Canadian Salary Deferral Arrangement Legislation
  - 5/4/2009


May 4, 2009 
On May 4, 2009, Tax Executives Institute submitted the following recommendations to the Canadian Department of Finance, recommending changes to the Salary Defferal Arrangement legislation in order to afford greater flexibility in the design of long-term incentive compensation packages. TEI's comments were prepared under the aegis of its Canadian Income Tax Committee, whose chair is Rod C. Bergen of The Jim Pattison Group. Contributing substantially to the development of TEI's comments were Marvin E. Lamb and Stephen Galka of Imperial Oil Limited. Jeffrey P. Rasmussen, TEI Tax Counsel, serves as legal staff liaison to the committee. 

The Salary Deferral Arrangement (SDA) legislation was enacted more than 20 years ago in order to prevent abuses of the employee benefit plan (EBP) rules by non-taxable employers. While the purpose of the SDA rules is targeted, in application the rules have been applied broadly and impede the development of effective, modern long-term incentive compensation (LTIC) packages that taxable Canadian corporations must offer to attract and retain talented employees. On behalf of Tax Executives Institute, I write to propose changes to the SDA rules that will narrow their scope without undermining their efficacy in preventing excessive accumulations of retirement income by employees of non-taxable employers.
 Tax Executives Institute is the preeminent association of business tax executives. The Institute’s 7,000 professionals manage the tax affairs of 3,200 of the leading companies in Canada, the United States, Asia, and Europe and must contend daily with the planning and compliance aspects of Canada’s business tax laws.  Canadians make up 10 percent of TEI’s membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions. Our non-Canadian members (including those in Europe and Asia) work for companies with substantial activities in Canada.  In sum, TEI’s membership includes representatives from most major industries including manufacturing, distributing, wholesaling, and retailing real estate; transportation; financial services; telecommunications; and natural resources (including timber and integrated oil companies). TEI is concerned with issues of tax policy and administration and is dedicated to working with government agencies to reduce the costs and burdens of tax compliance and administration to our common benefit.

Evolution of Compensation Practices Enhances Long-Term Employee Retention

Corporate compensation programs have changed substantially since the SDA rules were adopted in 1986. Then, most compensation programs consisted of a salary, an incentive-based cash bonus, and, as a long-term incentive, ordinary stock options. Over time, employers have complemented these programs by instituting innovative LTIC programs to attract and retain talented employees on a long-term basis.

The longer the rewards under an LTIC program are deferred, the greater the incentive for employees to remain with the employer and the better the employer can align shareholder and employee interests. Moreover, because of (1) concerns in the capital markets about the leveraging and dilutive effects of employee stock options on existing shareholders and (2) recent changes in the accounting for stock options, employers have reduced the use of ordinary stock option grants in favor of LTIC programs, especially those utilizing full-value equity instruments.1  Thus, LTIC programs are increasingly based on restricted stock, restricted stock options, restricted stock units, phantom stock, and tandem programs with multiple incentives. To be effective as an incentive for long-term performance, these plans must be structured for periods longer than three years but the interpretation of the SDA rules inhibits this.

SDA Rules 

Under subsection 248(1) of the Income Tax Act, Canada, an SDA is any arrangement, whether funded or unfunded, under which a person has the right in a taxation year to receive an amount after the year where it is reasonable to consider that one of the main purposes for the creation or existence of the right is to postpone tax payable under the Tax Act by the taxpayer in respect of salary or wages for services rendered by the taxpayer in the year or a preceding year. (Emphasis added.) An exception under paragraph (k) of the definition of Salary Deferral Arrangement in subsection 248(1) permits an employee to defer income for up to three years after the year in which the services are performed.

The current SDA rules are essentially unchanged since their adoption more than two decades ago. The government first identified a concern with respect to how certain deferred compensation arrangements were structured under the EBP rules in 1984, describing the issue as follows:

These plans have created an unintended tax deferral opportunity for employees of non-taxable or non-profit employers who are unconcerned by the question of deductibility. A non-taxable employer, such as one in the public sector, can establish and maintain an EBP providing employees with essentially the same tax deferral benefits as a [registered pension plan, registered retirement savings plan, or deferred profit sharing plan] but not subject to any deduction limits.2

In effect, non-taxable employers were using EBPs to provide a tax-free accumulation of retirement income in excess of established retirement deduction limits. To curb that practice, the government explained the proposed SDA rules’ purpose, as follows:

As noted in the May 1985 budget, the government is concerned that employee benefit plans can offer unintended tax deferral advantages to certain groups of employees . . . .

Where the employer is non-taxable, there is no cost to it of entering into an arrangement to permit the employee to defer tax on employment income . . . .

The government is concerned about the implications of such plans for government revenues and the unfair distribution of tax benefits to individuals in different employment situations. The budget proposes a measure designed to prevent this deferral of salary for tax purposes without interfering with other arrangements where employee benefit plans are not primarily motivated by tax deferral considerations.3

Despite the government’s express concern about the perceived abuse of EBPs by non-taxable employers, the legislation is not limited to such employers. Indeed, the statute is broadly worded. It permits all forms of salary deferral arrangements, whether tax-motivated or not, as long as the deferral period is limited to three years. For plans with deferral periods longer than three years, the provision incorporates a purpose test applicable to all entities — taxable or not — as well as all forms of deferred compensation — funded or unfunded. The SDA rules are not, however, intended to apply to “arrangements where employee benefit plans are not primarily motivated by tax deferral considerations.”4

Within months of adopting the SDA rules, the government proposed the Retirement Compensation Arrangement (RCA) rules as “new anti-avoidance rules aimed at arrangements entered into to postpone unduly the tax on salary or wages . . . .”5  The press release introducing the proposed RCA rules describes the notion of “off side” or “non-statutory” retirement plans, implying that such plans differ from the deferred compensation arrangements the SDA rules were implemented to address.6   The language in the press release announcing the draft RCA legislation, however, is strikingly similar to the language in the 1984 publication Building Better Pensions for Canadians, which provided the background and rationale for adoption of the SDA rules in the 1986 budget. Indeed, one commentator attributes the RCA rules directly to the perceived abuse identified in the government’s 1984 policy paper:

The Part XI.3 refundable tax was introduced for the purpose of countering the perceived abuse of the employee benefit plan rules by tax-exempt or other non-taxable employers who provided for deferred tax on retirement benefits without being concerned with the deductibility thereof, deferred or otherwise. . . . The system is therefore designed to prevent the tax-free accumulation of retirement income for the benefit of the employee by levying an advance refundable tax of 50 per cent of contributions and earnings.7

Thus, with respect to funded plans, the RCA rules implemented in 1987 effectively address the same deferred compensation arrangements articulated in 1984 that led to the SDA rules. In addition, the government subsequently introduced the specified retirement arrangement (SRA) rules in 1992 to ensure that the amount of RRSP “room” of employees of tax-exempt entities is reduced where the employees are entitled to pension benefits under an unfunded or partially funded and unregistered plan.8  On a combined basis, the SDA rules substantially overlap the RCA and SRA rules.

In light of that overlap, as well as the evolution of corporate compensation practices since 1986, we believe the purpose and effects of the SDA rules should be re-examined for non-exempt entities. 


U.S.-based employers are increasingly using full-value share vehicles such as restricted stock and restricted stock units (payable in cash or stock at the employee’s election) in their LTIC plans.9  To satisfy the employers’ long-term compensation objectives, three to five years of service is generally required for vesting, with some plans having deferral periods up to ten years.10  Because of the uncertainty under the SDA rules, such LTIC plans must be adapted for use in Canada.

One major obstacle for taxable Canadian corporations is that Canada Revenue Agency (CRA) interprets the “purpose” test of the SDA rules very broadly. CRA nearly always finds that a full-value plan has a tax deferral purpose whenever the deferral period is longer than three years even where the plan is not structured or motivated by tax deferral considerations.11 In effect, CRA’s rulings focus on the characteristics or outcome of the plan rather than on the purpose of the plan.  Indeed, in response to a request to issue guidelines describing when a “purpose” would be found the Agency stated, “Because of the wide variety of arrangements . . . we have not been able to formalize general guidelines as to what will, or will not, be evidence of ‘purpose’ or as to the difference between ‘purpose’ and ‘main purpose.’”12  More than 20 years have elapsed since CRA’s initial statement and no additional guidance has been promulgated with respect to the purpose test. As important, no consensus has emerged among practitioners about how to design a plan that complies with it. Consequently, Canadian LTIC plan designers stay within the three-year safe-harbour rule of paragraph (k) in the definition of an SDA in subsection 248(1).

The three-year rule, however, frustrates employers’ objectives of establishing a long-term incentive plan. In today’s global economy, the use of full-value share vehicles with vesting provisions longer than three years is necessary to (1) attract and retain the most talented individuals and (2) align the long-term interests of those key employees with shareholders. As a result, Canadian employers are at a competitive disadvantage with those in the United States that are afforded more scope in their plan designs.

To ensure that the Canadian tax treatment of LTIC plans is competitive with the United States while preserving administrable and consistent tax policy rules for the treatment of such plans, we suggest that the Department of Finance consider introducing changes to the SDA legislation or the Income Tax Regulations. Specifically, consistent with the legislative background of the SDA provision (discussed above and cited in footnotes two through four), we suggest the following alternatives:

  • limit the rules to tax-exempt employers. (Employers that pay income tax under statutes such as the Ontario Electricity Act, 1998, and similar provincial legislation should not be considered tax exempt).
  • prescribe conditions under which an SDA will be deemed not to violate the purpose test. For example, the purpose test might be limited to situations where tax symmetry is not maintained between a non-exempt employer’s deduction and the employee’s income inclusion. So long as a plan is unfunded and no cash or benefit is transferred to the employee, there would seem to be no tax policy reason for accelerating both the employer’s deduction and the employee’s income inclusion simply because the incentive period exceeds an arbitrary three-year limit.13

TEI urges the Department of Finance to revisit the SDA rules to clearly delineate the tax policy differences between acceptable and unacceptable deferred compensation programs, especially where the “purpose” test might apply. We submit that a three-year period is too abbreviated to permit employers to build effective, long-term incentive plans that encourage employee retention and long-term performance. If an indefinite deferral period is not possible, we recommend that the Department consider providing a 10-year limit on LTIC plans. We would appreciate an opportunity to meet with representatives of the Department of Finance in order to discuss our recommendations and proposals.


TEI’s comments were prepared under the aegis of the Institute’s Canadian Income Tax Committee, whose Chair is Rod Bergen. If you should have any questions about the recommendations, please do not hesitate to call Mr. Bergen at 604.488.5231 (or or Sherrie Ann Pollock, TEI’s Vice President for Canadian Affairs, at 416.955.7373 (or 

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1  A “full-value” equity instrument is any form of compensation that, once vested, will be based upon the full value of the underlying company shares. In a stock option or stock appreciation rights (SAR) plan, the recipient benefits from the appreciation in value of the underlying stock subsequent to the grant. In other words, for an SAR or a stock option plan to have value, the price of the underlying stock must rise and stay above the exercise price. By contrast, in a “full-value” incentive plan, unless the stock’s value plummets to zero, the equity instrument will always have some value to the recipient upon the lapse of a vesting period or other plan restriction.

2  See Building Better Pensions for Canadians—Improved Tax Assistance for Retirement Saving, Department of Finance (February 1984), at 12 (Emphasis added). 

See Securing Economic Renewal—Federal Budget Papers, Department of Finance (February 26, 1986), at 35-36. See also Securing Economic Renewal—Federal Budget Papers (May 23, 1985), at 56.
4  Securing Economic Renewal—Federal Budget Papers, Department of Finance (February 26, 1986), at 36 (Emphasis added).
5  See A Better Pension System—Saving for Retirement, Improved Tax Treatment: Detailed Rules and Procedures, Department of Finance (October 1986). “The February 26, 1986 budget proposed new anti-avoidance rules aimed at arrangements entered into to postpone unduly the tax on salary or wages . . . . The existing rules relating to employee benefit plans permit the deferral of tax on certain pension and retirement arrangements that are not registered. These plans are generally referred to as “off-side” pension plans and can be used to circumvent the limits on tax assistance provided with respect to RPPs and other statutory plans such as RRSPs and DPSPs. Off-side pension plans are utilized . . . by employees of non-taxable entities. New rules are proposed for retirement compensation arrangements that are designed to remove the tax benefits flowing from the use of off-side plans.”  

See Department of Finance Press Release (March 27, 1987). 
7  Canada Tax Service — McCarthy Tétrault Analysis, 207.5-207.7 — Tax in respect of Retirement Compensation Arrangements.
8  For the SRA rules, see section 8308.3 of the Income Tax Regulations. 
9  The trend toward the use of full-value share plans instead of options was accelerated by the revision of the financial accounting treatment of options under FAS 123(R). See Current Trends in Executive Compensation, Culpepper Compensation & Benefits Surveys (September 12, 2006). See also Equity Compensation Continues Shift Towards Restricted and Performance-Based Stock, Culpepper Compensation & Benefits Surveys (March 9, 2006).
10  In the United States, deferred compensation is generally governed by Internal Revenue Code section 409A. Under those rules, U.S. employers are not restricted in the amount, form, instrument, calculation method, or duration of the deferred compensation. Instead, the rules prescribe the time for making deferral elections and generally restrict the employees’ ability to make subsequent changes. 
11  Several interpretations acknowledge that deferred compensation payable more than three years from the date the services are performed may be in the form of a restricted stock unit, but the amount to be paid must be limited to the appreciation in the value of the underlying equity unit subsequent to the date of grant. See, e.g., Technical Interpretation 2003-0001905—Restricted stock units salary deferral arrangement rules (April 15, 2003). Other interpretations require the amount paid beyond the three-year period to be totally dependent on future earnings events. See, e.g., Technical Interpretation 2000-0056537—Salary deferral arrangement incentive based on future earnings (November 24, 2000).
12  See Revenue Canada Roundtable, Q.27 Main Purpose of Postponing Tax Payable, REPORT OF THE PROCEEDINGS OF THE FORTIETH TAX CONFERENCE (1988 Canadian Tax Foundation Meeting), at 53:44-45.

13  As a result of the accelerated income inclusion the employee will bear a significant cash tax burden before any cash is available to pay the tax. The employer receives an immediate tax deduction pursuant to paragraphs 20(1)(oo) or 20(1)(pp) of the Act even though no cash outlay or payment may be made for several years, which is a notable exception to the 180-day rule in subsection 78(4) of the Act for deducting accrued but unpaid compensation.