2020-0872371E5 Sabbatical leave plan - Application of SDA rules

Principal Issues: Whether a sabbatical leave plan (Plan) having certain features would be a salary deferral arrangement (SDA)

Position: Yes, the Plan would likely be an SDA; general comments provided with respect to the application of the SDA rules to the Plan.

Reasons: The Plan would not meet the requirements of paragraph 6801(a) of the Regulations, nor any other exclusion in the SDA definition in subsection 248(1) of the Act.

Author: Pietrow, Victor
Section: 6(1)(a) and (i), 6(11), 8(1)(o), 9(1), 12(1)(n.2), 20(1)(oo), Reg. 6801

XXXXXXXXXX                                                                                                      2020-087237
                                                                                                                               V. Pietrow

April 23, 2021

Dear XXXXXXXXXX:

RE:   Sabbatical leave plan – Salary Deferral Arrangement rules

We are writing in response to your letter of November 27, 2020 wherein you requested our views regarding the income tax treatment of a particular sabbatical leave plan (the Plan) as proposed by your client (Employer). In your letter, you summarize the principal features of the Plan as follows:

*    Participating employees in the Plan elect to purchase credits towards a future sabbatical leave by deferring receipt of their salary for a specified number of days each year. The Employer matches this purchase by making a “notional contribution” towards the cost of the future sabbatical leave using a predetermined formula.

*    The accrual period during which employees can elect to purchase these credits will be limited to a minimum of three years and a maximum of seven years.  The sabbatical leave must be taken no later than the seventh calendar year after the first year in which accruals commence.

*    Neither the employee’s deferred salary nor the notional contributions by the Employer will be funded during the period of accrual. No interest or other investment income will accrue on these amounts.

*    Subject to certain conditions, the employee can elect to take a sabbatical leave corresponding to the number of weeks that have been purchased, together with the Employer notional contributions in respect of the purchase. During the sabbatical leave, the employee will continue to receive their current salary for the duration of the leave. If the employee’s salary increases over the accrual period, the employee will, during the sabbatical leave, receive a top-up amount from the Employer. 

*    If an employee’s employment terminates before the employee has taken their accrued sabbatical, or if the employee withdraws from the Plan, or if the Plan itself is terminated (referred to collectively as an “Early Termination Event”), the notional contributions made by Employer will be forfeited and the employee will receive a lump-sum payment equal to the amount of the employee’s deferred salary that was unrealized as sabbatical leave.

You have initially assessed the Plan as a salary deferral arrangement for purposes of the Income Tax Act. Based on this assumption, you have asked us to provide our comments regarding the income tax treatment for both employees and the Employer of the Plan in connection with the salary deferral amounts, the notional contributions, the benefit payments and the possible forfeitures or lump sum withdrawals under the Plan.

We will assume the Employer and all participating employees of the Plan are resident in Canada.

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R11, Advance Income Tax Rulings and Technical Interpretations.

The salary deferral arrangement (SDA) provisions of the Act were enacted to ensure that salary earned in a particular taxation year is taxed in that year. Deferred salary is included in income when it is earned pursuant to these provisions of the Act, even though the salary may only be received in a subsequent year. However, deferred salary under a deferred salary leave plan (DSLP) is expressly excluded from these rules with the result that it is included in income when received rather than when earned. To qualify as a DSLP, an arrangement must satisfy the conditions set out in paragraph 6801(a) of the Income Tax Regulations.

The Plan as described above will not meet the requirements of paragraph 6801(a) of the Regulations as a DSLP (for multiple reasons including the length and timing of the sabbatical leave and the notional Employer contributions). Further, the Plan as described will also not meet any other exclusion in the SDA definition in subsection 248(1). As such, we agree with your assessment that the Plan will likely be considered an SDA for purposes of the Act. We offer the following comments on that basis. 

Deferred amounts during the accrual period

The amount of salary that an employee defers in a particular taxation year to purchase future sabbatical leave under the Plan, together with the amount of any matching notional Employer contributions in respect of the purchase, would constitute a “deferred amount” (as that term is defined in subsection 248(1)). Therefore, these deferred amounts would, by virtue of subsection 6(11) and paragraph 6(1)(a), be included in computing the employee’s income for the particular year.

In addition, where an employee’s salary increases in a particular taxation year and the Employer makes notional top-up contributions to the Plan to cover this increase, the amount of these notional top-up contributions would also be a “deferred amount” and included in the employee’s income for the particular year.

The Employer may, under paragraph 20(1)(oo), claim a deduction in respect of those deferred amounts, as an expense in computing its income from a business for its taxation year in which the particular taxation year of the employee ends.

Amounts received by the employee during the sabbatical leave

Amounts paid to an employee under the Plan during the sabbatical leave period that were previously included in the employee’s income as deferred amounts for a previous taxation year are, by virtue of paragraph 6(1)(i), not required to be included in computing the employee’s income in the year of receipt.

Note however, that the amount of employee contributions and notional contributions by the Employer made to the Plan in a current year (prior to the leave period) would still be required to be included in the employee’s income for that year.

Forfeited amounts upon an Early Termination Event

Upon an Early Termination Event, all notional Employer contributions in the Plan are forfeited.  Therefore, the amount of these contributions would be deductible by the employee pursuant to paragraph 8(1)(o) in computing the employee’s income for the taxation year in which the forfeiture occurs, but only to the extent that this amount was included in the employee’s income for previous taxation years.

It follows that where deferred amounts under the Plan in respect of an employee that consist of notional Employer contributions had been deducted by the Employer under paragraph 20(1)(oo) in computing its income for a preceding taxation year, any amount in respect of those deferred amounts that was deductible for a particular taxation year by the employee as a forfeited amount under paragraph 8(1)(o), must be included under paragraph 12(1)(n.2) in computing the Employer’s income for that taxation year.

Lump-sum amount received by an employee upon an Early Termination Event

A lump-sum amount received by an employee under the Plan upon an Early Termination Event includes only employee contributions which, as deferred amounts, were required to be included under paragraph 6(1)(a) in computing the employee’s income for previous taxation years. Pursuant to paragraph 6(1)(i) and provided those deferred amounts were, in fact, included in computing the employee’s income for a previous taxation year, the lump-sum amount received by the employee upon an Early Termination Event would not be included in computing the employee’s income for the year of receipt.

Note however, that employee contributions made to the Plan in a current year that were subsequently paid to the employee as a lump sum upon an Early Termination Event in the same year, would still be required to be included in the employee’s income for that year.

T4 Slip reporting by the Employer

The Employer must report all amounts required to be included in the employee’s income for the year in box 14 (Employment income) on the T4 Statement of Remuneration Paid for the employee for the particular year. For additional information in this regard, please refer to the CRA’s current Guide RC4120 Employers' Guide - Filing the T4 slip and Summary.

We confirm that amounts received by the employee under the Plan that are, by virtue of paragraph 6(1)(i), not required to be included in the employee’s income are not reported on the employee’s T4 slip. However, the Employer should advise an employee in writing of any amounts that were forfeited under the Plan due to an Early Termination Event as this amount may be deductible pursuant to paragraph 8(1)(o) in the year by the employee to the extent the amount was included in computing the employee’s income for a previous taxation year.

We trust these comments will be of assistance.

Yours truly,

Kimberly Duval, CPA, CA
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

PROTECTED A

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2021

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2021