In November of this year at the Canadian Tax Foundation’s 67th Annual Tax Conference (Conference), the Canada Revenue Agency (CRA) announced its current positions on Deferred Share Unit (DSU) conversions; payment events for DSU plans that cover U.S. taxpayers; and the requirement that Private Health Services Plans (PHSPs) provide benefits that qualify for the medical expense tax credit.
The CRA was asked about the conversion of restricted share units (RSUs) and performance share units (PSUs) that were designed to satisfy the conditions of paragraph (k) of the salary deferral arrangement (SDA) definition in subsection 248(1) of the Income Tax Act, which permits bonuses to be deferred for three years, to DSUs that were intended to satisfy the requirements of paragraph 6801(d) of the Income Tax Regulations (Regulations), i.e., share-based awards that are only payable after death, retirement or loss of office.
The CRA advised that its past rulings that plans could provide for these types of conversions and such conversions could occur on a tax-free basis no longer reflected its position. The CRA’s new position is that these conversions do not satisfy the conditions of paragraph (k) of the SDA definition or paragraph 6801(d) of the Regulations because they could result in payments being made after the three-year period permitted under paragraph (k) or before the employee’s retirement, loss of office or death, as provided in paragraph 6801(d). Consequently, it is now CRA’s position that a plan may not provide employees with the right to convert RSUs to DSUs or vice versa.
Previously issued favourable rulings on plans that contained the above-noted conversion feature are being revoked, according to the CRA. The revocation will not apply to units in existence prior to the date specified in the notice of revocation or to additional units credited in respect of such existing units, for example due to dividend equivalents or changes in the underlying shares. For plans that contain a conversion feature but did not receive a ruling, units in existence on or before November 24, 2015, and additional units credited in respect of such existing units, may still be converted in accordance with CRA’s previous position as articulated in its prior favourable rulings on such conversion features.
DSUs AND SEPARATION FROM SERVICE UNDER SECTION 409A OF THE INTERNAL REVENUE CODE
The CRA was asked whether a DSU plan could provide for payments to be made to U.S. taxpayers on a “separation from service”, as defined for purposes of section 409A of the Internal Revenue Code (Code), and still comply with the requirements of paragraph 6801(d) of the Regulations.
Since payments on a separation from service under section 409A of the Code can occur earlier than the time of actual loss of office or employment, as required by paragraph 6801(d), the CRA is of the opinion that a “separation from service” under section 409A of the Code can occur in situations that do not satisfy the requirements of paragraph 6801(d) of the Regulations.
The CRA indicated that deferred amounts under DSU plans that provide for payment on a separation from service under section 409A of the Code, but are not subject to the more restrictive payment requirements of paragraph 6801(d) of the Regulations, are technically includable in the DSU holders’ income. As indicated below, the CRA is providing some transitional relief for DSUs that are currently outstanding, but did mention at the Conference that the taxable amount could be brought forward to the earliest non-statute barred year where the right to payment in respect of the DSU is still in existence.
Favourable rulings on DSU plans providing for payment on “separation from service” are in the process of being revoked, according to the CRA. In the case of such plans, DSUs credited prior to the date specified in the notice of revocation and additional units credited in respect of such existing units will not be affected by the revocation of the ruling. In the case of a DSU plan that provides for payment on “separation from service” but did not receive a ruling, CRA will continue to apply its position on payment on “separation from service” as set out in its prior favourable rulings to DSUs that are outstanding under such a plan on November 24, 2015, and additional DSUs credited in respect thereof.
Effective January 1, 2015, the CRA will consider a plan to be a PHSP as long as all or substantially all of the premiums paid relate to expenses that would qualify for the medical expense tax credit. This is a change from the CRA’s historic position that a PHSP exists only if all premiums paid relate to expenses that are eligible for the medical expense tax credit. The CRA indicated it did not intend to exclude plans from being PHSPs based on incidental or nominal aspects of the plan that do not qualify for the credit.