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.  

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

This is the 2^nd 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.