2017-0720901R3 Use of a Surety Bond by RCA

Principal Issues: Whether an RCA can secure its obligations with a surety bond.

Position: Yes.

Reasons: Substantially the same considerations apply as for an RCA securing its obligations with a letter of credit.

Author: XXXXXXXXXX
Section: Definition of RCA in subsection 248(1); subsection 207.5(1); paragraph 20(1)(r); paragraph 153(1)(p)

XXXXXXXXXX                                                                                                                                  2017-072090

XXXXXXXXXX, 2018

Dear XXXXXXXXXX:

Re:    Advance Income Tax Ruling Request
          XXXXXXXXXX – Business Number XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX requesting an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge the information provided for this file by email and in telephone conversations.

To the best of your knowledge and that of the taxpayer involved, none of the proposed transactions and/or issues involved in the ruling request are the same as or substantially similar to transactions and/or issues that are:

(i)    in a previously filed tax return of the taxpayer or a person related to the taxpayer;

(ii)    being considered by a tax services office or a tax centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii)    under objection by the taxpayer or a related person;

(iv)    the subject of a current or completed court process involving the taxpayer or a related person; or

(v)    the subject of a ruling request previously considered by this Directorate.

Unless otherwise stated, all references to a statute are to the Act and all terms and conditions used in this letter that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

Definitions

In this letter, the following terms have the following meanings. 

(a)    “Act” means Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1.

(b)    “Actuary” means the actuary for the SERP.

(c)    “Company” means XXXXXXXXXX, a taxable Canadian corporation that was incorporated pursuant to the Canada Business Corporations Act.  The Company’s head office is located at XXXXXXXXXX.  The Company deals with the XXXXXXXXXX Tax Services Offices and files its corporate income tax returns at the XXXXXXXXXX Taxation Centre.  The Company’s taxation year-end is XXXXXXXXXX.

(d)    “Current Trust Agreement” means the trust agreement entered into between the Company and the Trustee dated XXXXXXXXXX.

(e)    “Current Trust” means the trust established under the Current Trust Agreement.

(f)    “Draw” means the amount paid by a Surety under a surety bond in an Event of Default.

(g)    “Event of Default” means an event which results in the Company’s failure to either pay or secure benefits as required under the SERP which is defined as an event of default in the Current Trust Agreement, the New Trust Agreement and/or the Indemnity Agreement.

(h)    “Indemnity Agreement” means the agreement between the Company and the Surety described in paragraph 12.

(i)    “LOC” means letter of credit.

(j)    “Net Liabilities” means the liabilities of the SERP, as determined by the Actuary, less the market value of any assets of the SERP as at the relevant valuation date.

(k)    “New Trust Agreement” means the trust agreement described at paragraph 9.

(l)    “New Trust” means the trust established under the New Trust Agreement.

(m)    “RCA” means retirement compensation arrangement as defined under subsection 248(1).

(n)    “Regulations” means the regulations promulgated under the Act.

(o)    “SERP” means the non-registered supplemental employee retirement plan established by the Company as described in more detail below.

(p)    “Standby Fee” means the fee charged by the issuer of an LOC for issuance, renewal or replacement of such LOC.

(q)    “Surety” means an insurance company regulated by the Office of the Superintendent of Financial Institutions to issue surety bonds.

(r)    “Surety Fee” means the fee charged by the Surety for the issuance, renewal or replacement of a surety bond.

(s)    “Trustee” means XXXXXXXXXX.

Facts

1.    The Company has established and maintains the SERP in order to provide pension benefits to eligible employees of the Company who are members of the Company’s registered pension plan and whose benefits under such plan are restricted as a result of the maximum pension limitations under the Act.  The SERP constitutes an RCA.

2.    Benefits payable to or in respect of a member of the SERP upon retirement, death or termination of employment of the member are paid by the Company out of its general revenues available at the time of payment.

3.    To provide security for the benefits payable under the SERP, the Company entered into the Current Trust Agreement to establish the Current Trust.  The Current Trust constitutes a trust governed by an RCA with the Trustee as the custodian of the RCA.

4.    Benefits under the SERP are secured with renewable LOCs issued by a chartered bank or similar financial institution naming the Trustee as the beneficiary of the LOCs.  If an Event of Default occurs, the Trustee is required to draw on the LOCs and use the proceeds to pay benefits in accordance with the terms of the SERP.

5.    On a periodic basis not less than annually, the Company makes arrangements for the renewal or replacement of the LOCs in a face amount equal to the Net Liabilities.  The issuing bank charges the Standby Fee for the renewal or replacement of an LOC issued each year.  To fulfil its obligation under the Current Trust Agreement, the Company makes a payment to the Trustee in an amount equal to the Standby Fee and makes a payment in the same amount to the Receiver General on account of the refundable tax payable under Part XI.3.  The Trustee, in turn, pays the Standby Fee to the bank.  Upon receipt by the bank of the payment from the Trustee, the bank delivers the renewal or replacement LOCs to the Trustee.

6.    For clarity, the SERP also permits the Company to make contributions to the Current Trust to fund the liabilities under the SERP.  However, the Company intends not to make such contributions.

7.    The annual fee for the current LOCs was XXXXXXXXXX basis points as of XXXXXXXXXX (on a weighted average basis).  The estimated liability under the SERP is approximately $XXXXXXXXXX.

Proposed Transactions

8.    The Company proposes to establish a new security mechanism for the Net Liabilities under the SERP in the manner hereinafter described. The agreement governing the SERP will be amended as necessary to support the proposed security mechanism.

9.    In lieu of securing the Net Liabilities of the SERP by means of renewable LOCs held by the Trustee of the Current Trust, the Company proposes to enter into the New Trust Agreement to establish the New Trust.  In conjunction with the establishment of the New Trust, the Company will make arrangements with one or more Sureties to obtain and deliver surety bonds to the Trustee under the New Trust Agreement which in aggregate have a penal sum equal to the Net Liabilities.  Each surety bond will have a term of not less than one (1) year.  The SERP will be amended to provide for the Net Liabilities of the plan to be secured using surety bonds rather than LOCs (or through a combination of surety bonds and LOCs), and to document the criteria that such surety bonds must satisfy at each renewal date.

10.    Under the terms of the SERP (amended as described above) and the New Trust Agreement, the Company will be required to make arrangements on or before the expiry of a surety bond to renew or replace such surety bond such that the aggregate penal sum of all the surety bonds held in the New Trust continues to equal the Net Liabilities.

11.    Every time a surety bond is required to be issued, renewed or replaced under the terms of the SERP or the New Trust Agreement, the SERP and the New Trust Agreement will require the Company to make a payment to the Trustee under the New Trust in an amount equal to the Surety Fee.  The Company will make a corresponding payment to the Receiver General equal to the Surety Fee on account of the refundable tax payable under Part XI.3.  The Trustee will, in turn, pay the Surety Fee to the Surety for such issuance, renewal or replacement of a surety bond.

12.    The Company will enter into an Indemnity Agreement with the Surety which will set out the terms and conditions under which the Company will be obligated to repay any amounts owing to such Surety (including interest), if a surety bond is called.  The Company may enter into a general security agreement relating to the Indemnity Agreement.  Under such general security agreement:

a)    no security interest will be granted over any specific assets or inventory;

b)    no funds, assets or inventory would be set aside;

c)    nothing would prevent any particular funds, assets or inventory of the Company from being used for any purpose determined by the Company; and

d)    no funds, assets or inventory would be subject to the direct claim of any member of the SERP.

13.    Under the terms of the SERP and the New Trust Agreement, if an Event of Default occurs:

a)    the Trustee will be required to draw on the surety bonds in a penal sum up to the Net Liabilities;

b)    each Surety will be required under the terms of such surety bonds to pay to the Trustee of the New Trust an amount equal to half of the respective Draw;

c)    each Surety will make a corresponding payment to the Receiver General equal to half of the respective Draw on account of the refundable tax payable under Part XI.3; and

d)    the Company will have the obligation to repay the full amount of each Draw to the respective Surety under the terms of the Indemnity Agreement.

14.    Following the delivery to the Trustee of the New Trust of the surety bonds representing in aggregate a penal sum equal to the Net Liabilities, the Company will terminate the Current Trust Agreement and direct the Trustee to surrender the LOCs held thereunder and wind up the Current Trust.

15.    The SERP will continue to be the same in all respects other than those described in paragraphs 8 to 14 above.  As such the formation of the New Trust and wind-up of the Current Trust will not result in the termination of or a distribution from the RCA.

16.    For clarity, notwithstanding the proposed security arrangement, the Company intends to continue paying benefits under the SERP as they fall due out of its general revenues available at the time of payment.

17.    The Company has obtained quotes from XXXXXXXXXX Sureties that are prepared to issue surety bonds (up to maximum amounts) for the New Trust Agreement for annual fees ranging from XXXXXXXXXX basis points.  Given the estimated liability under the SERP noted above, the use of surety bonds with lower annual fees compared to LOCs will result in material annual savings to the Company.

Purpose of the Proposed Transactions

18.    The purpose of the proposed transactions is to establish a new financing arrangement for the SERP under which benefits will be secured by the proceeds of surety bonds rather than LOCs (or by a combination of surety bonds and LOCs), if an Event of Default occurs.  The Company proposes to use surety bonds for this purpose as the Company anticipates that it will be able to obtain more favourable terms and conditions, including reduced annual fees on a continuing basis, for surety bonds as compared to LOCs.  In addition, surety bonds will not reduce the Company’s borrowing capacity (in contrast to LOCs).

Rulings Given

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

A.    The proposed transactions described in paragraphs 8 to 16 above will not, in and of themselves, result in the SERP ceasing to constitute an RCA.

B.    For the purposes of subsection 207.7(1) and the definition of “refundable tax” under subsection 207.5(1), the following amounts will constitute contributions made to the RCA:

a.    amounts paid to the Trustee by the Company as specified in paragraph 11;

b.    amounts remitted to the Receiver General by the Company as specified in paragraph 11 pursuant to paragraph 153(1)(p) of the Act and subsections 103(7) and 108(1) of the Regulations;

c.    any amount paid to the Trustee by a Surety as specified in paragraph 13; and

d.    any amount remitted to the Receiver General by a Surety as specified in paragraph 13 pursuant to paragraph 153(1)(p) of the Act and subsections 103(7) and 108(1) of the Regulations.

C.    Contributions described in Rulings B (a) and (b) above will be deductible by the Company to the extent permitted by paragraph 20(1)(r) for the taxation year in which the contributions are made.

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R7 issued on April 22, 2016, and are binding on the CRA provided that the proposed transactions described in paragraphs 8, 9, 12 and 14 are completed on or before XXXXXXXXXX.

Comments

This letter is based on the law as it presently reads and does not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.  This letter is based solely on the facts and transactions described above and makes no comment on the tax treatment of any taxpayers other than those explicitly referenced.  The documentation submitted with your request that is not described above does not form part of the facts and transactions and any references to the documentation are provided solely for the convenience of the reader.

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, or any transaction or event taking place either prior or subsequent to the implementation of the proposed transactions, whether described in this letter or not, other than those specifically described in the rulings given above.  In particular, nothing in this ruling should be construed as confirming, either expressly or implicitly that the CRA has agreed or made a determination that the SERP is an RCA. The CRA is of the opinion that if a Surety is called upon, as described in paragraph 13 above, to pay an amount to the Trustee, that amount will not be a contribution to the trust by the Company but will be a contribution to the trust by the Surety. Paragraph 20(1)(r) requires, inter alia, that amounts paid by a taxpayer as contributions under an RCA must be in respect of services rendered by an employee or former employee of the taxpayer.  As a result, the payment made by the Surety would not give rise to a deduction in computing the income of the Company.

The CRA is also of the opinion that the formation of the New Trust and wind-up of the Current Trust will not result in an entitlement to a refund of refundable tax because, as noted in paragraph 15, there will not be a termination of or a distribution from the RCA.

Yours truly,

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

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