Days numbered for current EPSPs?

“In my opinion,” says Trevor Parry, executive vice president and national sales director with Toronto-based actuarial consulting firm Gordon B. Lang & Associates Inc., “there is aggressive abuse of EPSPs in certain instances, which requires action by the government.”

An EPSP is a trust set up by an employer to share business profits with its employees. The structure does not require registration, and is relatively easy to run.

The funds deposited in the EPSP trust — determined by a formula that calculates annual contributions based on profitability — are invested by the trustee on behalf of the plan members. The funds in the trust grow tax-free, and the employer may deduct its contributions from its profits.

Amounts in the EPSP trust are taxed when they are “allocated” inside the trust to the employees. The employees pay taxes on these amounts upon allocation, whether or not they actually receive them. However, employees pay no taxes when these amounts are disbursed to them. Crucially, these allocations and subsequent payouts are not treated as employment income and thus are not subject to Canada Pension Plan contributions or employment insurance premiums, which together can amount to more than $6,000 per employee annually.

The EPSP structure also allows an employer (such as a self-employed professional) to split high profits with close associates — often, family members — by placing the business’s earnings in an EPSP trust and then “allocating” them to the business’s employees, who may be family members.

This achieves both avoidance of CPP and EI payments on employment income and easy income-splitting: over the past decade, the Canada Revenue Agency has been coming down hard on income-splitting through the use of “salaries” to family members and others, thus boosting the popularity of EPSPs as an alternative vehicle. The EPSP structure also allows plan members to receive compensation that is not used to calculate contribution limits for their RRSPs. Indeed, the EPSP structure has many advantages and few downsides.

So, while EPSPs can be a legitimate and practical way for a growing company to spread the wealth among its deserving employees, these plans now are often being used as a means of reducing taxes in ways that some tax experts say is inappropriate. “Most people are doing it [just] to drop out of the CPP,” says Parry. “The CPP is the law of the land and must be accepted.”

Notes David Ablett, director of tax and retirement planning with Winnipeg-based Investors Group Inc.: “A lot of  owners are using EPSPs to circumvent tax rules [and] engage in aggressive and unwarranted income-splitting.”

Ablett suggests that some employers are putting family members who do little for the company on their payrolls, making them eligible for EPSP payouts. In some cases, he says, “Minor children are made part of the company and become entitled [to] profit-sharing.”

As a result, says Jamie Golombek, managing director, tax and estate planning, with Canadian Imperial Bank of Commerce’s private wealth-management division in Toronto, “The government has stated specifically what it is looking at.” He believes changes will be made to the EPSP rules — affecting smaller private companies in particular, which are using these plans “for reasons that were never intended.”

Ablett suggests that if the government has gone to the extent of identifying its concerns with EPSPs, it also is likely to amend the CPP and EI legislation to turn payments from EPSPs into employment income, which will attract EI and CPP source deductions.

However, Parry cautions, changes to the CPP regulations will require the agreement of at least nine provinces. New rules governing profit allocation, plan membership and tax deferral may also emerge.

Golombek believes the “days of EPSPs, in their current form, are numbered. If business owners feel strongly that EPSPs are being used appropriately,” he adds, “they should submit their comments on the consultation paper.”  IE