Canada Consults On Tax Rules For Employee Profit Sharing Plans

by Mike Godfrey, Tax-News.com, Washington

01 September 2011

The Canadian government is reviewing the tax rules for Employee Profit Sharing Plans (EPSPs), vehicles which have increasingly been used for reducing or deferring tax on profits and avoiding the payment of Employment Insurance (EI) premiums.

The government's intention to consult with stakeholders on the EPSP system was announced at Budget 2011 in March, and it has now invited comment on the existing regime, with a view to ensuring the rules continue to accommodate the appropriate use of such plans.

EPSPs are trust arrangements which enable business owners to align the interests of their employees with those of the business by sharing the profits of their business with their employees. In general, they are a tax neutral investment, where the trustee is required to allocate to beneficiaries each year all employer contributions, profits from trust property, capital gains and losses and certain amounts in respect of forfeiture.

The allocations are included in computing the income of the beneficiaries for income tax purposes in the year in which they are allocated, and are also generally recognized as employment income for various measures in the income tax system. Payments out of the trust are generally not subject to tax when received by the beneficiaries.

According to the Department of Finance, EPSPs have seen a rapid growth in popularity, with numbers increasing fivefold between 2005 and 2009. They are mostly used among small, closely-held Canadian-controlled private companies. The Department says that the plans have increasingly been used as a means for some business owners to direct profit participation to members of their families with the intent of reducing or deferring taxes on these profits. Some employers are also using EPSPs to avoid making Canada Pension Plan (CPP) contributions and to avoid paying EI premiums on employee compensation.

To ensure that EPSPs continue to be a useful vehicle for employers and used for their intended purpose, the government is reviewing the existing rules for EPSPs to determine whether technical improvements are required in this area. The Department is asking for opinions on a variety of questions, including what the impact would be if employees not dealing at arm's length with the employer were excluded as eligible EPSP beneficiaries. It also wishes to know whether there is a specific rationale for excluding allocations from the tax on split income provisions, and what the impact would be if minor children were subject to the tax on split incomes.

In addition, the consultation asks if there is a specific rationale for allowing unlimited EPSP employer contributions, and what the impact would be if they were limited as a certain percentage of the employee's salary or wages. It enquires as to the impact of subjecting EPSPs to income tax withholding requirements similar to those applied to salaries and wages, and what would happen if they were considered employment income for EI and CPP purposes.

The consultation is open until October 25.

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