Canadian corporations employing U.S. citizens should review their deferred compensation plans in light of a controversial new U.S. law. The new law primarily regulates elections to defer compensation and the timing of payments, but also includes limitations on funding methods and accelerated payouts.
Executives and legal compliance team members are abuzz about sweeping new laws in the United States regulating the design and operation of a broad array of deferred compensation arrangements. Deferred compensation plans must comply with the provisions of the new law, Section 409A of the U.S. Internal Revenue Code, which was added to the Code under the American Jobs Creation Act of 2004. It became effective January 1, 2005 but transition rules and grandfathering exceptions may apply to some plans. The new law primarily regulates elections to defer compensation and the timing of payments, but also includes limitations on funding methods and accelerated payouts. The new rules are controversial for Canadian clients for several reasons:
The rules affect any employer who employs even a single United States taxpayer anywhere in the world. U.S. citizens, simply by virtue of their citizenship and regardless of where they reside, are subject to U.S. taxation on their worldwide income.
The meaning of "deferred compensation" is extremely broad and as yet not clearly defined. Traditional non-qualified deferred compensation and supplemental executive retirement plans are affected. However, the new law also affects many plans that are not ordinarily associated with traditional deferred compensation. For example, bonus plans, discount stock options, and even severance and employment agreements are all covered under the "deferred compensation" umbrella.
The consequences of non-compliance are severe. Deferred compensation that fails to comply with Section 409A will result in immediate taxation on the deferred amounts (even if not yet paid) and a 20% additional tax, payable by the employee, plus penalties and interest. At the time the compensation is actually received it will be subject to tax in Canada, which could result in double taxation, unless relief is available under the Canada - U.S. tax treaty.
The regulations affect compensation retroactively. If compensation was deferred or a bonus awarded but the deferred compensation was not "earned and vested" prior to the January 1, 2005 effective date, the plan must comply with the new rules.
Employers should take action now to identify which plans or agreements may involve "deferred compensation" and review them for compliance with Section 409A. However, we recommend waiting to make conforming amendments until the U.S. treasury department issues further guidance, expected this summer.
Author credit: Sandra Cohen is a partner practising in the Pensions and Benefits Department in Osler, Hoskin & Harcourt LLP's New York office. Sandra is the U.S. compensation and benefits practice leader, which includes advising Canadian and U.S. corporations on U.S. executive compensation and employee benefits matters.
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