The Canada Revenue Agency (CRA) has recently voiced displeasure with what it views as overly aggressive tax planning involving retirement compensation arrangements (RCAs). Some of the uses that CRA has identified as suspicious include:
- loans made by RCAs back to the contributing employer or a related entity;
- excessive RCA contributions made on behalf of an owner-manager who subsequently moves off-shore; and
- RCA contributions that are not commensurate with the employee’s position, salary and service, or that do not take into account benefits provided under a registered pension plan.
Ironically, the RCA rules were added to the Income Tax Act (ITA) in 1986 as part of a series of anti-avoidance rules which included the salary deferral arrangement (SDA) rules. These rules were introduced to deal with executive compensation arrangements that were perceived, at the time, to be abusive. RCAs are governed by a special tax regime, which provides that contributions, as well as income earned and capital gains realized, are subject to a 50 per cent refundable tax to be refunded when amounts are distributed from the RCA.
CRA has indicated that an abusive arrangement could be viewed as actually constituting an SDA (which would result in an immediate income inclusion for the employee), or that contributions made to it should not be deductible or, more broadly, that the general anti-avoidance rule (GAAR) should apply.
Some of CRA’s pronouncements have been in response to questions concerning the deductibility of employee RCA contributions. In CRA’s view, the following may lead to the conclusion that the arrangement is an SDA rather than an RCA:
- indications that all or part of the RCA funds are not intended to fund employee benefits after retirement or a substantial change in employment or are being loaned to the employer or a related entity; or
- evidence of a decrease in an employee’s remuneration concurrent with an RCA contribution made on his or her behalf.
In addition, these conditions may suggest that the employee’s contributions are not deductible:
- the participating employee has the power and control to determine any aspect of the RCA including funding amounts; or
- no other employees are participating in the arrangement or their benefits do not compare to those being provided to the employee.
Lastly, the following evidence may lead to the conclusion that the employee’s contributions are not reasonable:
- employee contributions are not based on an actuarial report or other formula-based calculation; or
- the benefits provided to the employee under the arrangement do not compare to benefits accumulating for other employees in a registered pension plan.