Introduction: What is a Retirement Compensation Arrangement?
Retirement planning is a cornerstone of long-term financial security, especially for high-income earners and corporate executives whose pensionable earnings often exceed the thresholds permitted under traditional retirement savings vehicles. One such advanced planning mechanism available in Canada is the Retirement Compensation Arrangement (RCA).
While effective for achieving retirement goals, RCAs also introduce complex tax compliance issues, especially when foreign jurisdictions are involved. This article explores the Canadian legal and tax framework surrounding both domestic and foreign RCAs, drawing on statutory provisions, administrative policies, and key judicial interpretations to outline the opportunities and pitfalls of using these instruments.
A Retirement Compensation Arrangement is defined under subsection 248(1) of the Income Tax Act as a plan or arrangement under which an employer or former employer makes contributions to a custodian to fund retirement benefits for an employee. A custodian refers to the person or organization which holds the contributed funds in trust, with the intent of eventually distributing such funds to the designated beneficiary of an RCA.
The designated beneficiary can be an employee, a former employee, or another beneficiary designated by such employee/former employee. Importantly, these contributions are intended to provide benefits either upon retirement, loss of office or employment, or another similar contingency. Unlike Registered Pension Plans (RPPs) or Registered Retirement Savings Plans (RRSPs), RCAs are not subject to annual contribution limits tied to employment income, making them particularly useful for senior executives or owner-managers of private corporations.
50% of Refundable Withholding Tax under Part XI.3 of the Income Tax Act Payable on Contributions to RCAs in Canada
In a typical RCA structure, the employer contributes funds to a custodian—usually a trust—on behalf of the employee. These funds are then invested and accumulate income. However, to prevent the deferral of taxes on investment income indefinitely, the Income Tax Act imposes a "refundable tax" mechanism to ensure some level of taxation occurs contemporaneously with the deferral of benefit payments.
In other words, contributions to an RCA are taxable under Part XI.3 of the Income Tax Act as a withholding tax, which is equal to 50% of the amount of the contributions. Similarly, any business income or capital gains realized within the RCA trust is also subject to the same withholding tax.
However, as its name implies, the tax is refundable to the custodian upon processing of the required T3-RCA Tax Return, after taking into consideration any distributions made out of the RCA trust and income earned by the trust.
Martin v The King, 2024 TCC 153: Canadian Tax Treatment of RCA Contributions
In a recent Tax Court of Canada decision, Martin v The King, 2024 TCC 153, the court examined the tax implications of contributions made to a Retirement Compensation Agreement (RCA). The case centred on one issue: In computing a non-resident taxpayer's Canadian taxable income under the Income Tax Act, can the taxpayer's RCA contributions from Canadian-sourced employment income be allocated to deduct foreign income?
The Appellants in Martin v The King, Russell Martin and Joshua Donaldson, two professional baseball players, received salary and supplementary compensation from 2015 to 2017 via contribution to the Retirement Compensation Arrangements (RCAs) from their U.S.-based team. Both were non-resident in Canada for income tax purposes. They performed part of their playing duties in Canada and part in the U.S. Their U.S.-based team thereby remitted half of the RCA contributions to the CRA for the Appellants under Part XI.3 of the Income Tax Act, since approximately 50% of the income was estimated to be considered Canadian income.
As a result, the Appellants filed their Canadian income tax returns for the relevant years, and allocated the RCA contributions against their Canadian income. The Canada Revenue Agency (CRA), however, sought to allocate their global income and apply RCA contributions against the Appellants' total income.
The Appellants contended that under section 115(1)(a)(i) of the Income Tax Act, RCA contributions should be deducted solely from Canadian‑source income—i.e., income tied to the percentage of duties performed in Canada—rather than the total global income. In the Appellants' view, applying contributions against foreign‑source income improperly reduced Canadian taxation.
The CRA argued that RCA contributions formed part of the Appellants' total compensation package and, pursuant to the Income Tax Act, should be applied before the global income was apportioned, effectively lowering the Canadian source as well.
The Tax Court ultimately sided with the Appellants. Justice Gagnon held that RCA contributions are indeed part of a taxpayer's remuneration and must be included in total income before allocation. However, Canada has no jurisdiction over a non-resident's income from foreign sources, and, thereby, the RCA contributions cannot offset foreign-source income.
Thus, the Appellants' RCA contributions can only reduce the portion of their income earned in Canada. The Court further criticized the CRA's methodology of applying the contributions globally, ruling that doing so would convert the arrangement into a Salary-Deferral Arrangement (SDA) rather than an RCA. This case has significant implications for retirement compensation agreements (RCAs) as well as cross-border tax planning.
Pro Tax Tips – Tax Deferred is Tax Saved!
The main purpose of a Retirement Compensation Agreement for an employee is to defer taxes otherwise payable if the contributions to an RCA were distributed to the employee as employment income or other types of benefits.
The phrase "tax deferred is tax saved" highlights the financial advantage of deferring taxes to a future date, typically when one's income—and thus tax rate—is lower. By postponing tax payments through vehicles like Retirement Compensation Agreements, you can receive additional benefits, invest such benefits, and allow your investments to grow without incurring immediate tax liability. This compound growth on pre-tax dollars can significantly increase long-term wealth, as returns are reinvested in full rather than reduced by yearly tax liabilities.
From a strategic standpoint, tax deferral is not about avoiding taxes altogether but about timing them to your advantage. For individuals, this often means deferring income until retirement, when their tax bracket may be lower.
For corporations, it means deducting contributions today while retaining control over how and when funds are distributed in the future. In both cases, the goal is to optimize after-tax returns and preserve capital—making tax deferral a cornerstone of effective tax and retirement planning.
If you believe that you need assistance with tax planning advice, you should engage with one of our expert Canadian tax lawyers. Our expert Canadian tax lawyers can identify potential options to minimize your tax liability and provide short-term and long-term plans customized to your needs and circumstances.
FAQ
What is a Retirement Compensation Agreement?
A Retirement Compensation Agreement (RCA) is a type of employer-sponsored retirement plan in Canada designed to provide supplemental retirement benefits to employees, typically high-earning executives or professionals. Unlike Registered Pension Plans (RPPs) or Registered Retirement Savings Plans (RRSPs), RCAs are not subject to the same contribution limits and are often used to offer additional retirement income where other registered plans fall short due to income restrictions.
Under an RCA, both the employer and employee may contribute funds, which are held in a trust. However, the Canada Revenue Agency (CRA) requires that 50% of each contribution (and income earned within the RCA) be remitted as a refundable tax to the CRA, which may be refunded when retirement benefits are paid out. This makes RCAs a tax-deferred, rather than tax-free, structure. Due to their complexity and administrative costs, RCAs are usually used in specific, high-income or executive compensation situations.
What is the Tax Benefit of Contributing to a Retirement Compensation Agreement?
The primary tax benefit of contributing to a Retirement Compensation Agreement (RCA) is that employer contributions are generally tax-deductible, reducing the company's taxable income and immediate income tax liability.
Additionally, contributions made to RCAs are not considered taxable income for the employee at the time they are made, allowing for tax deferral until the funds are actually received upon the employee's retirement. This makes RCAs especially attractive for high-income earners whose retirement needs exceed the limits of RRSPs or Registered Pension Plans (RPPs).
Another significant advantage is that investment income earned within the RCA trust grows on a tax-deferred basis, though 50% of both contributions and investment returns are remitted as refundable tax to the CRA.
When retirement benefits are eventually paid out, the previously remitted refundable tax is returned to the RCA and can be used to fund future distributions. This structure creates a long-term tax deferral mechanism, potentially lowering the employee's overall tax burden by shifting income from high-earning years to lower-income retirement years.
What is a Salary-Deferral Arrangement (SDA)?
A Salary-Deferral Arrangement (SDA) is defined in subsection 248(1) of the Income Tax Act (ITA). Under the ITA, an SDA can be any plan or arrangement between an employer and an employee where salary or wages are deferred to a future year primarily for the purpose of deferring tax on that income, subject to certain exceptions. Common exceptions include a registered pension plan, a deferred profit-sharing plan, an employee trust, and a supplementary unemployment benefit plan.
Under such arrangements, employees must include the full amount of any future payment of compensation—and any interest that accrues on it—in their income for the year in which they become entitled to it, not when they actually receive the payment. Employers, meanwhile, can deduct the deferred amount in the same year it is included in the employee's income but must ensure accurate T4 reporting and appropriate withholdings to avoid compliance issues.