Services requirement (pp. 486-7)
Consistent with contributions to other pension arrangements, employer contributions to an RCA are deductible in the year they are paid. [fn 28: Paragraph 20(1)(r).] Retirement benefits are taxable to the employee at the time of receipt. [fn 29: Paragraph 20(1(x).]
It should be noted that the deduction is permitted only for contributions made with respect to services rendered by an employee or a former employee. Accordingly, even though the definition of an RCA allows contributions to be made by a person not dealing at arm's length with the employer, [fn 30: Subsection 248(1)..."retirement compensation arrangement."] such contributions would not be deductible unless the employee had rendered services to that person. [fn 31: CRA document no. 2007-0259851I7, January 10, 2008.]
Past services included (p. 487)
…It seems to be acceptable to the CRA that a deduction is available with respect to past services, including services rendered prior to the year in which the RCA is established, provided that the contributions are reasonable and there is an employer-employee relationship. [fn 33: CRA document no. 2004-0082991E5, January 5, 2005.]
Refund mechanics (p. 485)
When the employer makes a contribution to an RCA, one-half of the contribution must be remitted to the CRA [fn 22: Subsection 207.5(1), the definition of "refundable tax," paragraph (a).] and placed in a refundable tax account (RTA). Similarly, one-half of the return generated by the invested portion of the assets must be transferred to the RTA. [fn 23: …paragraph (b).]
When benefits are paid from the plan, the funds are refunded from the RTA to the RCA at the rate of $0.50 for each $1 of benefit paid. [fn 24: … paragraph (c).]
In the event of termination of the plan, the assets in the RTA are refunded to the RCA. [fn 25: Subsection 207.5(2).]
Table 1 provides an illustration of how an RCA and RTA would work over a period of four years.
As noted above, the balance at the end of the year in the RCA and the RTA are equal, since one-half of all contributions and investment income must be remitted to the CRA. Upon termination of the RCA, the assets remaining in the RTA (if any) are refunded to the plan. However, the terms of the plan will dictate whether such surplus assets belong to the employer or to the plan members….
Letter of credit arrangements (p. 489-90)
…An alternative to using cash, where cash may not be available, is to obtain a letter of credit (LOC) from a financial institution. The LOC provides that in certain circumstances, such as the employer's failure to renew the LOC or to pay employee benefits, the bank that issued the LOC would pay the face value of the LOC into the RCA, fully funding the benefit. The employer would than owe the bank the face amount of the LOC. This arrangement provides security to the member while not requiring the employer to contributed directly to the RCA.
The LOC is typically renewed annually. The LOC is held by the RCA, and when the employer pays the annual tax-deductible fee to the bank for the LOC, an equal amount must be paid into the RTA. The LOC fee may vary depending on the credit worthiness of the employer. The face value of the LOC is usually determined on an actuarial basis, and it is meant to represent the amount sufficient to fully fund the pension promise.
Funds held in the RTA equal to the LOC fees may not be recoverable to the employer until many years later when the plan is terminated.
Resident contribution rule (p. 491)
Under these rules, if a newcomer to Canada remains a member of his or her home-country pension plan for more than five years, the foreign pension plan may still be considered an RCA for Canadian tax purposes. The RCA rules, including the requirement to pay tax into an RTA, will apply with respect to the resident's contributions, unless the employer makes an election with respect to the foreign arrangement such that the contributions are considered "prescribed contributions". [fn 58: Regulation 6804(2).]
Implications of prescribed contributions (p. 492)
If the contributions to the foreign retirement arrangement are prescribed contributions, the RCA rules will not apply, even if the employee is present in Canada beyond the five-year period. In this case, the characterization of the retirement arrangement and tax treatment will depend on the specific facts. For example, foreign pension plans are likely to be considered EBPs for Canadian tax purposes, since a custodian is involved in delivering retirement benefits. Consequently, the employer's deduction will be deferred to the year in which the employee is subject to tax on a distributions by the EBP. [fn 63: Subsection 32.1(1)] …
Meaning of "substantial changes in the services" (p. 481)
CRA... will consider that there has been a substantial change in services for the purposes of the definition of an RCA when the person retires or is terminated but continues to render different services than the ones formerly rendered to the employer. For example, a senior executive providing training as a part-time employee after termination would be considered to have experienced a substantial change in services. [fn 4: …guide T4041…]
"One of the main purposes…is to postpone tax" (p. 483)
One might argue that a retirement arrangement was not established to defer tax where the funding of the retirement benefits was not in lieu of regular compensation or bonus, and therefore such an arrangement would not be an SDA. However, Finance is of the view that tax deferral could be one of the main purposes of a retirement arrangement, and accordingly that arrangement would not be precluded from being an SDA simply because it provided for pension or superannuation benefits. The fact that Finance explicitly excluded RPPs from the SDA definition is a clear demonstration of the department's intention, since taxes on wages that would otherwise have been received are effectively deferred. [fn 16: CRA document no. 2007-0229361C6, June 21, 2007.] Therefore, taxpayers must not rely solely on this purpose test to determine whether a retirement arrangement is an SDA. In determining whether an arrangement is an SDA, the CRA will look carefully at variations in compensation. A sudden decrease in salary or bonus occurring in the same year as a payment to a retirement plan may be relevant in determining whether the plan is a scheme to defer compensation. [fn 17: CRA document no. 2001-0072795, May 8, 2001.]
Excessive benefits standard (p. 483)
If it is determined that a retirement arrangement does provide excessive benefits, it will be considered an SDA even if it otherwise meets the conditions set out in the RCA [retirement compensation arrangement] definition….
Consequences of SDA (p. 484)
If a plan is characterized as an SDA, adverse tax consequences result. The amounts contributed to the plan would be considered to be deferred income, taxable immediately to the employee in the taxation year in which the contributions are made by the employer. [fn 20: Subsection 6(11).] Although the employee would be immediately subject to income tax on the contributed amount, the cash would not be available since it would remain with the custodian of the plan.
Comparison with employee benefit plan (p. 484)
Finally, where a funded unregistered arrangement is neither an SDA nor an RCA, it will likely constitute an EBP where the arrangement involves a custodian. In the case of post-employment compensation, an EBP may be used to deliver incentive awards or provide benefits to former employees. The EBP rules allow the tax to be deferred until the employee receives the benefit payment. In this way, the EBP rules may be viewed as less harsh than the SDA rules, which require immediate income recognition even where the amount has not been received. However, the RCA offers more flexibility in providing benefits than either an EBP or an SDA.
Practical effect of limitation (p. 487)
In cases where an employee's contribution does not meet these conditions [for deduction under s. 8(1)(m.2)] – for example, because the employee is not legally required to contribute to the RCA – the employee may be entitled to a deduction at a later time when there is an income inclusion from the RCA, such as when the employee retires or dies. [fn 35: Paragraph 60(t)] This provision allows the employee to recover undeducted contributions to the RCA, plus any amount paid or received to acquire or dispose of an interest in the RCA. [fn 36: … Explanatory Notes…December 1997….] The deduction is limited to the amount of the benefit included in income for a given year. Practically speaking, several years could elapse before the employee is entitled to a full deduction of the contributed amounts, so in certain situations, it may not be appropriate to make such contributions.
No deduction for unreasonable contributions (pp. 487-8)
The CRA has stated that the provision allowing the deduction of employee contributions is not intended to provide a deduction for contributions that are considered unreasonable if paid in full by the employer. The CRA challenged a situation where an employer, in addition to his own contributions to the RCA, paid an amount to an employee who then made a contribution to the RCA, and the total amount contributed exceeded a reasonable amount. [fn 37: …2005-013240107….] …
Overview (p. 488)
…Spouses will now be able to split RCA distributions to the extent that the beneficiary of the income is at least 65 years of age and benefits received are in the form of a life annuity supplemental to an RPP. [fn 40: Subsection 60.03(1)..."eligible pension income," subparagraph (b)(i).] The amount that is eligible for splitting is limited to the lesser of the RCA income for the year and the amount, if any, of the beneficiary's other eligible pension income in excess of the defined benefit limit for the year ($2,696 for 2013) [fn 41: Regulation 8500(1).] multiplied by 35. . [fn 42: Subsection 60.03(1)…"eligible pension income," subparagraph (a)(ii).]
Resident contribution rule (p. 491)
Under these rules, if a newcomer to Canada remains a member of his or her home-country pension plan for more than five years, the foreign pension plan may still be considered an RCA for Canadian tax purposes. The RCA rules, including the requirement to pay tax into an RTA, will apply with respect to the resident's contributions, unless the employer makes an election with respect to the foreign arrangement such that the contributions are considered "prescribed contributions". [fn 58: Regulation 6804(2).]
Overview (pp. 491-2)
The prescribed contribution rules are complex, but essentially are as follows: [fn 59: Regulation 6804(6).]
1. Contributions are made to a "qualifying entity," defined as a non-resident entity that holds the assets of the foreign plan, that is resident in a country that levies income taxes, and that qualifies for favourable tax treatment because it holds assets of a retirement plan. [fn 60: Regulation 6804(1) and 6804(6)(a).]
2. If the employer is not a "foreign non-profit organization:, [fn 61: Defined in regulation 6804(1) and regulation 6804(6)(e).]
a. the employee was non-resident at any time before the contribution is made;
b. the employee became a member of the foreign plan before the end of the month after the month in which the individual became resident in Canada; and
c. the employee is not a member of an RPP, or a deferred profit-sharing plan, in which the employer, or a person or body of persons that does not deal at arm's length with the employer, participates.
3. If the employer is a foreign non-profit organization, additional requirements with respect to the amount of the contribution must be met, notably with respect to a notional pension adjustment applicable to the employee. [fn 62: Regulation 6804(6)(c).]
Implications of prescribed contributions (p. 492)
If the contributions to the foreign retirement arrangement are prescribed contributions, the RCA rules will not apply, even if the employee is present in Canada beyond the five-year period. In this case, the characterization of the retirement arrangement and tax treatment will depend on the specific facts. For example, foreign pension plans are likely to be considered EBPs for Canadian tax purposes, since a custodian is involved in delivering retirement benefits. Consequently, the employer's deduction will be deferred to the year in which the employee is subject to tax on a distributions by the EBP. [fn 63: Subsection 32.1(1)] …
Retirement compensation arrangement as pension (p. 493)
[U]nder the model convention, payments from an RCA are likely to be considered a pension rather than income from employment.
From a Canadian perspective, pursuant to the Income Tax Conventions Interpretation Act (ITCIA), RCAs are considered to be pension vehicles if "pension is not otherwise defined in the tax convention concluded between Canada and a foreign country.
Advantage if OECD Model followed (p. 493)
Article 18 of the model convention provides that pension benefits are taxable only in the state of residence of the beneficiary.
If the foreign country of residence applies the OECD position, no Canadian taxes will be withheld at source on a payment from an RCA to a non-resident beneficiary because such income will not be taxable in Canada. To the extent that the effective tax rate in the beneficiary's country of residence is significantly lower than the rate that would otherwise apply to a Canadian resident, there are tax-saving opportunities in situations where the beneficiary is expecting to leave Canada.
Advantage if RCA payments instead subject to Cdn. withholding but a local FTC is required (pp. 494-5)
[T]he Canada-France treaty provides that pension benefits are taxable only in the state in which they arise. [fn 79: Article 18(1)… .] In this situation, a French resident who was employed in France and is a beneficiary of a Canadian RCA would be subject only to Canadian withholding tax, at the rate of 25 percent, in respect of the payment of retirement benefits. Pursuant to the treaty, France would allow a full foreign tax credit equivalent to the French taxes otherwise payable on this income. [fn 80: Article 23(2)(a)(i)… .] As a result, the tax rate on the payment of the retirement benefit would be limited to 25 percent, … This situation is, of course, possible only to the extent that the non-resident employee is a beneficiary of an RCA that is maintained primarily for the benefit of Canadian residents in respect of services rendered in Canada.
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