Employee Profit Sharing Plans – Changes to Come?

December 2011 | Bryant D. Frydberg, George Nystrom

In the 2011 Federal Budget, the government announced its intention to review the rules regarding employee profit sharing plans (“EPSPs“). Further to this announcement, the Department of Finance issued a consultation paper on August 30, 2011 requesting feedback from stakeholders on the rules governing EPSPs.

In its consultation paper, the Department of Finance noted that the number of EPSPs has increased significantly between 2005 and 2009 mostly among small closely-held Canadian-controlled private corporations.  According to the Department of Finance, there has been an increased proliferation of the use of EPSPs as a means for business owners to: (i) reduce their tax liability by splitting their income with family members; (ii) defer the payment of income tax; and (iii) avoid paying Employment Insurance premiums and Canada Pension Plan contributions.

The consultation paper is seeking feedback on the following four questions:

  1. Who should be allowed to participate as an employee (or beneficiary) in an EPSP?  More specifically, should non?arm’s length employees be able to participate in an EPSP?
  2. Should the so called “kiddie?tax” rules apply to allocations made from an EPSP to minor children?
  3. Should there be a limitation on the contributions an employer can make to an EPSP?
  4. Should the withholding requirements (including those relating to income taxes, Canada Pension Plan contributions and Employment Insurance premiums) with respect to salary paid to employees apply to allocations made from an EPSP to an employee (or beneficiary) of an EPSP?

It is quite evident from these questions that the Department of Finance is seriously looking to crack down on the use of an EPSP by small business owners as a means to income split, defer taxes and/or avoid paying Employment Insurance premiums and Canada Pension Plan contributions. The Department of Finance stated in the consultation paper that the intended purposes of EPSPs are to enable employers to share profits with employees, assist employees to save and better align the economic interests of management and labour.  It appears that the Department of Finance is now looking at ways in which to curtail the current use of an EPSP such that future use of an EPSP will be more aligned with the intended purposes of these rules.

Given the fact that the Department of Finance is reviewing the rules with respect to EPSPs, it is important for employers who are considering implementing an EPSP to obtain legal and tax advice related thereto.

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