Canada: Federal Budget 2012 Changes

Last Updated: April 18 2012
Article by Eva M. Krasa, Pamela L. Cross and Sonia T. Mak

Most Read Contributor in Canada, November 2017

The March 29, 2012 federal budget ("Budget 2012") included several proposed changes in the pension and benefits area. On April 2, 2012 the Canada Revenue Agency issued a number of Qs&As which provide some additional detail on certain of the changes.

Retirement Compensation Arrangements

Many of our clients are either sponsors of, or service providers to, supplemental employee retirement plans ("SERP") established to provide supplemental pensions to the sponsor's employees. A SERP which is funded will usually constitute a Retirement Compensation Arrangement ("RCA") for tax purposes.

Unlike registered plans such as RRSPs and registered pension plans, RCAs have not to date been subject to any specific restrictions regarding the investments which can be held. Budget 2012 proposes to change this by introducing new "prohibited investment" rules for RCAs. Further, new "advantage" and "strip" rules are also being introduced. No definitions of these new terms are provided; rather Budget 2012 simply indicates that they will be similar to the existing definitions of corresponding terms in the RRSP context.

The new rules are anti-avoidance in nature, their intent being to prevent RCAs from engaging in certain tax-motivated non-arm's length transactions. The budget papers specifically identified two areas of concern:

  • arrangements involving large deductible contributions that are indirectly returned to the contributors such that the RCA ends up with little or no assets but being entitled to claim refundable tax using the impaired asset exception, and
  • arrangements using insurance products to allocate costs to the RCA for benefits that arise outside of the RCA, such as where the RCA owns the surrender value of the policy and another person holds the death benefit.

The new provisions will only apply where the RCA has a "specified beneficiary". An RCA beneficiary will be a "specified beneficiary" if he/she has a "significant interest" in the employer (generally defined to mean a 10% or greater interest). Analogizing to the current prohibited investment rules for RRSPs, it can be anticipated that prohibited investments for an RCA will likely include debt of the specified beneficiary and shares or debt of any corporation in which the specified beneficiary has a 10% or greater interest. "Advantage" will include benefits attributable to a prohibited investment and strip transactions whereby value is intentionally eroded from the RCA without adequate consideration.

The consequences of the RCA holding a prohibited investment or extending an advantage will be onerous:

  • a 50% tax on the fair market value of the prohibited investment
  • a tax equal to 100% of the fair market value of the advantage obtained by the specified beneficiary
  • the special election normally available where there has been a decline in value of RCA property (which allows RCA tax to be refunded despite insufficient distributions from the RCA) will not be available where the decline in value is attributable to a prohibited investment or advantage, with the result that the ability to obtain a refund of RCA tax will be jeopardized.

The above taxes are imposed on the RCA trustee but with provision for the specified beneficiary to be jointly and severally liable for the tax if he/she participates in acquiring the prohibited investment or in extending the advantage. Given their potential liability, RCA trustees should consider whether indemnity provisions in the RCA trust agreement provide the trustee with adequate protection. Trustees and sponsors should be particularly cautious in owner manager situations where one or more of the RCA beneficiaries is likely to be a "specified beneficiary". Tight restrictions designed to avoid a breach of the prohibited investment and advantage rules should be built into the plan documents. The new rules will generally be of no relevance to RCAs sponsored by widely held corporations where no single individual owns 10% or more of the shares of any class or to RCAs which rather than being funded are secured by a letter of credit and have no assets other than the letter of credit.

Employees Profit Sharing Plans

New anti-avoidance rules are also being proposed for Employees Profit Sharing Plans ("EPSP"). An EPSP is an arrangement under which the employer makes tax-deductible contributions to a trust and the employee is subject to tax on all contributions and earnings allocated to him/her in the year. Budget 2012 proposes that a plan member who is a "specified employee" be subject to a special tax on any "excess EPSP amount". "Specified employee" means an employee who has a significant equity interest in the employer or does not deal at arm's length with the employer. "Excess EPSP amount" means the portion of an employer's EPSP contribution allocated to a specified employee which exceeds 20% of the employee's salary for the year. The tax is generally equal to the top federal marginal tax rate plus the top provincial marginal tax rate for the employee's province of residence.

As in the case of the RCA changes, the EPSP changes will have the most impact in the context of closely held corporations. The new rules will eliminate the previous income tax savings which arose from making contributions to EPSPs which were then allocated to lower income family members. Unlike in the case of the RCA changes, the trustee will have no liability for the special tax which is imposed solely on the specified employee.

Some More Pension and Benefits Changes

Budget 2012 also includes the following announcements:

  • The government is committed to introducing legislation to require federally-regulated private sector employers to insure, on a go-forward basis, the long-term disability (LTD) plans offered to their employees.
  • The government is moving with the timely implementation of Pooled Registered Pension Plans (PRPPs).
  • The government will introduce technical amendments to strengthen the Pension Benefits Standards Act, 1985 (PBSA).
  • The government intends to gradually increase the age of eligibility for Old Age Security (OAS) and Guaranteed Income Supplement (GIS) programs from age 65 to age 67, commencing in April 2023 with full implementation by January 2029.
  • The government will overhaul the exempt test rules applicable to life insurance policies.

The introduction of a statutory obligation on a federally-regulated employer to insure an LTD plan for its employees will likely have a significant financial impact on maintaining an LTD plan by an employer (particularly if the LTD plan is currently uninsured) or offering an LTD plan in the future. The extent of the impact will depend on the actual legislative provisions which impose such an obligation (e.g., what will be considered as an "LTD" plan and what are the transition provisions for a currently uninsured plan).

The federal PRPPs are applicable to only federally-regulated employees and individuals in the territories. The provinces need to introduce their own PRPP legislation to cover individuals employed in their jurisdictions. To date, only Quebec has done so.

The budget papers do not mention the types and nature of the PBSA amendments which will be introduced except by describing them as "technical". The significance of such amendments waits to be seen.

Employers which offer defined benefit pension plans providing for pension benefits which integrate with benefits provided by OAS and GIS will need to consider how the pension plan design will be affected by the increase of age of eligibility for OAS and GIS programs.

The exempt test rules for life insurance policies differentiate tax exempt protection-oriented life insurance policies from those that are investment-oriented. Exempt life insurance policies have been a common investment for RCAs. Prior to introducing detailed proposals, the Department of Finance will undertake consultations with key stakeholders to reduce the likelihood of unintended and arbitrary impacts. It is anticipated that the new rules will apply to policies issued after 2013.

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