Is There An Employee Benefit Plan In Your Future?
Authors: Butler R.M. 
Published: March 2010

It is becoming increasingly difficult to find ways of compensating employees in a tax-effective manner, as the tax collector continues to tighten the screws on employee benefit and deferred compensation arrangements. The "employee benefit plan" is one oft-overlooked element of compensation packages which is beginning to attract more attention.

This month, Tax Topics examines the tax ills and outs of the employee benefit plan.

Introduction

Starting with the federal government's 1969 White Paper on tax reform, the screws have been tightening slowly but surely on tax-effective ways of compensating employees. Many once-popular arrangements have gradually gone the way of the dinosaur, as the Departments of Finance and National Revenue weave an increasingly tight tax net.

One of the victims of this disconcerting trend is the traditional deferred compensation plan. Prior to 1980, it was possible to devise a deferred compensation plan whereby the employer would make an irrevocable payment into a trust for the employee's benefit. The plan would provide for no payments to the employee until a specified future date. Typically, the funds in the plan would be invested in deferred annuities so that no income would arise in the plan until the plan was required to make payments to the employee.

The introduction of the concept of the Employee Benefit Plan ("EBP") to the income tax legislation, with effect from 1980, dealt a fatal blow to the traditional deferred compensation arrangement. The following commentary discusses in broad terms the essence of the various features of the EBP.

What is an EBP?

The Income Tax Act defines the term "employee benefit plan" in broad language. To quote the Act itself, an EBP is defined as "an arrangement under which contributions are made by an employer ... and under which one or more payments are to be made to or for the benefit of employees or former employees of the employer ... ".

As a practical matter, the EBP offers the employer and employee some excellent opportunities for deferring compensation, and the taxation of such deferred compensation, through the utilization of a funded trust. In simple terms, the essence of the EBP is as follows:the employer makes payments (the "deferred compensation") to a trust established by the EBP;the custodian administers the trust;in accordance with the terms of the plan agreement, the custodian makes payments out of the trust to the employee, generally at stipulated future dates.

An EBP can be easily set up by an employer for only one employee or for any size group of employees.

Notably, an EBP is not a registered plan - the plan does not need to be registered with Revenue Canada or any other government authority as is the case with registered pension plans, deferred profit sharing plans and other compensation-related plans. The broad language of the definition of an EBP is not without purpose. Generally speaking, the increasingly xtensive use of deferred compensation plans in the pre-1980 era finally reached and passed Revenue Canada's tolerance threshold - the cost to the treasury in terms of deferred tax revenues was getting out of hand.