Income Tax. This bulletin supersedes bulletin IMP /R1 dated November 30, 1995.

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1 INTERPRETATION AND ADMINISTRATIVE BULLETIN CONCERNING THE LAWS AND REGULATIONS Income Tax IMP /R2 Deferred salary leave arrangement Date of publication: December 29, 2005 Reference(s): Taxation Act (R.S.Q., c. I-3), ss and 78.1 Regulation respecting the Taxation Act (R.R.Q., 1981, c. I-3, r.1, as amended), s R1 (par. a) This bulletin supersedes bulletin IMP /R1 dated November 30, This bulletin states the position of the Ministère du Revenu concerning the criteria to be considered when determining whether a deferred salary leave arrangement established after July 27, 1986, is a prescribed plan or arrangement for the purposes of paragraph l of section of the Taxation Act (TA). APPLICATION OF THE ACT GENERAL 1. Subject to section of the TA, any plan or arrangement, whether funded or not, under which any person has a right in a taxation year to receive an amount after the end of the year, where it is reasonable to consider that one of the main purposes for the creation or existence of the right is to postpone tax payable by the individual in respect of an amount that is, or is on account of or in lieu of, salary or wages of the individual for services rendered by the individual in the year or a preceding taxation year, is a salary deferral arrangement and is subject to the rules provided for in sections to of the TA. Therefore, any deferred salary leave arrangement established after July 27, 1986, is considered to be a salary deferral arrangement, unless the arrangement constitutes a prescribed plan or arrangement under paragraph l of section of the TA. 2. An arrangement in writing established between an employer and an employee after July 27, 1986, will be regarded as a prescribed plan or arrangement if the conditions in points 3 to 10 of this bulletin are met. In such a case, the portion of salary or wages for services rendered by an employee in the year that is deferred under such a prescribed plan or arrangement must be included in computing the employee s income only for the taxation year in which it is received.

2 ELIGIBILITY CONDITIONS 3. An arrangement must be established for the main purpose of allowing the employee to fund, through deferral of a portion of his or her salary or wages, a leave of absence that must be taken within the framework of his or her employment, and not for the purpose of providing benefits for the employee at retirement. Where, in view of the circumstances, including the terms and conditions of the arrangement and any related agreement, it appears that the main purpose of the arrangement in which the employee participates is to provide benefits at retirement rather than to allow the employee to fund a leave of absence, the arrangement is subject to the rules governing salary deferral arrangements from the time it comes into effect. 4. A leave of absence must commence immediately after the end of a period (the deferral period ) of not more than six years from the date on which a portion of the employee s salary or wages is first deferred for the leave of absence. If the employee makes contributions to several trustees, the Ministère considers that the period of not more than six years is calculated from the time of the employee s first contribution under the arrangement. An arrangement does not cease to be a prescribed plan or arrangement where it provides for the interruption of the period in which the employee s salary or wages are deferred, provided the total period of deferral, including the period of interruption, does not exceed a period of six years from the date on which a portion of the employee s salary or wages is first deferred for the leave of absence. An arrangement may provide that the leave of absence will be taken before all of the amounts the employee is to receive for the duration of the leave have been deferred. The fact that a leave is partially financed through advance payment of salary or wages does not prevent the arrangement from being a prescribed plan or arrangement. However, an arrangement providing that the leave will be taken before the end of the first taxation year of the plan is not subject to the salary deferral arrangement rules provided for in sections to of the TA, and is not required to meet the conditions in points 3 to 10 of this bulletin, since the purpose of such an arrangement is not to defer the tax payable by the employee on all or a portion of his or her salary or wages. In this regard, see the current version of bulletin IMP. 36-1, which discusses the matter of leave paid through advance payment of salary or wages. An arrangement may also provide that the leave of absence will be taken on a date that is subsequent to the date on which the employee ceases to receive reduced salary or wages for purposes of his or her leave, to the extent that the arrangement requires the leave to commence not later than at the expiry of a period of not more than six years from the date on which amounts are first deferred for the leave of absence. 5. A leave of absence must last not less than three consecutive months if its purpose is to allow the employee to attend full time a designated educational institution within the meaning of subsection 1

3 of section of the Income Tax Act (R.S.C., 1985, c. 1 (5th Suppl.)), and six consecutive months in all other cases. For the purposes of this bulletin, (a) month means a calendar month, that is, the period between the first day and the last day of a month, or the period between a given date in a month and the same date in the following month. Thus, a fraction of a month cannot be considered a complete month; (b) designated educational institution means i. an educational institution in Canada that is a university, college or other educational institution designated by the Lieutenant Governor in Council of a province under the Canada Student Loans Act (R.S.C., 1985, c. S-23), designated by an appropriate authority under the Canada Student Financial Assistance Act (S.C., 1994, c. 28), or designated by the Minister of Education for the purposes of the Act respecting financial assistance for education expenses (R.S.Q., c. A-13.3), or certified by the federal Minister of Human Resources and Skills Development to be an educational institution providing courses, other than courses designed for university credit, that furnish a person with skills for, or improve a person s skills in, an occupation; ii. a university outside Canada at which the individual referred to in subsection 2 of section of the Income Tax Act was enrolled in a course of not less than 13 consecutive weeks duration, leading to a degree; iii. an educational institution in the United States that is a university, college or other institution providing post-secondary education, if, throughout the year referred to in subsection 2 of section of the Income Tax Act, the individual referred to in that subsection resided in Canada near the boundary between Canada and the United States and regularly commuted between the individual s residence and that educational institution. The Ministère considers that an employee cannot interrupt and subsequently resume a leave of absence for any reason (including sickness, maternity leave, leave without pay, disability, or a return to work). Furthermore, the period of leave of absence must correspond to a period throughout which the employee would otherwise have been required to report for work. 6. The deferred portion of an employee s salary or wages received for services rendered in a year may not exceed 33 1/3% of the amount of the salary or wages that the employee could reasonably have expected to receive in the year in respect of the services, had there been no arrangement. An arrangement may provide that a lump-sum amount will be deferred annually, to the extent that the amount does not exceed 33 1/3% of the salary or wages that the employee could reasonably have expected to receive in the year in respect of services rendered in the year, had there been no arrangement.

4 An employee may participate in more than one deferred salary leave arrangement, to the extent that the total amount deferred in respect of a particular office or employment does not exceed one-third of the amount of the salary or wages that the employee could reasonably have expected to receive in the year in respect of the services rendered in the course of the office or employment. 7. The arrangement must provide that, throughout the leave of absence, the employee will not receive, from the employer or from any other person or corporation with whom the employer does not deal at arm s length, any salary or wages other than (a) the amount of the employee s salary or wages that was deferred or is to be deducted under the arrangement, or amounts corresponding to the percentage of the salary and wage scale of the employer that is established for the deferral period (that is, the period of not more than six years from the date on which a portion of the employee s salary or wages is first deferred) and the duration of the leave of absence; (b) the reasonable fringe benefits that the employer usually pays to or on behalf of the employees. The determination of what constitutes the amount of reasonable fringe benefits that an employer usually pays to or on behalf of employees is essentially a question of fact. Fringe benefits means the normal benefits provided by an employer to employees (such as amounts paid to provide employees with medical care, insurance coverage or a pension plan), to the extent that the value of the benefits is reasonable. This condition is not met where an employer pays an amount to an employee as a scholarship during a leave of absence, since a scholarship cannot be deemed to be an amount deferred under the arrangement or an amount corresponding to a percentage of the employees salary and wage scale, or reasonable fringe benefits that the employer usually pays to or on behalf of the employees. During a leave of absence, certain employees (such as policemen) may be called on to perform a work-related task such as protecting someone s life or testifying in court. The Ministère considers that such situations will not, in themselves, result in the arrangement no longer being regarded as a prescribed plan or arrangement. However, if an employee called to testify in court during a leave of absence is entitled to be paid overtime under the terms of a collective agreement, the arrangement cannot be regarded as a prescribed plan or arrangement. 8. An arrangement must provide that the amounts deferred in respect of the employee under the arrangement are held (a) by or on behalf of a trust governed by a plan or arrangement that is an employee benefit plan, and that the amount that may reasonably be considered to be the income of the trust for a taxation year and that has been earned by the trust for the benefit of the employee will be paid to the employee in that taxation year; or

5 (b) by or on behalf of a person other than a trust governed by a plan or arrangement that is an employee benefit plan, and that an amount equal to the interest or other additional amounts that may reasonably be considered to have accrued to or for the benefit of the employee at the end of a taxation year will be paid to the employee in that taxation year. The Ministère considers that, where a provision of an arrangement stipulates that the employee may suggest certain types of investments to the custodian in which the custodian may invest, as well as the proportion in which each type of investment should be made, the plan will be considered to be an employee benefit plan for the purposes of section 47.6 of the TA only if the custodian does not act as the employee s mandatary. It is therefore important that the custodian should be able to make the final decision concerning investment in a given security and should act as if he or she were the owner of the plan s property. 9. An arrangement must provide that, after a deferred salary leave and for a period that is not less than the period of leave, the employee is to return to his or her usual employment with the employer or with an employer participating in the same or a similar arrangement. In other words, the employee must physically return to work. An arrangement providing that an employee may take a leave without pay immediately following a deferred salary leave may be regarded as a prescribed plan or arrangement, to the extent that the employee is to return, for a period not less than the period of deferred salary leave, to his or her usual employment with the employer or with an employer participating in the same or a similar arrangement. Where an employee is entitled to maternity leave within the framework of her employment, the Ministère is prepared to consider that the employee has returned to her usual employment on the anticipated date of her return from the deferred salary leave, even if the employee is temporarily detained from resuming her regular duties because of her condition which was not foreseen when the arrangement was established. Such an employee, however, must resume her regular duties at the end of her maternity leave. After a deferred salary leave, the employee may return to his of her usual employment part time, to the extent that the total work period following the leave of absence is at least equal to the period of leave. The total period of work and the period of leave correspond respectively to the number of hours worked and the number of hours during which the employee was on leave. 10. Subject to point 8 above, the arrangement must provide that the amounts held for the employee s benefit will be paid to the employee not later than the end of the first taxation year commencing after the end of the deferral period (that is, the period of not more than six years from the date on which a portion of the employee s salary or wages is first deferred for the leave of absence. The arrangement must provide that, regardless of the duration of the leave of absence, the total amount accrued for the benefit of the employee must be paid to the employee not later than the end of the first taxation year commencing after the end of the period in which the amounts accrued in the plan for the benefit of the employee.

6 For example, if the deferrals of salary or wages commence on July 15, 20X0, the leave of absence is to begin on July 16, 20X6 (that is, at the end of the period of not more than six years), and the anticipated duration of the leave of absence is two years, the amounts held for the benefit of the employee must be paid to the employee not later than December 31, 20X7. The employee cannot be paid any portion of the accrued amounts in 20X8. SPECIAL CASES 11. Where a deferred salary leave arrangement constitutes a prescribed plan or arrangement and the employee wishes to terminate the arrangement for reasons of retirement, withdrawal or resignation, the Ministère considers that (a) the arrangement ceases to be a prescribed plan or arrangement if the employee wishes to terminate it before taking the leave of absence. In such a case, the employee must include the amounts held for his or her benefit under the arrangement in computing his or her income from an office or employment for the taxation year in which he or she decides to terminate the arrangement; (b) the employee contravenes a provision of the arrangement if he or she terminates the plan after using only a portion of the leave, since the employee does not fulfil the condition concerning a return to work. The employee must include the amounts held for his or her benefit under the arrangement in computing his or her income from an office or employment for the taxation year in which he or she decides to terminate the arrangement. Thus, in any case where the leave ends in the taxation year in which the employee decides to terminate the arrangement, the employee s decision does not alter the fiscal treatment applicable to the amounts deferred under the arrangement. However, in the event that the Ministère, after analyzing the facts, is of the opinion that the main purpose of the arrangement in which the employee participated was to provide benefits at retirement, rather than to finance a leave of absence, the arrangement will be regarded as a salary deferral arrangement. Moreover, if the employee s leave was partially financed through advance payment of salary or wages and the employee must, pursuant to an arrangement, reimburse the employer for any advance amount, the amount so reimbursed may qualify for the deduction provided for in section 78.1 of the TA; (c) the employee contravenes a provision of the arrangement if he or she terminates the arrangement after using the anticipated leave but before completing a period of return at least equal to the leave of absence, in the employee s usual employment with his or her employer or with an employer participating in the same or a similar arrangement. However, given that all the amounts deferred by the employee were paid to him or her during the leave, there is no fiscal impact for the employee, except where the Ministère, after analyzing the facts, is of the opinion that the main purpose of the plan in which the employee participated was to procure benefits at retirement, rather than to finance a leave of absence. In such a case, the arrangement constitutes a salary deferral arrangement. Moreover, if the employee s leave was partially financed through advance payment of salary or wages and the employee must, pursuant to an arrangement, reimburse the employer for any advance

7 amount, the amount so reimbursed may qualify for the deduction provided for in section 78.1 of the TA.