Tuesday, December 20, 2011

Employee Profit Sharing Plans (EPSP’s), Part 4 of 4

This is the last part of our EPSP blog series where we will discuss the remaining items on the summary of consultations. 

3. Limitations on contributions
Under the Income Tax Act, employers may deduct expenses and outlays only to the extent that they are reasonable in the circumstances. The Income Tax Act also includes specific limits to employer contributions to certain plans. For example, consistent with limits on other retirement savings vehicles, employer contributions to a Deferred Profit Sharing Plan may not exceed the lesser of 18 per cent of an employee’s compensation, or one-half of the money purchase Retirement Pension Plan limit (for 2011, one-half of the money purchase limit is $11,485).

While studies have indicated that a profit pool between 3 and 5 per cent of salaries/wages is sufficient to positively influence the behavior of employees, the Income Tax Act does not place a specific limit on the size of EPSP employer contributions [2]. This could change under the new provisions.

Is there a specific rationale for allowing unlimited EPSP employer contributions?

What would be the impact on your business or clients if employer contributions to an EPSP were subject to a specified limit, such as a certain percentage of an employee’s salary or wages paid directly by the employer for the year? What would be an appropriate limit?

4. Withholding Requirements
The Income Tax Act imposes withholding requirements on several sources of income and includes tax by installment rules. EPSP allocations are not subject to the same income tax withholding requirements as salary and wages paid directly by the employer, and can be structured to avoid tax by installment rules. This can allow related persons to delay the payment of income taxes.
As EPSP contributions are allocated directly from the trust rather than the employer, they are also not subject to EI and CPP withholding requirements. This could change with the revision.

What would be the impact on your business or clients if EPSPs became subject to income tax withholding requirements similar to those applying to salary or wages paid directly by the employer for the year? What would be the effect of this change if EPSP allocations were also considered employment income paid by the employer for EI and CPP purposes (and, therefore, subject to EI and CPP withholdings)?

5. Additional Questions
In the context of reviewing EPSP rules, are there additional aspects of EPSPs that you think should be reviewed, or taken into consideration, to ensure that EPSPs remain an effective compensation tool? Are there any technical improvements that could be proposed as part of the review of EPSP rules?

Currently, while we wait, it may not be good to set up an EPSP where the rules are going to change.  It is best to know all the current rules before getting into something such as an EPSP.  EPSPs can still be used for the purpose designed by the government, but should not be used as a way to avoid CPP and/or EI.  There are other ways to achieve this goal that are much more efficient and are not being looked at to be changed by parliament!  Don’t hesitate to contact us at Kustom Design to consult further on this topic.  

Thursday, December 15, 2011

Employee Profit Sharing Plans (EPSP’s), Part 3 of 4

Here is the 3rd part of our EPSP blog series.  In this 3rd part, we focus on the consultations made in connection with some proposals to change EPSP rules.

If the rules change as we think they may, this could really put a damper on this loophole for many business owners.  Here is the summary of the consultation that was published.

1. Eligibility to participate in an EPSP
The Income Tax Act contains provisions that limit the ability of employees who do not deal at arm’s length with their employer to enter into certain compensation arrangements with their employer. For example:
  • To be accepted for registration, a deferred profit sharing plan must exclude persons related to the employer and specified shareholders from participating in the plan; and
  • To qualify for a deduction, employees who exercise stock options must deal at arm’s length with the employer.
With the proposed changes, EPSP provisions may include similar restrictions on the participation of employees.

Is there a specific rationale for allowing non-arm’s length employees to participate in an EPSP?
What would be the impact on your business or clients if employees who do not deal at arm’s length with the employer, such as related persons, were excluded as eligible EPSP beneficiaries?

2. Role of Minor Children
The Income Tax Act contains provisions to limit income-splitting techniques that seek to shift certain types of income (e.g., certain capital gains, taxable dividends, income from partnerships) from a higher-income individual to a lower-income minor. Under the tax on split income provisions, for example, income received by minor children is taxed at the highest federal marginal income tax rate (29 per cent). In Budget 2011, the Government extended the tax on split income to certain capital gains on shares of most unlisted corporations. EPSP allocations are not subject to these provisions currently, however the revision could change this.

Is there a specific rationale for excluding EPSP allocations from the tax on split income provisions?
What would be the impact on your business or clients if EPSP allocations to minor children were subject to the tax on split income?

There are 3 items left on the summary of the consultation – Limitations on contributions, Withholding Requirements and Additional Questions.  We will take a look at these on the next part of this series. 

Tuesday, December 13, 2011

Employee Profit Sharing Plans (EPSP’s), Part 2 of 4

This is the 2nd part of our 4-part blog series on EPSP’s.  This part will talk more about the benefits of EPSP’s and how they can affect your taxes.
Getting back to EPSPs, there have been some benefits to setting one up.  One is that the trust is not taxed.  No tax is payable by a trust governed by an E.P.S.P. on its taxable income. This means that like registered pension plans or R.R.S.P.'s, the income of the trust accumulates on an untaxed basis.  Another benefit is that employees are taxed annually on the activities of the trust.  The allocations are included in the employee’s income in the year of allocation but income tax is not withheld on the transaction.  The employer will deduct the amounts paid to the EPSP within 120 days of the Corporation’s year end.  The EPSP can be used as an opportunity to reward employees and help create loyalty.

Many EPSPs have been a way for small business owners to distribute profit among family members, children and other employees.  However, the original intent behind EPSPs, as a parliament initiative, was to create a way for business owners to align the interests of their employees with those of the business by sharing the profits of their business with their employees.  The intent was to create vehicles for employees to save money through the EPSP that would be invested tax free, allowing the profits plus gains to be distributed on an annual basis to employees.  Since many business owners have simply been using it as a way to get around CPP and EI, there are currently major consultations going on with the department of finance in the way of proposed changes.  If you’d like to see the consultations that closed just recently (October 25, 2011) go to http://www.fin.gc.ca/activty/consult/epsp-rpeb-eng.asp

On part 3, we’ll talk about the different scenarios involved when EPSP rules change. 

Friday, December 9, 2011

Employee Profit Sharing Plans (EPSP’s), Part 1 of 4

This is a 4-part blog series focusing on Employee Profit Sharing Plans or EPSP’s.  I will discuss this in as much detail as I can.  But if you need further clarification, please feel free to contact me at info@kustomdesign.ca.  Thank you and I look forward to hearing from you soon! Here is the first part of our series:

The average person does not hear about things like EPSP’s. However, over the last number of years, with the increase of knowledge through the internet and other sources, many other smaller private Corporations are beginning to use them.  In fact between 2005 and 2009, the number of EPSPs has increased about fivefold, mostly among small, closely-held Canadian-controlled private corporations.

So what is an EPSP?  An Employees Profit Sharing Plan ("E.P.S.P.") is a trust that allows an employer to share business profits with some or all of its employees. The E.P.S.P. does not require registration.  Amounts are paid to a trustee to be held and invested for the benefit of the employees who are members of the plan.  The idea is to invest the funds for growth and future distribution. However, many EPSPs have not been investing the funds, but instead just flowing through the profits to the employees as a way to avoid CPP on the employee’s earnings.  The government is currently looking at changing the rules as they don’t want to see EPSPs used to simply avoid CPP (and EI). 

That being said, avoiding CPP can be a good thing particularly if you’ve maxed out your lifetime contributions.  To find out if you have maximized your CPP contributions, you must contact Service Canada.  Avoiding CPP is better achieved by paying dividends.  Dividends can only go to the shareholders of the corporation (which may also be employees), so you must structure your affairs accordingly.

Next week, we’ll discuss the benefits of EPSP’s.