2015-0586831R3 Settlement - Pension Payments

Principal Issues: Will settlement payments made to employees and former employees pursuant to the terms of a settlement agreement between an employer and the employees/former employees of the employer constitute a salary deferral arrangement, as defined in subsection 248(1) of the Act? How will the settlement payments, which will either be paid as periodic payments or as a lump sum payment, be treated for income tax purposes?

Position: No. The payments will be pension or superannuation benefits as defined in 248(1).

Reasons: The settlement payments will be pension or superannuation benefits and included in income in the year received, in accordance with subparagraph 56(1)(a)(i). The settlement payments will not be in respect of "salary or wages” and deferred for the purpose of deferring the payment of tax as required by the definition of salary deferral arrangement in subsection 248(1) of the Act.

Author: XXXXXXXXXX
Section: 248(1), 56(1)(a)(i), 153(1)

XXXXXXXXXX                                                                                                     2015-058683

XXXXXXXXXX, 2016

Dear XXXXXXXXXX:

Re:    Advance Income Tax Ruling
         XXXXXXXXXX

This letter is in reply to your letters wherein you requested an advance income tax ruling on behalf of the above-referenced Employer, and the information provided in your letters, your email exchanges and telephone calls (XXXXXXXXXX).

This letter is based solely on the facts and proposed transactions described below.  Any documentation submitted in respect of your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

We understand that, to the best of your knowledge and that of the Employer, none of the issues involved in this letter are:

i.    in an earlier information return of the Employer or a related person;

ii.    being considered by a tax services office or tax centre in connection with a previously filed information return of the Employer or a related person;

iii.    under objection by the Employer or a related person;

iv.    except as noted below, before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; nor,

v.    the subject of a ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise stated, all references in this letter to a statute are to the Income Tax Act (Canada) R.S.C. 1985 (5th Supp.), c.1, as amended to the date of this letter (the “Act”), and all terms used herein that are defined in the Act have the meaning given in such definitions unless otherwise indicated.

Facts

1.    The Employer was established in XXXXXXXXXX under the terms of an act of the XXXXXXXXXX and continues to exist pursuant to the XXXXXXXXXX.  The Employer is a XXXXXXXXXX as defined in subsection 248(1) of the Act.

2.    The Employer established the XXXXXXXXXX

3.    XXXXXXXXXX

4.    Since the incorporation of NPO, XXXXXXXXXX Members XXXXXXXXXX ceased to be entitled to receive payment directly from XXXXXXXXXX for those services and those amounts were instead paid to NPO.

5.    Since the inception of the XXXXXXXXXX, XXXXXXXXXX Members have received income primarily from two sources: (i) a base salary, paid by the Employer (“Base Salary”), and (ii) professional earnings up to certain established individual ceilings (“Ceiling Income”).

6.    Ceiling Income was funded mostly from amounts paid to NPO from XXXXXXXXXX with respect to XXXXXXXXXX provided by XXXXXXXXXX Members XXXXXXXXXX.

7.    The Employer is the sponsor and administrator of the XXXXXXXXXX and the XXXXXXXXXX. Both pension plans are registered pension plans as defined in subsection 248(1) of the Act (the “Registered Pension Plans”) and provide retirement benefits to certain salaried employees of the Employer, including the XXXXXXXXXX Members.

8.    The Registered Pension Plans are contributory defined benefit plans. The Registered Pension Plans provide a pension benefit based on a XXXXXXXXXX Member’s pensionable earnings, years of service and a benefit accrual rate (“Formula Benefit”).

9.    Since at least XXXXXXXXXX, Base Salary has been used in determining a XXXXXXXXXX Member’s XXXXXXXXXX pensionable earnings for the purpose of computing the amount of pension benefit that XXXXXXXXXX Members are entitled to receive under the Registered Pension Plans. 

10.    Beginning in XXXXXXXXXX, the possibility of also including Ceiling Income in determining the XXXXXXXXXX Member’s pensionable earnings for purposes of the Registered Pension Plans was raised with the Employer.

11.    In XXXXXXXXXX the Employer amended the Registered Pension Plans to recognize both Base Salary and Ceiling Income in determining a XXXXXXXXXX Member’s pensionable earnings for purposes of the Registered Pension Plans.

12.    In XXXXXXXXXX, the Employer and certain XXXXXXXXXX Members recognized that some XXXXXXXXXX Members’ pensionable earnings had grown to the point that they exceeded the level of earnings that could be used for purposes of accruing a pension under a registered pension plan (the “Pension Cap”) as a maximum pension limitation was imposed pursuant to paragraph 9(g) of IC72-13R8 Employees’ Pension Plans (“IC72-13R8”) in respect of pre-1990 pension benefits and pursuant to Regulation 8504 in respect of post 1989 pension benefits. Paragraph 9(g) of IC72-13R8 and Regulation 8504 indirectly limit the dollar value of income that can be recognized for purposes of determining the amount of lifetime benefits payable from a defined benefit registered pension plan.

13.    In recognition of the foregoing, in or about XXXXXXXXXX, a committee comprised of XXXXXXXXXX Members and members of the Employer’s administration agreed on an interim solution under which the XXXXXXXXXX Members would continue to be entitled to receive pension benefits on retirement based on Base Salary plus Ceiling Income, despite the Pension Cap but under a different funding arrangement.  The Employer would fund the pension Formula Benefit through the Registered Pension Plans up to the Pension Cap and the Employer would pay a supplemental pension benefit equivalent to the portion of the pension Formula Benefit in excess of the Pension Cap out of its operating funds (the “Supplemental Plan”).

14.    In XXXXXXXXXX, following years of discussions and negotiation, a more permanent solution was affirmatively voted on by then current XXXXXXXXXX Members (the “XXXXXXXXXX Agreement”).

15.    The XXXXXXXXXX Agreement provided that each XXXXXXXXXX Member would continue to be entitled to receive the pension benefits as described in paragraph 13, up to a “Transition Date” between XXXXXXXXXX, individually selected by the XXXXXXXXXX Member.  The latest Transition Date was determined based on a formula set out in the XXXXXXXXXX Agreement that took into consideration the number of years of service of the XXXXXXXXXX Member.  After the Transition Date, contributions to the Registered Pension Plans were still calculated based on Base Salary and Ceiling Income, up to the Pension Cap. However, payments in lieu of the amounts that otherwise would have been contributed to the Supplemental Plan, if the Supplemental Plan was a funded supplemental pension plan, on earnings in excess of the Pension Cap were paid in the form of in-year cash payments (the “In Lieu Payments”).  The In Lieu Payments commenced on the XXXXXXXXXX Member’s Transition Date and continued to be paid, in accordance with the XXXXXXXXXX Agreement. The In Lieu Payments were reported on a XXXXXXXXXX Member’s T4-Statement of Remuneration Paid for the taxation year in which the In Lieu Payments were received in accordance with Regulation 200. As a result of the XXXXXXXXXX Agreement, the right of XXXXXXXXXX Members to receive, on retirement, a supplemental pension from the Supplemental Plan was limited because it was calculable only by reference to service up to and including the Transition Date.

16.    The Employer and certain XXXXXXXXXX Members disagree as to how the In Lieu Payments would be funded.  The Employer asserts that the XXXXXXXXXX Members knew and approved that the In Lieu Payments were, subject to certain exceptions, being funded by the XXXXXXXXXX Members in a number of ways including, without limitation, by way of costs charged back to XXXXXXXXXX Members under administrative procedures. In effect certain of the In Lieu Payments were being funded through Ceiling Income. Certain XXXXXXXXXX Members dispute that XXXXXXXXXX Members were generally aware of this funding arrangement.

17.    On XXXXXXXXXX, a statement of claim (the “Statement of Claim”) was filed by certain XXXXXXXXXX Members (the “Representative Plaintiffs”) in the XXXXXXXXXX. 

Specifically, the settlement agreement entered into in XXXXXXXXXX (the “Settlement Agreement”) describes the issue as follows: 

XXXXXXXXXX

18.    The Representative Plaintiffs were seeking to represent a class encompassing all persons who, as at the date of issuance of the Statement of Claim, were members, former members, or such member’s beneficiaries, of the Registered Pension Plans and who were XXXXXXXXXX Members at any time between XXXXXXXXXX (each, a “Class Member”).

19.    The Statement of Claim alleged, inter alia, that the Employer failed to make certain contributions to the Registered Pension Plans in respect of Class Members.

The Claim asked for, inter alia, the following remedies:

a)    A reimbursement to the XXXXXXXXXX Members of the contributions to the pension plan that were funded by way of costs charged back to the XXXXXXXXXX Members on the ground of Unjust Enrichment resulting from the fact that contributions based on the Ceiling Income were funded by the XXXXXXXXXX Members and not by the Employer; and

b)    Specific performance of XXXXXXXXXX (that being a pension which included both Base Salary and Ceiling Income for purposes of determining the pensions a XXXXXXXXXX Member would receive) as if the XXXXXXXXXX Agreement was void and had no effect.

20.    The Employer and the Representative Plaintiffs entered into the Settlement Agreement to avoid litigation and finally resolve and settle all claims raised in the Statement of Claim.

21.    On XXXXXXXXXX, the Settlement Agreement was ratified by the Class Members and by the Employer (the “Settlement Date”).

22.    On XXXXXXXXXX the XXXXXXXXXX issued an order (the “Court Order”) certifying the action as a class proceeding for settlement purposes and conditionally approving the Settlement Agreement as fair, reasonable, and in the best interests of the Class Members.

The Settlement Agreement

23.    The Court's approval of the Settlement Agreement became final on XXXXXXXXXX (the “Effective Date”).

24.    No Class Member is entitled to any amount until the Effective Date.  Subsequent to the Effective Date, a Class Member is not entitled to payment of any amount under the Settlement Agreement until a release has been executed in favour of the Employer.  Some amounts payable to certain Class Members under the Settlement Agreement will be further delayed until that Class Member’s actual retirement date.

Class Member Entitlements Under the Settlement Agreement

25.    The relevant financial terms of the Settlement Agreement are as follows:

"1.     Every Class Member who received a Transition Date under the XXXXXXXXXX Agreement will be given the choice to either:

(a)    XXXXXXXXXX,

(b)    XXXXXXXXXX.

2.    Additionally, any Class Member who has retired, terminated employment or died, after the Class Member's original Transition Date and prior to the Settlement Date, or who is actively employed by the Employer as of the Settlement Date (hereinafter referred to as “a XXXXXXXXXX Agreement Loser”), and whose names are listed in XXXXXXXXXX which is hereby incorporated into these Minutes of Settlement, shall receive a lump sum payment with a dollar value equal to XXXXXXXXXX percent of the costs charged back to the Class Member for In Lieu Payments individually received by the Class Member between the Class Member's original Transition Date and the Settlement Date [the “In Lieu Payment Refund”];

3.    Where the Class Member so elects, the amount of In Lieu Payments that the Class Member is required to refund to the Employer under Paragraph 1(b), may be offset against the payment the Class Member is entitled to receive under Paragraph 2 such that the Class Member will not have to make a payment to the Employer under Paragraph 1(b) but shall receive a reduced amount under Paragraph 2 [the “Net In Lieu Payment Refund”];

4.    It is the intention of the Parties to endeavour, subject to the limitations and restrictions imposed by law, to provide for the payment of the amounts contemplated by Paragraph 2, as adjusted by Paragraph 3, to be effected by way of future non-indexed periodic payments to be effective as of and from the later of: (i) the Settlement Date; and (ii) the Class Member's actual Retirement Date (hereinafter referred to as the “Commencement Date”).  In the event that it is not legally possible to convert the said lump sum dollar value to periodic payments or, where the Class Member specifically requests, prior to their Commencement Date, in the form required by the Employer, the said amount shall be paid to the Class Member as a lump sum on retirement;

5.    Each Class Member shall receive a lump sum payment in the amount of $XXXXXXXXXX [the “XXXXXXXXXX Payment”].  The Parties understand and agree that this payment is made, in part, as compensation for any contractual or statutory claim or potential claim that a Class Member may have had, has, or may in future have, to receive a refund of the Registered Pension Plan Member's contributions together with interest thereon, that exceeds XXXXXXXXXX percent of the commuted value of their pensions, the so-called XXXXXXXXXX Percent Rule, as set forth in Section 39(3) of the Pension Benefits Act, and the Regulations thereunder, or otherwise."

26.    The Settlement Agreement has resolved the Class Members’ claim and has resulted in a Class Members’ right to receive the In Lieu Payment Refund.  The In Lieu Payment Refund is intended to supplement the pension benefits of the Class Members. The In Lieu Payment Refund arises by virtue of the Class Members entering into the court approved Settlement Agreement, and is an obligation which the Employer is assuming solely as a consequence of the court approved Settlement Agreement.  Accordingly, should the Employer fail to make the In Lieu Payment Refund or the Net In Lieu Payment Refund required under the Settlement Agreement the Class Members would have a cause of action against the Employer for breach of this right under the Settlement Agreement.  Conversely, any XXXXXXXXXX Member not included in the Settlement Agreement would have no such right against the Employer.

27.    The employment income of Class Members will not vary as a consequence of the In Lieu Payment Refund or the Net In Lieu Payment Refund.  The In Lieu Payment Refund or Net In Lieu Payment Refund, payable after a Class Member’s retirement date, will be paid in addition to any pension benefits payable under the Registered Pension Plans, the Supplemental Plan, the terms of the Settlement Agreement or otherwise by the Employer from operating funds.

28.    Fewer than XXXXXXXXXX% of the Class Members elected to retain their pension entitlements as determined under the XXXXXXXXXX Agreement.  Certain Class Members have expressed the intention to not accept any payments under the Settlement Agreement, including the In Lieu Payment Refund and the XXXXXXXXXX Payment (“Forgoing Class Members”).

29.    The Employer paid the XXXXXXXXXX Payment to each Class Member other than a Forgoing Class member (an “Entitled Class Member”) and will duly remit a T4A (Statement of Pension, Retirement, Annuity, and Other Income) disclosing a payment of pension income.  The Employer withheld and remitted the amount required under the Act on the XXXXXXXXXX Payments.

Proposed Transactions

30.    Each Forgoing Class Member will advise the Employer in writing that he or she surrenders any and all rights or entitlement to receive any amount (including the XXXXXXXXXX Payment and the In Lieu Payment Refund) that would otherwise have been paid to that Forgoing Class Member in respect of any entitlements under the Settlement Agreement (the “Forgone Amount”).  No Forgoing Class Member will have the ability to direct the Employer in any way as to how to use the funds that otherwise would have been used for payment of the Forgone Amount.

31.    The Employer will pay the In Lieu Payment Refund or the Net In Lieu Payment Refund in XXXXXXXXXX equal annual instalments to each Entitled Class Member.  An Entitled Class Member may elect instead to receive the In Lieu Payment Refund or the Net In Lieu Payment Refund as a lump sum amount by making a specific request to the Employer, as contemplated by the Settlement Agreement.

32.    In the event that an Entitled Class Member has retired after the Effective Date, the first In Lieu Payment Refund or Net In Lieu Payment Refund (if an election to receive a lump sum was made, the aggregate In Lieu Payment Refund or Net In Lieu Payment Refund) will be paid on or after the date of retirement of such Entitled Class Member and if no election to receive a lump sum was made, subsequent In Lieu Payment Refunds or Net In Lieu Payment Refunds will be made on or after the anniversary date of the Entitled Class Member's retirement.

In the event that an Entitled Class Member has retired prior to the Effective Date, the first In Lieu Payment Refund or Net In Lieu Payment Refund (if an election to receive a lump sum was made, the aggregate In Lieu Payment Refund or Net In Lieu Payment Refund) will be made on or after the Effective Date and if no election to receive a lump sum was made, subsequent In Lieu Payment Refunds or Net In Lieu Payment Refunds will be made on or after the anniversary date of the first In Lieu Payment Refund or Net In Lieu Payment Refund to the Entitled Class Member.

33.    In the event that the Entitled Class Member dies before all of the In Lieu Payment Refund or Net In Lieu Payment Refund has been paid, the balance remaining shall be paid to the estate (or such other person as may be appropriate) of the deceased Entitled Class Member as soon as practicable after the Employer has received evidence to its satisfaction that the Entitled Class Member has died.

34.    Notwithstanding the forgoing, the Employer will not pay any amount under the Settlement Agreement to an Entitled Class Member until that Entitled Class Member has executed a release in favour of the Employer.

Purpose of the Proposed Transactions

The purpose of the Settlement Agreement and ensuing payments is to resolve all outstanding disputes between the Class Members and the Employer as they may relate to the funding of any pension plan related to service with the Employer between XXXXXXXXXX.

Rulings

Provided the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are implemented as described above, we rule as follows:

A.    The Settlement Agreement will not constitute a “salary deferral arrangement” as that term is defined in subsection 248(1) of the Act. 

B.    The In Lieu Payment Refund or Net In Lieu Payment Refund will be superannuation or pension benefits and included in a Class Member’s income in the year received, by virtue of subparagraph 56(1)(a)(i) of the Act.

C.    Paragraph 153(1)(b) of the Act and Regulation 200 of the Income Tax Regulations will apply to the payment of the In Lieu Payment Refund or the Net In Lieu Payment Refund to Entitled Class Members who reside in Canada for purposes of the Act.  Paragraph 212(1)(h) of the Act and Regulation 202(2)(a) of the Income Tax Regulations will apply to the payment of the In Lieu Payment Refund or the Net In Lieu Payment Refund to Entitled Class Members who do not reside in Canada for purposes of the Act.

The above Rulings, which are based on the Act in its present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R7 dated April 22, 2016, and are binding on the CRA provided that the Proposed Transactions are implemented as described above.

Comments

For greater certainty, the In Lieu Payment Refund or Net In Lieu Payment Refund will be pension benefits described in paragraph 118(8)(f) of the Act for purposes of subsection 118(7) and section 60.03 of the Act.

Nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or made any determination in respect of any tax consequences relating to the facts, the proposed Plan, or any transaction or event taking place either prior or subsequent to the implementation of the proposed Plan, whether described in this letter or not, other than those specifically described in the Rulings given above. 

Yours truly,

for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
 

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