Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: How is a plan distinguished as being an RCA, SDA or section 7 arrangement?
Position: Provided information
Reasons: It is a factual determination that is made after giving consideration to the terms of the plan and the circumstances in which it is to be implemented.
XXXXXXXXXX 2005-012426
W. C. Harding
May 3, 2005
Dear XXXXXXXXXX:
Re: Employee Stock Ownership Plan ESOP)
This is in reply to your correspondence of March 3, 2005, in which you asked for clarification of the Canada Revenue Agency's position on the taxation of certain forms of ESOPs.
In particular, you are concerned with the taxation of an arrangement that is designed to provide shares to employees through the use of a trust. Under the arrangement, a corporate employer will first establish a trust and then contribute amounts to it from time to time. The trustee will then use the contributions to acquire shares of the employer, either directly from the employer or from shareholders, including corporate shareholders that do not deal at arm's length with the employer. The shares will eventually be provided by the trust to the employees of the employer as directed by the employer. However, this distribution of the shares to the employees will not immediately occur. Instead, the trust will continue to hold the shares for the benefit of the specific employees through the use of accounts established for the employee. The shares may then be distributed by the trust to the employees at a future date on the occurrence of an event such as the employees' termination of employment.
In our view, subsection 7(6) of the Income Tax Act (the "Act") may be applicable to this form of arrangement. It is also our view that subsection 7(2) of the Act will apply when the shares held in the trust are allocated to the accounts of the employees. As a consequence, it is also our view that paragraph 7(3)(b) of the Act will apply to limit the reduction of the employer's income for any year as a consequence of the distribution of shares to an employee under the arrangement. To clarify, in our view, one of the intentions of section 7 of the Act is to deny an employer a reduction of income when an employer, directly or indirectly, sells or issues its shares to employees. In consequence, where it is evident, from its inception, that the arrangement is subject to subsection 7 of the Act, it is our view that an employer cannot deduct any amounts with respect to any contributions made by the employer under the arrangement.
In our previous discussions of this matter, we indicated that an arrangement of this nature could be a salary deferral arrangement (an "SDA"), a retirement compensation arrangement (an "RCA") or an employee benefit plan (an "EBP") depending on the terms of the plan and the particular facts pertaining to the arrangement. However, we subsequently indicated that where it is established that an arrangement is subject to section 7 of the Act it would be our view that the arrangement could not also be an SDA, an RCA or an EBP. Therefore, it is not possible that an amount could first be included in income, for example, under the SDA or the RCA provisions, and subsequently added to income under paragraph 7(1)(a). Similarly, an employer could not claim a deduction for an amount as a contribution to an EBP, an SDA or an RCA where it is established that the arrangement is subject to section 7 of the Act.
Notwithstanding the above, CRA has taken the position that section 7 of the Act will not apply to situations where an employer contributes an amount to a trust and the trust uses the funds to acquire shares through open market transactions. Instead, we have taken the view that in these circumstances, the EBP provisions of the Act will apply. Furthermore, we have indicated that where a trust acquires some shares from an employer or a related corporation and other shares on the open market, CRA is, in general, prepared to apply the EBP provisions of the Act with respect to the shares acquired on the open market and the provisions of section 7 to the remaining shares. However, in order to apply this position we would think that some methodology to track the distribution of the shares acquired from the various sources would be required and this may not be possible if the shares from the various sources are commingled. We must also note that shares acquired from persons dealing at arm's length with an employer may or may not be acquired on the open market.
We trust our comments will be of assistance to you.
Yours truly,
Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
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