The following are selected corporate tax items discussed by the CRA at the Canadian Tax Foundation’s annual conference in Montreal last week. The CRA’s formal written comments (on all the Roundtable questions) have not yet been published.
1. CRA reverses prior position on deferred bonus plans convertible into DSUs
In the past, the CRA provided favorable rulings for compensation plans that essentially “stacked” together two independent exemptions in the definition of a “salary deferral arrangement” in s. 248(1). The first exemption, in paragraph (k), allows a bonus for a year to be paidwithin 3 years after the year. The second exemption, in paragraph (l) and Regulation 6801(d), allows for deferred stock unit (“DSU”) plans that involve the payment of defined amounts after the employee's death, retirement, or loss of employment. The stacked plans allowed an employee to elect to convert a deferred bonus into DSUs instead. Effective November 24, 2015, the CRA has formally reversed its position on these plans. The CRA now says that such stacked plans do not satisfy either of the two exemptions because: (1) amounts could be paid after the 3-year deferral period described in paragraph (k), and (2) amounts could be paid before employee's death, retirement, or loss of employment described in Regulation 6801(d). The CRA confirmed that any units issued (under a prior ruling) before November 24, 2015 are grandfathered, and can still be converted.
The CRA did not touch on an important legal question in this context. Depending on the evidence, a deferred bonus plan structured as “performance stock units” (“PSUs”) might not be an SDA at all. That is, in some cases the only main purpose for the PSU plan might be to provide performance-based compensation that aligns with the shareholders’ interest. Such a purpose could have nothing to do with “postponing tax payable”, and on that basis would not be an SDA as defined.
2. CRA says DSU plans that incorporate U.S. IRC s. 409A could be offside
Where a DSU plan includes employees who are subject to income tax in the United States, the plan must meet the requirements of s. 409A of the Internal Revenue Code in order to qualify for a tax deferral in the US. The problem is that the triggering events under s. 409A are broader, and can be earlier, than the triggering events in Reg. 6801(d). Accordingly, the CRA announced that a DSU plan could not provide for the full range of triggering events permitted by s. 409A without disqualifying the plan under Reg. 6801(d). The CRA further confirmed Reg. 6801(1) applies on an employee-by-employee basis. As a result, the CRA said a “sub-plan” could potentially be tailored for a limited group of employees such that the sub-plan complies with the both Reg. 6801(d) and s. 409A.
3. CRA announces views on revised purpose test in s. 55(2)
The CRA confirmed that the proposed changes to s. 55(2) still center on the purpose of a dividend, not the result or effect of the dividend. In Ludco v. The Queen, the Supreme Court of Canada said that the determination of purpose should be guided by both subjective and objective manifestations of purpose. Accordingly, the CRA will examine all the surrounding circumstances of a dividend to determine whether its purpose was to reduce the value of a share or to increase the cost of the dividend-recipient’s property (the newly expanded test). The CRA also said the following:
Ordinary course dividends: Where a dividend is paid pursuant to a well-established dividend policy (written or otherwise), and the amount of the dividend does not exceed a reasonable return on equity, the dividend should not be caught by the new purpose test in s. 55(2). This is common sense and somewhat helpful, but is certainly not a bright-line test.
Lumpy dividends: The CRA said that “lumpy dividends” are a potential concern in relation to the new purpose test, including in the context of potential creditor-proofing. Again, the concept was not clearly defined.
Loss consolidation transactions: The only purpose of in-house loss consolidations is to move losses between related or affiliated corporations, and therefore dividends paid in these transactions should not engage amended s. 55(2). Also, an indication that an offending purpose is absent is the fact that any cost base created in the transaction is typically eliminated when the structure is unwound at the end of the arrangement.
Database of rulings: The CRA acknowledged the difficulty that industry faces under revised s. 55(2), and expects to build a database of rulings going forward. The hope is that these rulings will provide a practical guide for corporations to efficiently predict how s. 55(2) will be applied in the future. Time will tell.