Comments on pending Canadian income tax issues: November 14, 1991 - submitted by Tax Executives Institute to Canadian Department of Finance; includes letter on proposed legislation on prepaid interest bonds, November 11, 1991

Tax Executive, The, Jan-Feb, 1992

Consequently, we recommend that the Department of Finance examine this issue and propose a legislative change to rectify this situation.

XII. SECTION 144: EMPLOYEE PROFIT-SHARING PLANS

In connection with TEI's January 11, 1990, liaison meeting with the Department of Finance, the Institute made the following representation:

When employees leave a company

(as a result of terminations,

layoffs, or otherwise), frequently

a company's contributions

since the last withdrawal

entitlement date are forfeited.

Such employees will, of course,

receive their own contributions

plus any accumulated return

thereon, but the forfeited amount

reverts to the plan for redistribution

among the remaining

members of the plan. Subsection

144(9) provides that when

forfeitures occur, the affected

employee will receive a tax

credit of 15 percent of the

amount forfeited. This provision

has been in place without

change since 1956.

In our view, the 15-percent tax

credit allowed by subsection

144(9) is inadequate and unfair.

An employee who suffers

such a forfeiture is effectively

taxed on income he will never

receive. This tax is collected at

a rate equal to the difference

between the employee's marginal

tax rate and 15 percent.

Given that the marginal combined

federal-provincial tax

rate can approach or exceed 50

percent (depending on the employee's

Province of residence),

this amounts to a penalty of [up

to] 35 percent on the forfeited

income. The inequity of the situation

is exacerbated by the

fact that forfeitures typically

occur in unplanned situations,

such as terminations and lay-offs.

The Department responded that the inadequacy of the 15-percent credit has been recognized for some time. Nevertheless, we were advised that if the rules were changed, it would require reallocations of the forfeited amounts to the remaining members of the plan who would then be taxed on the reallocated amounts. The Department suggested that the reallocation requirement would spawn greater problems than the 15-percent credit, but did state its willingness to reconsider the matter.

Our understanding of subsection 144(1) is that it already requires plan administrators to allocate to employees all amounts received from the employer, including all forfeited amounts for which there is deemed to have been a tax payment made under subsection 144(9). Furthermore, subsection 144(3) requires an employee to include in income all amounts allocated to him by the trustee. Based on our interpretation of these subsections (coupled with the experience of our members with the actual administration of such trusts), we submit that the reallocations that Finance is seeking to avoid are already required by the Income Tax Act and, indeed, have for some time been effected.

In summary, we urge the Department not to lose sight of the fact that under the current regime substantial double taxation occurs -- the reallocation of forfeited amounts to the remaining members of a plan -- on every dollar forfeited, with the remaining members paying tax at a rate equal to the difference between their marginal tax rates and 15 percent. The practical effect can be to subject the income to an aggregate effective tax rate of 85 percent, which is clearly not justifiable. Consequently, we reiterate our earlier recommendation that subsection 144(9) be amended to provide for a deduction from income of any such forfeitures in lieu of the existing tax credit.