As part of budget 2012, the federal government is proposing a change to the legislation governing employee profit sharing plans. The proposed change is intended to prevent certain uses of EPSPs that the government considers to be potentially abusive.
In recent years, the government says, EPSPs have been used increasingly as a means for some business owners to direct profits to members of their families in order to reduce or defer the payment of income tax on those profits. In the 2011 budget, the government announced it would begin a review of EPSPs.
In budget 2012, the government is proposing a special tax payable by a “specified employee” on an “excess EPSP amount.” A specified employee is defined in the Income Tax Act as an employee who has significant equity interest in his or her employer or who does not deal at arm’s length with his or her employer.
In general terms, an “excess EPSP amount” will be the portion of an employer’s EPSP contribution, allocated by a trustee to a specified employee, that exceeds 20% of the specified employee’s salary received in the year by the employee from the employer.
The special tax proposed by the government will consist of two components.
The first component will be equal to the top federal marginal tax rate of 29%. The second component will be equal to the top marginal tax rate of the province of residence of the employee and will be shared with provinces and territories participating in a Tax Collection Agreement, according to budget documents. A new deduction will be introduced to ensure that an excess EPSP amount is not also subject to regular income tax. A specified employee will, however, not be able to claim any other deductions or credits in respect to an excess EPSP amount.
The proposed change would have the effect of discouraging excessive employer contributions to EPSPs.
“We’ve known for some time that EPSPs were being used by small-business owners as a means to accomplish income splitting and avoid withholding requirements such as [Canada Pension Plan or Employment Insurance contributions]. This was clearly not the policy intention of the rules governing EPSPs,” says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management.
“The government, having forewarned last year that they were concerned about this issue, is now taking action to limit the use of EPSPs in situations [in which] the beneficiary/employee has a non arm’s-length relationship with the employer.”
EPSPs are trust arrangements that enable employers to share profits with employees. Under an EPSP, an employer may make tax-deductible contributions to a trust and the trustee is required to allocate to beneficiaries each year all employer contributions, profits from trust property, capital gains and losses and certain amounts in respect of forfeitures.
These EPSP allocations, with certain exceptions, are included in computing the income of the beneficiaries for the taxation year in which they are allocated. Once amounts are allocated, payments are made by the trustee to the beneficiaries in accordance with the terms of the plan. Because the allocations are taxable, payments out of the trust are generally not subject to tax when received by the beneficiaries.
As part of the proposed change, a mechanism will be introduced to allow for the minister of national revenue to waive or cancel the application of these excess EPSP amount rules if the minister considers that it is just and equitable to do so. In such cases, the normal rules will apply.
This proposed change will apply in respect to EPSP contributions made by an employer on or after March 29, 2012 other than contributions made before 2013 pursuant to a legally binding obligation arising under a written agreement or arrangement entered into before budget day.