Re-release date: October 14, 2015
Running time: 08:10 minutes
Our “Top global mobility issues facing Tax Directors” series continues as we discuss deferred compensation arrangements. This podcast emphasizes the importance of reviewing the characteristics of foreign plans to ensure that they meet the requirements to be considered tax deferred under Canadian laws, in order to avoid any unintended tax consequences for the employer and employee. It outlines the rules that are in place and the three main exceptions that are relevant for deferred compensation.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.
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Chantal: Hi, this is Chantal McCalla of PwC Canada. Welcome to our HRS podcast series that discusses the top mobility issues facing tax directors in Canada. Today we are discussing “Deferred compensation arrangements”. With us we have Kin Ngan, a Senior Manager from the PwC Human Resource Services tax group. Kin has practised in the international assignment and expatriate tax area since 1999. Welcome Kin.
Kin: Thanks for having me, Chantal.
Chantal: Kin, to start, can you tell us why Canadian companies should pay close attention to issues surrounding their deferred compensation plans?
Kin: Sure. The issue is really about reviewing a company’s deferred compensation plan from an international assignment perspective. That is, the focus being on plans which may not be Canadian deferred compensation plans. It is important to review the characteristics of the foreign plan to ensure it meets the requirements to be considered tax deferred under the laws of Canada.
Often, the tax consequences of participation in these plans are not considered when the ultimate decision is made to place an employee on assignment. Potentially, this could result in adverse tax consequences for both the company and the employee.
Chantal: Ok, so what are the rules in Canada in order to achieve a tax deferred status?
Kin: There is a basic rule against the deferral of salary or wages earned in a year, subject to a number of specific exceptions. A plan or arrangement is defined under Canadian tax legislation as a “salary deferral arrangement” or SDA if it results in the deferral of an amount of salary or wages to a later year and one of the main purposes is to defer tax. There also has to be no substantial risk of forfeiture. The CRA interprets this very broadly, and most people don’t seek to rely upon either the tax deferral purpose or risk of forfeiture tests. What we do rely on are the exceptions to the definition.
Chantal: And what are those exceptions?
Kin: There are three main exceptions that are relevant for deferred compensation.
The first is a three year bonus deferral rule and it’s met if the amount is a bonus or similar amount and you pay it out before the end of the third calendar year after the year in which services relating to the compensation were rendered. For example, in share unit-type plans, it’s this exception we typically rely on: Restricted stock units, otherwise known as RSUs, often vest and pay out in cash in three years.
The second exception is for plans — typically called deferred share units or DSUs — that are based on the value of a share and are payable only upon termination, death or retirement. These are mostly used to compensate directors, but we occasionally see them used for executives as well.
The third exception — and my description here is at a high level — is for employees who were participating in a deferred compensation plan that is primarily for non-residents before they became resident in Canada. This exception is time-limited: basically, the employee can continue participating for three years.
I should also point out that certain types of plans that are settled in shares can avoid the SDA definition as well, but they need to be reviewed to ensure they’re exempt.
Chantal: What happens if a plan is found not to be compliant with the Canadian rules?
Kin: If a deferral plan is found to be non-compliant under Canadian domestic tax law, the employer is required to report the deferral as income in the year the employee actually has the right to receive an amount, not in the year the amount is actually received. Taxes must be calculated and remitted in the year on the income. Therefore, depending on a company’s global mobility policy, this can result in increased and unforeseen tax costs for the employee. Or, if tax equalization applies, this could be a cost passed on to the employer.
Chantal: I see. Are there any specific challenges you have seen with your clients from an expatriate tax perspective?
Kin: The most common issue we have seen with our clients in a cross-border scenario occurs when there are foreign employees who participate in a non-Canadian deferred compensation plan and those employees remain on their home country payroll while working in Canada. In these instances, it is possible that the Canadian payroll may not be aware of the deferral if it isn’t reported in compensation breakdowns provided by the employer. As a result, an opportunity to ensure that the deferred compensation meets the requirements in Canada may be lost. If the plan is ultimately found not to comply with the Canadian tax rules, the company may be exposed to the associated penalty and interest charges levied for under-reporting and under-remittance of compensation and income tax respectively.
Theoretically, the exposure could be quite large depending on the amount of the deferral and whether the employee is being tax-equalized. I say theoretically because we’ve never seen the CRA reassess an incentive plan on the basis that it’s an SDA: they’ve been quite clear in their policy about what they think could be an SDA, but the lack of actual enforcement means we have little guidance as to what happens if something is actually found to be an SDA. Nevertheless, because of their very broad interpretation of what could constitute an SDA, most Canadian practitioners abide by the exceptions noted above.
Chantal: In that case Kin, is there anything an employer can do to mitigate this from happening?
Kin: Yes, Chantal. An employer engaged in sending employees on foreign assignments to Canada should think about reviewing their deferred compensation plans for their effectiveness in Canada.
Companies may also consider discontinuing their use of these plans or change the terms of the plan to accommodate Canadian resident participants.
Ideally, it is also recommended that employees seek tax planning advice before they embark on a Canadian assignment to ensure they have a good understanding of their tax position.
Lastly, we have talked about employees coming to Canada, but it is also important to consider the Canadian outbound employee. Many jurisdictions globally have their own laws related to deferred compensation arrangements. It becomes especially complex when employees are travelling to multiple jurisdictions. As a tax director, it will be important to understand the rules in each of those jurisdictions in order to manage tax costs.
Chantal: Ultimately, it sounds like, as with most issues, that it is important to proactively approach these matters and properly assess the risk to ensure that transactions are structured in a tax effective manner. This will help manage tax costs and avoid surprises.
Kin: Exactly Chantal.
Chantal: Thanks a lot for joining us today, Kin. If people listening to this podcast have any questions pertaining to these types of employment arrangements, Kin’s contact details are listed on our PwC podcast website at www.pwc.com/ca/taxtracks.
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