In 2004, the U.S. Congress enacted section 409A of the U.S. Internal Revenue Code to eliminate perceived abuses in the taxation of non-qualified deferred compensation. Section 409A creates a host of complex compliance issues for any Canadian company (including its branches and subsidiaries) that offers bonus- or equity-based compensation plans and arrangements to employees who are U.S. citizens or residents. Participating U.S. employees in Canadian arrangements that fail to comply with these rules by December 31, 2008 face severe U.S. tax consequences, including a harsh 20% penalty tax and interest charges.
Document Compliance. To comply by the December 31 deadline, affected Canadian companies typically will need to re-examine a broad range of non-qualified deferred compensation arrangements, including deferred share unit plans, restricted share unit plans, performance share unit plans, phantom stock awards, stock option plans and stock appreciation rights. No assumption can be made that an arrangement that complied under prior law will satisfy the new requirements without revision. For example, section 409A requires an affected plan or arrangement to comply with detailed rules regarding timing of deferral elections, payments and funding, as well as a general prohibition on the acceleration of benefits.
Operational Compliance Program. The very complexity of these rules has led the U.S. tax authorities to provide limited relief to taxpayers who correct certain "unintentional operational violations." However, this limited relief does not apply to "documentation failures," and thus all non-qualified deferred compensation documents must be in compliance by the December deadline. Canadian companies that fail to bring such documents into compliance by the deadline or that otherwise fail to exercise commercially reasonable efforts in complying will not qualify for relief under the unintentional operational violations program.
To respond to concerns regarding the difficulty of bringing existing non-qualified deferred compensation arrangements into compliance, the U.S. Treasury Department has extended the original effective date (January 1, 2008) of the final regulations under section 409A by one year. It is unlikely that transitional relief will be extended beyond the current December 31, 2008 deadline. Given the harsh U.S. tax consequences to participating U.S. employees if a deferred compensation arrangement fails to comply with section 409A, employers should consider reviewing existing arrangements to ensure compliance by year-end.
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