o the distributio, 38 which the pla member reports as taxes paid o his or her persoal tax retur. Effective Jauary 1, 2013, pesio icome-splittig provisios have bee exteded to rcas. 39 Spouses will ow be able to split rca distributios to the extet that the beeficiary of the icome is at least 65 years of age ad beefits received are i the form of a life auity supplemetal to a rpp. 40 The amout that is eligible for splittig is limited to the lesser of the rca icome for the year ad the amout, if ay, of the beeficiary s other eligible pesio icome i excess of the defied beefit limit for the year ($2,696 for 2013) 41 multiplied by Fially, whe a member of a rca dies, the etitlemet to the pesio beefit uder the rca ca be trasferred to the member s spouse o a tax-deferred basis. 43 The survivig spouse must be the beeficiary of the pla whe the member dies. Beefits will be icluded i the spouse s icome at the time of receipt. 44 If there is o survivig spouse, there will be a full icome iclusio i the termial retur of the deceased, 45 creatig a tax liability i the year of death of the member. The remaiig assets i the pla that were iteded for the deceased are the available to the estate or to aother beeficiary. 37 CRA documet o , September 16, Guide T4041, supra ote Jobs ad Growth Act, 2012, SC 2012, c. 31, sectio 14(2). 40 Subsectio 60.03(1), the defiitio of eligible pesio icome, subparagraph (b)(i). 41 Regulatio 8500(1). 42 Supra ote 40, at subparagraph (a)(ii). 43 Paragraph 70(3)(a). 44 Paragraph 70(3)(b). 45 Subsectio 70(2).

11 Implicatios for Custodias persoal tax plaig 489 The rca defiitio does ot specify who may be the custodia. However, a iter vivos trust is deemed to be created whe the rca is established, ad the custodia is deemed to be the trustee. 46 As the trustee of a rca trust, the custodia is required to aually file form t3-rca ( Retiremet Compesatio Arragemet (rca) Part xi.3 Tax Retur ) withi 90 days after the ed of the taxatio year. 47 The custodia must disclose details of cotributios received durig the year, distributios made durig the year, aual ivestmet icome geerated i the trust, ad the computatio of refudable tax for the curret year. The custodia must also pay tax equal to the amout, if ay, by which the refudable tax at the ed of the year exceeds the refudable tax at the ed of the immediately precedig taxatio year. Ay shortfall i the rta balace must be settled before the deadlie to submit form t3-rca. 48 I additio, the custodia is required by the cra to track all employee cotributios ad advise the employees of deductible amouts, o a aual basis. 49 The total amout of the employee cotributios caot exceed the total amout of the cotributios made by the employer for the year. 50 Fially, the custodia is resposible for withholdig icome tax o distributios made to all beeficiaries, whether they are residets 51 or o-residets of Caada. 52 Fudig the RCA Letter of Credit Arragemets Fudig a serp pesio through a rca may require a sigificat cash outlay, especially for a ewly established serp that also provides beefits for past service. The employer may ot wish to pre-fud beefits i this maer, but rather pay them as they fall due. Yet the employer may still desire to provide (or the serp members may demad) a certai level of beefit security. A alterative to usig cash, where cash may ot be available, is to obtai a letter of credit (loc) from a fiacial istitutio. The loc provides that i certai circumstaces, such as the employer s failure to reew the loc or to pay employee beefits, the bak that issued the loc would pay the face value of the loc ito the rca, fully fudig the beefit. The employer would the owe the bak the face amout of the loc. This arragemet provides security to the member while ot requirig the employer to cotribute directly to the rca. The loc is typically reewed aually. The loc is held by the rca, ad whe the employer pays the aual tax-deductible fee to the bak for the loc, a equal 46 Subsectio 207.6(1). 47 Paragraph 207.7(3)(a). 48 Paragraph 207.7(3)(c). 49 Guide T4041, supra ote Clause 8(1)(m.2)(iii)(A). 51 Paragraph 153(1)(q). 52 Paragraph 212(1)(j).

12 490 caadia tax joural / revue fiscale caadiee (2013) 61:2 amout must be paid ito the rta. The loc fee may vary depedig o the creditworthiess of the employer. The face value of the loc is usually determied o a actuarial basis, ad it is meat to represet the amout sufficiet to fully fud the pesio promise. Fuds held i the rta equal to the loc fees may ot be recoverable to the employer util may years later whe the pla is termiated. The loc is typically secured by a geeral floatig charge o the employer s assets. However, a loc secured by a charge o specific assets gives rise to the risk that the value of assets formig specific security will be cosidered a cotributio to the rca subject to refudable tax i additio to the loc fees paid. 53 Whe beefits are required to be paid from the serp ad a loc has bee put i place, the employer may choose to pay beefits directly, bypassig the rca ad hece avoidig paymet of a equivalet amout ito the rta. Eve whe the rca is fuded with cash, i some circumstaces the employer may choose to pay beefits directly (for example, where the beefit is perceived as a special paymet that was ot pre-fuded i the rca). Both the loc fee paymets ad the employee beefit paymets made by the employer are deductible to the employer. As discussed earlier, beefits paid uder the pla are taxable to the employee o receipt. Iteratioal Cosideratios The rca rules described above apply to residet employees who provide services i Caada throughout their career. Specific rules must be cosidered whe rcas are cotemplated to deliver retiremet beefits to o-residet as well as mobile employees. The use of such arragemets has bee growig i a icreasigly global busiess eviromet. As described previously, uder the statutory defiitio a arragemet maitaied primarily for the beefit of o-residets of Caada for work performed outside Caada is ot cosidered a rca. 54 However, a foreig pesio arragemet may come withi the ambit of the rca rules (provided that it meets the purpose test discussed above) if a cotributio to the foreig arragemet ca reasoably be cosidered to have bee made i respect of services redered by a employee i a period throughout which the employee was a residet of Caada ad redered services to the employer i Caada or i coectio with a busiess carried o by the employer i Caada; ad 2. at the begiig of which the employee was a Caadia-residet taxpayer for at least 60 of the precedig 72 moths, where he or she was a o-residet 53 CRA documet o , Jue 28, Subsectio 248(1), the defiitio of retiremet compesatio arragemet, paragraph (l). 55 Paragraph 207.6(5.1)(b).

13 persoal tax plaig 491 of Caada at ay time before the period ad became a member of the pla before the ed of the moth i which he or she became a Caadia residet. If the above coditios are met, the cotributio made by the employer (referred to as the residet s cotributio ) will be deemed to be a cotributio made to a Caadia retiremet arragemet. 56 More specifically, the followig presumptios will apply to the retiremet arragemet: 57 The residet s cotributios, ad all property derived from those cotributios, will be treated as a separate arragemet (referred to as the residets arragemet ). The residets arragemet will be deemed to be a rca. The perso to whom the residet s cotributios are made will be deemed to be the custodia of the rca. Uder these rules, if a ewcomer to Caada remais a member of his or her home-coutry pesio pla for more tha five years, the foreig pesio pla may still be cosidered a rca for Caadia tax purposes. The rca rules, icludig the requiremet to pay tax ito a rta, will apply with respect to the residet s cotributios, uless the employer makes a electio with respect to the foreig arragemet such that the cotributios are cosidered prescribed cotributios. 58 The prescribed cotributio rules are complex, but essetially are as follows: Cotributios are made to a qualifyig etity, defied as a o-residet etity that holds the assets of the foreig pla, that is residet i a coutry that levies icome taxes, ad that qualifies for favourable tax treatmet because it holds assets of a retiremet pla If the employer is ot a foreig o-profit orgaizatio, 61 a. the employee was o-residet at ay time before the cotributio is made; b. the employee became a member of the foreig pla before the ed of the moth after the moth i which the idividual became residet i Caada; ad c. the employee is ot a member of a rpp, or a deferred profit-sharig pla, i which the employer, or a perso or body of persos that does ot deal at arm s legth with the employer, participates. 56 Subsectio 207.6(5.1). 57 Subsectio 207.6(5). 58 Regulatio 6804(2). 59 Regulatio 6804(6). 60 Regulatios 6804(1) ad 6804(6)(a). 61 defied i regulatio 6804(1) ad regulatio 6804(6)(e).

14 492 caadia tax joural / revue fiscale caadiee (2013) 61:2 3. If the employer is a foreig o-profit orgaizatio, additioal requiremets with respect to the amout of the cotributio must be met, otably with respect to a otioal pesio adjustmet applicable to the employee. 62 If cotributios to the foreig retiremet arragemet are prescribed cotributios, the rca rules will ot apply, eve if the employee is preset i Caada beyod the five-year period. I this case, the characterizatio of the retiremet arragemet ad tax treatmet will deped o the specific facts. For example, foreig pesio plas are likely to be cosidered ebps for Caadia tax purposes, sice a custodia is ivolved i deliverig retiremet beefits. Cosequetly, the employer s deductio will be deferred to the year i which the employee is subject to tax o a distributio by the ebp. 63 I additio, cotributios made to a foreig pla may limit the amout that the employee may cotribute to a rrsp, sice a pesio adjustmet must be determied with respect to such cotributios. For this purpose, a foreig pla icludes a pla that would be a rca were it ot maitaied primarily for o-residets of Caada. 64 The pesio adjustmet must be computed 65 if the etitlemet to the rca for a give year relates to services that were redered i a period throughout which the employee was residet i Caada, ad services that were primarily redered i Caada or i coectio with a busiess carried o by the employer i Caada. It should be oted that the cra has the authority to require a pesio adjustmet to be determied i a alterate maer that it cosiders appropriate where the applicatio of the geeral rules does ot provide a appropriate result, 66 ad where such determiatio is requested i writig. 67 Taxatio of Retiremet Beefits to No-Residets The tax treatmet of paymets from a rca to a o-residet of Caada depeds o the applicatio of a icome tax treaty betwee Caada ad the foreig coutry of residece. Caada has cocluded separate tax treaties with more tha 90 coutries. Sice those treaties geerally share a commo framework based o the model covetio of the Orgaisatio for Ecoomic Co-operatio ad Developmet 62 Regulatio 6804(6)(c). 63 Subsectio 32.1(1). 64 Regulatio (1). 65 Regulatio (2)(b). 66 Regulatio 8310(2). 67 Regulatio 8310(3).

15 persoal tax plaig 493 (oecd), 68 the discussio that follows will focus maily o the relevat provisios of the model covetio ad the related commetary. The iitial questio i applyig a particular treaty is whether a pesio beefit has bee paid. The model covetio does ot provide a defiitio of pesio for the purposes of article 18, which relates to the taxatio of pesios; however, the commetary discusses whether paymets should be cosidered employmet icome or a pesio. Pesio should be cosidered, uder the ordiary meaig of the word, to mea a periodic paymet; however, article 18 also refers to other similar remueratio, a term that is broader. The commetary states that paymets made from a pesio scheme would ormally be covered by the Article, 69 but other factors i favour of pesio characterizatio should be cosidered, icludig the followig: 70 Are the paymets made after cessatio of employmet? Has the beeficiary reached the ormal age of retiremet? Is the beeficiary etitled to other pesio beefits? I light of the above, uder the model covetio, paymets from a rca are likely to be cosidered a pesio rather tha icome from employmet. From a Caadia perspective, pursuat to the Icome Tax Covetios Iterpretatio Act (itcia), rcas are cosidered to be pesio vehicles if pesio is ot otherwise defied i the tax covetio cocluded betwee Caada ad a foreig coutry. 71 Uder the Icome Tax Act, paymets from a rca to a o-residet of Caada are subject to o-residet withholdig tax. 72 The applicable treaty betwee Caada ad the relevat foreig coutry of residece may provide for a rate that is lower tha the Caadia part xiii tax rate of 25 percet. Article 18 of the model covetio provides that pesio beefits are taxable oly i the state of residece of the beeficiary. If the foreig coutry of residece applies the oecd positio, o Caadia taxes will be withheld at source o a paymet from a rca to a o-residet beeficiary because such icome will ot be taxable i Caada. To the extet that the effective tax rate i the beeficiary s coutry of residece is sigificatly lower tha the rate that would otherwise apply to a Caadia residet, there are tax-savig opportuities i situatios where the beeficiary is expectig to leave Caada Orgaisatio for Ecoomic Co-operatio ad Developmet, Model Tax Covetio o Icome ad o Capital: Codesed Versio (Paris: OECD, July 2010) (herei referred to as the model covetio ), ad the related commetary. 69 Paragraph 6 of the commetary o article Ibid. 71 Icome Tax Covetios Iterpretatio Act, RSC 1985, c. I-4, as ameded, sectio Paragraph 212(1)(j). 73 The CRA may cosider the establishmet of a RCA to be part of departure plaig ad subject to challege.

16 494 caadia tax joural / revue fiscale caadiee (2013) 61:2 However, some jurisdictios do ot apply the model covetio; istead, both the residece coutry ad the source coutry reserve the right to tax pesio paymets. I this situatio, taxes withheld by the source coutry are likely to be take ito accout by the residece coutry for foreig tax credit purposes; 74 this is the case, for example, uder the Caada-us treaty. 75 As a result, plaig opportuities may arise for employees who do ot expect to remai i Caada durig retiremet. I the evet that a paymet from a rca is taxable both i Caada ad i the coutry of residece of the beeficiary, a tax credit is ordiarily grated i the jurisdictio where the beeficiary resides at the time of paymet i respect of the taxes paid to Caada. This credit will be equivalet to the taxes payable i Caada to the extet that they do ot exceed the taxes payable o such icome i the foreig jurisdictio. 76 Thus, if the effective tax rate i the foreig coutry is less tha the applicable Caadia part xiii withholdig, the overall tax rate applicable to the rca distributio will be equivalet to the part xiii withholdig. If the effective rate i the coutry of residece exceeds the Caadia withholdig, the total tax paid will be limited to the effective tax i the coutry of residece. If this is less tha the tax that would have bee payable i Caada had the beeficiary still bee a residet of Caada at the time the distributio was made, tax savigs result. It should be oted that a right to receive a amout from a rca is a excluded right for Caadia tax purposes 77 ad thus ot subject to a deemed dispositio 78 ( departure tax ) whe a rca beeficiary emigrates from Caada. Some coutries do ot follow the oecd positio with respect to the taxatio of pesios, ad this also may give rise to iterestig plaig opportuities. For example, the Caada-Frace treaty provides that pesio beefits are taxable oly i the state i which they arise. 79 I this situatio, a Frech residet who was employed i Frace ad is a beeficiary of a Caadia rca would be subject oly to Caadia withholdig tax, at the rate of 25 percet, i respect of the paymet of retiremet beefits. Pursuat to the treaty, Frace would allow a full foreig tax credit equivalet to the Frech taxes otherwise payable o this icome. 80 As a result, the tax rate o the paymet of the retiremet beefit would be limited to 25 percet, which is 74 article 23B of the model covetio. 75 Article XVIII of the Covetio Betwee Caada ad the Uited States of America with Respect to Taxes o Icome ad o Capital, siged at Washigto, DC o September 26, 1980, as ameded by the protocols siged o Jue 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997, ad September 21, article 23B of the model covetio. 77 See subsectio 128.1(10), the defiitio of excluded right or iterest, subparagraph (a)(ix). 78 Subparagraph 128.1(4)(b)(iii). 79 article 18(1) of the Covetio Betwee Caada ad Frace for the Avoidace of Double Taxatio ad the Prevetio of Fiscal Evasio with Respect to Taxes o Icome ad o Capital, siged at Paris o May 2, 1975, as ameded by the protocols siged o Jauary 16, 1987 ad November 30, 1995 (herei referred to as the Caada-Frace treaty ). 80 article 23(2)(a)(i) of the Caada-Frace treaty.

17 persoal tax plaig 495 likely less tha the effective icome tax rate that would otherwise apply to such icome i Frace. This situatio is, of course, possible oly to the extet that the o-residet employee is a beeficiary of a rca that is maitaied primarily for the beefit of Caadia residets i respect of services redered i Caada. O the basis of the defiitio of a rca, if a sigle-purpose trust had bee created to fud ad deliver retiremet beefits to the Frech residet i the example above, the arragemet would ot be cosidered a rca because it would be maitaied primarily for a o-residet of Caada ad for services redered outside Caada. For Caadia tax purposes, the arragemet would likely be cosidered a ebp, assumig that oe of the cotributios were made i respect of services redered i Caada or while the employee was a residet of Caada. Paymets out of a ebp are typically cosidered employmet icome ad may be subject to differet rules tha those oted above. However, because the employee is a o-residet of Caada, the employer may deduct the cotributio i the year i which it is made, 81 i cotrast to the treatmet of a cotributio made to a ebp with respect to a residet employee. Fially, the characterizatio of the icome ad the timig of taxatio applicable to etitlemets uder a rca may be differet i foreig jurisdictios. Accordigly, the potetial applicatio of foreig tax legislatio should be carefully reviewed before a rca is established for a employee abroad. Other Plaig ImpliCATios rcas provide a meas to secure (with assets or locs) a o-registered pesio pla promise. Providig Superior Retiremet Beefits As oted above, rcas ca provide for retiremet beefits i excess of those permitted uder various registered plas. However, the level of cotributio that ca be made to a rca is ot ulimited. The promise that the employer fuds through a rca must be a boa fide pesio promise. While this still ca allow for a substatial amout to be cotributed to a rca, a aalysis should be performed to esure that those assets are withi the limits of what could reasoably be described as a pesio beefit. For example, it is likely that cotributios that are defied i a similar maer to those provided by a registered pla (otwithstadig the dollar limits imposed uder the Act) ca be supported as a boa fide reasoable pesio promise. I the cotext of defied cotributio plas, that may mea that cotributios of up to 18 percet of salary ca be cosidered reasoable cotributios. I the cotext of a defied beefit promise, a estimate of the value of a rich defied beefit pla (for example, a pesio that provides the maximum accrual allowed uder the Act, alog 81 Paragraph 18(10)(a). Sectio 9 ad paragraph 18(1)(a) should also be cosidered.

18 496 caadia tax joural / revue fiscale caadiee (2013) 61:2 with iflatio-idexed pesio ad survivor beefits) ca serve as the limit of what ca reasoably be supported as a pesio promise. This assessmet of a reasoable cotributio amout should be based o the employee s years of service with the employer, icludig service i the years prior to establishmet of the rca. Cotributig amouts i excess of such formula-derived cotributios could put the pla at risk of beig cosidered a sda. Adverse tax cosequeces could be triggered sice the etire cotributio could be cosidered a sda, ad ot oly the amout i excess of what ca be cosidered reasoable. Such cotributios would be taxable to the employee immediately i the year they are made, 82 because they would be cosidered deferred remueratio, otwithstadig that the employee would ot receive the actual icome util payout from the pla i future years. It is worth otig that it is ot ecessary for the employer to make all beefit paymets through a rca. For example, a rca (alog with the related rta refuds) ca be used to pay ogoig pesio beefits; however, i the evet that a special oe-off paymet is required, that paymet ca be made directly by the employer to the employee outside the rca (whether the pla is fuded by cash or loc). This avoids the eed to cotribute twice the required amout to the rca (ad pay half of that amout ito the rta). Case Study 1: Mid-Career Executive Hire A compay is egotiatig a compesatio package with a mid-career idividual who will assume a seior executive positio at the compay. While the compay does ot provide pesio beefits to its regular employees, it wishes to provide a defied beefit to this executive i order to compesate him for the loss of such beefit provided by his curret employer. Furthermore, the compay wishes to esure that the executive remais with the compay through a critical period over the ext five years. The compay proposes to provide the executive with a arragemet comparable to the defied beefit pla that he curretly ejoys by settig up a serp, to be fuded with cash through a rca. The beefit uder the serp will vest to the employee oly after he has bee with the compay for a five-year period, or i the evet of ivolutary termiatio without cause. The compay egages a actuary to calculate the required cotributios to secure this beefit. Oe-half of these cotributios are remitted to the cra ad are held i the o-iterest-bearig rta. Therefore, the employer is able to ivest oly oe-half of the cotributios, leadig to a potetially higher log-term cost of providig the beefit (sice o ivestmet retur ca be made o the balace i the rta). The executive remais with the compay for five years ad the retires. The employer provides the executive with the optio of a lifetime pesio or a sigle lump-sum amout. The executive elects a lump-sum trasfer, requirig the employer to pay out all the assets from the rca, obtai the refud from the rta, ad also pay a additioal amout outside the rca directly to the employee (sice the assets i the rca ad rta are isufficiet i this case to pay 82 Subsectio 6(11).

19 persoal tax plaig 497 for a full beefit). The employer cotributios are deductible, ad the employee is taxed o receipt of the beefits paid out of the pla. Facilitatig Purchase ad Sale of a Busiess Fudig a rca ca be a effective way to reduce the purchase price of a busiess prior to sale or trasfer. May ower-maagers retiremet strategies iclude the sale or trasfer of the busiess. Establishig a rca makes it possible to take some assets out of the busiess, thereby reducig the potetial purchase price ad facilitatig a sale or a trasfer. Fudig of Severace Paymets For the purposes of the Act, a severace paymet may be cosidered a retirig allowace that is, a paymet received o or after retiremet, or i respect of loss of a office or employmet. 83 Nothig i the Act precludes payig a retirig allowace i istalmets. However, a employer is etitled to a deductio i respect of a retirig allowace oly whe a paymet is made to the former employee as a geeral busiess expese. 84 A rca may be used to fud severace paymets that will be made i istalmets while providig the employer (or former employer) with a immediate tax deductio. The cra has stated that a retirig allowace paid to a third party would costitute a rca. 85 I such a case, the full amout of the cotributio would be immediately deductible to the employer, eve if the employee received the icome i a later year or i istalmets. Case Study 2: Severace Paymet A executive is beig termiated by her employer. The executive egotiates to receive the severace paymet i istalmets over several years. As oted above, for the purposes of the Act, a severace paymet may be cosidered a retirig allowace. The employer agrees to pay severace i istalmets over a five-year period. Normally, this would delay the deductio of the paymet util the time each paymet is made; however, as a alterative, the employer decides to pay the etire severace amout ito a rca. The employer the obtais a immediate tax deductio for the full amout of the severace paymet, while the former executive receives the severace i istalmets over the agreed period. Havig the full severace amout placed withi a rca provides protectio to the executive from the employer s creditors or chages i the employer s itetios. It also provides a opportuity to draw o the rca assets at a time whe the former executive may be subject to lower margial tax rates. 83 Subsectio 248(1), the defiitio of retirig allowace. 84 CRA documet o R3, CRA documet o E5, February 24, 2004.

20 498 caadia tax joural / revue fiscale caadiee (2013) 61:2 Attractig ad Retaiig Key Employees Compariso with Other Retiremet Plas ad Arragemets A key advatage of rcas over rpps (icludig ipps) is the flexibility provided i the o-registered cotext of the rca. Sice rcas are ot subject to the provisios of the Pesio Beefit Act, there is more flexibility i the provisio of beefits. 86 For example, a higher portio of earigs could be covered by the pla tha is allowed uder the maximum pesio restrictios for rpps ad ipps. Likewise, there is flexibility i terms of withdrawal requiremets, sice a rca ca provide for either a lump-sum paymet or auity paymets with varyig levels of payout. This flexibility allows for more effective attractio ad retetio of key employees. Cosider the example of a mid-career executive hire. The employer could offer a o-registered pesio beefit, fuded through a rca, that would recogize additioal years of service with the ew employer. For example, the rca pesio could be based o 2-for-1 years of service, or provide for a additioal beefit based o teure; thus, if the ew employee stayed with the compay for 5 years, the beefit uder the rca would be based o 10 years of service uder the pla. However, the beefits must be reasoable. Such flexibility is ot possible uder rpps or ipps. Similarly, give the flexibility i pla desig ad o requiremet for immediate vestig as is commoly the case for rpps, a rca could be used as a effective retetio tool. For example, it is possible to provide that the rca beefit will be payable oly if the employee remais with the compay for a specified period of time (for example, 5 or 10 years) or retires from active service with the compay; thus, the beefit would be forfeited if the employee left the compay prior to retiremet. rcas have the added flexibility that there is o requiremet, as uder the rpps or rrsps, to commece the pesio beefit by a certai age. Participatig i rpps reduces a employee s ability to cotribute to his or her rrsp, sice the employer is obliged to calculate ad report a pesio adjustmet o the employee s t4 i respect of the beefit eared uder the rpp. 87 No such requiremet exists for rcas; participatio i a rca does ot reduce the idividual s rrsp room. 88 Who Beefits from RCAs? Both the employees who participate i a o-registered pesio pla that is fuded through the rca ad the sposorig employer ca beefit from this type of arragemet. From the employee s perspective, the security provided by assets that are out of reach of the employer s creditors is a key beefit to havig a rca as compared with 86 However, the potetial applicatio of provicial pesio legislatio should be cosidered. 87 Regulatio 8301(1). 88 Regulatio (1)(d).