Canada: New Code § 457A - Deferred Compensation From Offshore Entities

As part of the Emergency Economic Stabilization Act of 2008 (H.R. 1424) (the "Act"), Congress added new § 457A to the Internal Revenue Code of 1986, as amended (the "Code"). Section 457A was prompted by a perceived need to curb deferral of income inclusion for popular fee arrangements currently used by offshore hedge funds. When a service recipient is not tax indifferent, a tension typically will exist between a service provider's interest in deferring income and a service recipient's need for a current deduction for that income payment. This tension not only serves to limit abuses in the deferral of income but provides somewhat offsetting tax revenue in the form of a deferred deduction matching a deferred inclusion. Section 457A was enacted to prevent certain deferrals of inclusion when service recipients, like offshore hedge funds, are tax indifferent, eliminating the offsetting need for a current deduction.1

Section 457A is effective for amounts deferred which are attributable to services performed after December 31, 2008. A special rule applies for deferred amounts attributable to services performed before January 1, 2009. The deferred amounts are not included in gross income until the last taxable year beginning before 2018, or until the taxable year in which such amounts are no longer subject to a substantial risk of forfeiture, if later.

  • Introduction

Section 457A provides that any compensation that is deferred under a "nonqualified deferred compensation plan" of a "nonqualified entity" will be included in gross income when there is no "substantial risk of forfeiture" of the rights to such compensation. A prior version of the Act made explicit § 457A's reach to encompass service providers who were accrual method taxpayers as well as cash method taxpayers. The reference to accrual method taxpayers was removed from the Act, leaving ambiguous whether accrual method taxpayers are covered. The language of § 457A also leaves doubt as to whether it reaches taxpayers other than individuals. The language of § 409A applies to an "individual" but was expanded to other persons in the Treasury Regulations; § 457A, however, refers to the performance of services by a "person". Section 457A would apply to consultants as well as employees, but does not apply to a partnership interest. Accordingly, carried interests in partnerships are not subject to § 457A.

  • Nonqualified Deferred Compensation Plans

For this purpose, a "nonqualified deferred compensation plan" is generally defined by crossreference to § 409A, except that a plan that provides rights to compensation based on appreciation in value of a specified number of equity units of the service recipient, such as a stock appreciation rights plan, is a nonqualified deferred compensation plan under § 457A, but not § 409A.

  • Nonqualified Entities

Included in the § 457A definition of a "nonqualified entity" are (i) a foreign corporation unless substantially all of its income is effectively connected with the conduct of a U.S. trade or business or subject to a comprehensive foreign income tax; and (ii) any partnership unless substantially all of its income is allocated to persons other than foreign persons who are not subject to a comprehensive foreign income tax on the allocable income or taxexempt organizations. No standard for "substantially all" is set out in § 457A. A person will be considered subject to a comprehensive foreign income tax if such person is eligible for the benefits of a comprehensive income tax treaty between the United States and the foreign country. If the applicable foreign country does not have a comprehensive income tax treaty with the United States or the service recipient is not eligible for treaty benefits, the foreign corporation or foreign partner, as the case may be, must demonstrate to the satisfaction of the Secretary, presumably pursuant to the Treasury Regulations directed to be issued, that the applicable foreign country has a comprehensive income tax. Absent some carve out in future Treasury Regulations, a partnership will be a nonqualified entity if substantially all of its income is allocated to tax-exempt partners even if those tax-exempt partners are not tax-indifferent with respect to the income at issue, for example, because they are subject to withholding tax under § 1446 or to unrelated business income tax.

Carried interests in partnerships will not necessarily be affected by § 457A.

  • Substantial Risk of Forfeiture

The concept of "substantial risk of forfeiture" under § 457A is different than substantial risk of forfeiture used elsewhere in the Code. For purposes of § 457A, "the rights of a person to compensation shall be treated as subject to a substantial risk of forfeiture only if such person's rights to such compensation are conditioned upon the future performance of substantial services by any individual". Accordingly, other conditions which might be required to receive the compensation, such as a requirement of a certain level of profitability being achieved by the service recipient or some other economic threshold being met prior to the service provider having an absolute right to the compensation, would not constitute a substantial risk of forfeiture. Section 409A contains the same definition of "substantial risk of forfeiture" as § 457A, with the exception of the word "only". The Treasury Regulations under § 409A, however, expanded the definition: "Compensation is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial." Treas. Reg. § 1.409A-1(d)(1). Based on the legislative history and the inclusion of "only", the Treasury Regulations to be issued under § 457A are not expected to expand the conditions which would constitute a substantial risk of forfeiture for purposes of § 457A.

An exception to this substantial risk of forfeiture limitation for compensation based on gain recognized on an investment asset is to be set forth in future Treasury Regulations. Section 457A provides that "to the extent provided in regulations prescribed by the Secretary", compensation determined solely by reference to the amount of gain recognized on disposition of an investment asset will be treated as subject to a substantial risk of forfeiture until the investment asset is disposed of. An investment asset is any single asset (other than an investment fund or similar entity) that is acquired by an investment fund or similar entity if the entity (or a related person) does not participate in the active management of the asset and if substantially all the gain on disposition of the asset is allocated to investors in such entity. Active management includes participation in the day-to-day activities of the asset but does not include the election of a director or other voting rights exercised by shareholders.

  • Interest Charge and 20% Penalty

Although, under § 457A, the amount of deferred compensation is included in gross income at the time the income is no longer subject to a substantial risk of forfeiture, an exception exists if the amount of compensation is not determinable at that time, for example, if the amount of compensation is based on a percentage of future earnings. If the amount of compensation is not determinable when it is no longer subject to a substantial risk of forfeiture, the amount of compensation will be included in gross income when determinable and the service provider will be subject to an interest charge and a penalty. The amount of the interest charge is calculated at an interest rate equal to the underpayment rate plus one percent and is applied to the underpayment that would have occurred had the deferred compensation been included in gross income for the taxable year in which it was first deferred or, if later, the first taxable year in which such deferred compensation was no longer subject to a substantial risk of forfeiture. The penalty amount is 20% of the amount of compensation, mirroring the penalty rule of § 409A. This interest and penalty charge eliminate the attractiveness to accrual based taxpayers of taking the position that an amount should not be included in income because it could not be determined with reasonable accuracy.

  • Short-term Deferral Exception

Compensation is not considered deferred for purposes of § 457A if the service provider receives the compensation no later than 12 months after the end of the taxable year of the service recipient during which the right to the payment of such compensation is no longer subject to a substantial risk of forfeiture. This short-term deferral exception is much longer than the 2½ month short-term deferral used in § 409A and elsewhere in the Code. The short-term deferral exception, however, does not extend to compensation determined solely by reference to the amount of gain recognized on the disposition of an investment asset. Thus, once the investment asset has been sold and the deemed substantial risk of forfeiture removed, the 12 month period would not apply.

In compliance with U.S. Treasury Department Circular 230, you are hereby notified that any discussion of U.S. federal tax issues contained herein is not intended nor written to be relied upon, and cannot be relied upon, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

Footnotes

1 Compensation paid by state and local governments, which are also tax indifferent service recipients, is addressed in § 457.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions