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Additional Rules for Controlling Shareholders

Additional Rules for Controlling Shareholders

 2011 Federal Budget introduced new definition of Individual Pension Plan (IPP)

Since 1990 when Registered Pension Plans were first permitted to be implemented for Connected Employees, these plans (and also designated plans for executive employees) have been commonly referred to by the pension industry as Individual Pension Plans even though this was not a defined term in legislation.

The 2011 Federal Budget introduced a definition of “Individual Pension Plan” into the Income Tax Act. This definition only refers to a sub-group of those plans which had previously been referred to as IPPs with the result that many plans which were previously referred to as IPPs are not, in fact, IPPs as now defined in the Income Tax Act.

 The significance of a Pension Plan being deemed to be an “Individual Pension Plan” as defined in the Income Tax Act is with respect to two additional legislative requirements:

 ·         A new definition of PSPA when an IPP is set up or when additional service is provided under the Plan.

 ·         For Members who are over age 71 and in receipt of a pension from an IPP, a minimum payment has to be made to the member in addition to the normal pension such that the total annual payment is not less than the minimum amount payable from a RIF in that year.

 
Income Tax Act - Definition of Individual Pension Plan

 The ITA definition is as follows:

 In respect of a  calendar year, an IPP is a registered pension plan that contains  a defined benefit provision if, at any time in the year or a preceding year, the plan

 (a)          has fewer than four members and at least one of them is “related*” to a participating employer in the plan, or

 (b)          is a designated plan and it is reasonable to conclude that the rights of one or more members to receive benefits under the plan exist primarily to avoid the application of paragraph (a)

 
Definition of “Related Person”

 “Related Person” is defined in ITA 251(2):

 Definition of “related persons”

 (2)          For the purpose of this Act, “related persons”, or persons related to each other, are

 (a) individuals connected by blood relationship, marriage or common-law partnership or adoption;

 (b) a corporation and

 (i)                  a person who controls the corporation, if it is controlled by one person,

 (ii)                a person who is a member of a related group that controls the corporation, or

 (iii)               any person related to a person described in subparagraph 251(2)(b)(i) or 251(2)(b)(ii); and

 The ITA definition of “control” is to have more than 50% of the voting shares.


 Conclusion – What is an IPP?

 So to be an IPP under the new rules, a plan must have less than 4 members, at least one of whom either

 ·         owns more than 50% of the voting shares

 ·         Belongs to a “group” which owns more than 50% of the voting shares

 ·         Is a relative of a person who has more than 50% of the voting shares or belongs to a group which owns more than 50% of the voting shares


Westcoast Commentary

The commentary in the 2011 Federal Budget indicated that the perception at the Federal Department of Finance is that IPPs are being used by some individuals to tax shelter large amounts of money. In our experience this perception is misguided. The original draft of the Budget contained measures which would have been negative for certain controlling shareholders with significant retirement savings who wished to set up a new IPP. However, Westcoast played a significant role in reducing the impact of the new PSPA rule by meeting with officials at the Department of Finance and persuading them to adopt a pro-rating rule for calculation of the PSPA which was incorporated in the final version of the ITA.

Our recent experience with new applications for IPPs is that Budget 2011 has, in fact, very little impact and the IPP is still an excellent vehicle for retirement planning with tax deductible contributions which are significantly higher than those permissible under RRSPs and Defined Contribution Pension Plans.

The following is a copy of Interpretation Bulletin IT429R2 which describes in detail such issues as Blood Relationships as defined in the ITA.

RELATED PERSONS

1. Paragraph 251(1)(a) deems that related persons do not deal with each other at arm's length. This is the case regardless of how they actually conduct their mutual business transactions. Subsection 251(2) defines related persons for the purposes of the Act. Subsections 251(3) to 251(6) clarify and expand on the definitions in subsection 251(2).

Related Individuals

2. According to paragraph 251(2)(a), individuals connected by blood relationship, marriage, common-law partnership (see ¶ 7) or adoption are related persons.

Blood relationship

3. Paragraph 251(6)(a) refers to a blood relationship as being that of a parent and a child (or other descendant, such as a grandchild or a great-grandchild) or that of a brother and a sister. Section 252 extends the meaning of those terms to encompass other individuals who might otherwise not be considered to fit the normal use of the term.

4. In addition to a natural child and an adopted child, subsection 252(1) provides that a child of an individual includes:

(a) a person who is wholly dependent on that individual for support if the person is or was, before reaching 19 years of age, in law or in fact, under the individual's custody and control;

(b) a child of the individual's spouse, (e.g., a stepchild) or common-law partner (see ¶ 7); and

(c) a spouse or common-law partner of the individual's child, e.g., a son-in-law or a daughter-in-law, as well as the spouse or common-law partner of a stepchild, of an adopted child or of an individual considered to be the taxpayer's child as described in (a) above.

On the divorce of an individual's child (whether a natural child, an adopted child, a stepchild, or an individual considered to be a child by reason of paragraph (a) above), the child's former spouse ceases to be the child's spouse and is no longer a child of the individual.

5. Paragraph 252(2)(b) provides that an individual's “brother” includes the brother of the individual's spouse or common-law partner and the spouse or common-law partner of the individual's sister. It does not include the spouse or common-law partner of the sister or of the brother of the individual's spouse or common-law partner. Similarly, paragraph 252(2)(c) provides that an individual's “sister” includes the sister of the individual's spouse or common-law partner and the spouse or common-law partner of the individual's brother. It does not include the spouse or common-law partner of the brother or sister of the individual's spouse or common-law partner. Therefore, if Mr. A and Mr. B are otherwise unrelated, and they have each married one of two sisters, they are not related by blood according to paragraph 251(6)(a). Similarly, if Mr. X and Mrs. Y are brother and sister, Mrs. X and Mr. Y are not related by blood. However, Mr. A and Mr. B, and Mrs. X and Mr. Y, in the respective examples, are connected by marriage according to paragraph 251(6)(b).

Marriage

6. According to paragraph 251(6)(b), two persons are “connected by marriage” if one person is married to the other person or to an individual who is connected by blood relationship to that other person. For example, an individual will be connected by marriage to the parents and any siblings of the individual's spouse. However, where an individual's marriage is dissolved by either divorce or the death of the individual's spouse, the individual will cease to be “connected by marriage” or to be “connected by blood relationship” to the parents and any siblings of the individual's former spouse.

Common-law partnership

7. Paragraph 251(6)(b.1) provides that two individuals are “connected by common-law partnership” if one individual is in a common-law partnership with the other or with a person who is connected by blood relationship to that other person. Subsection 248(1) defines a common-law partnership as the relationship between two persons who are common-law partners of each other. The expression “common-law partner” is also defined in subsection 248(1) and means a person of the opposite or same sex who, at that time, lives with and has a conjugal relationship with the individual. In addition, one of the following conditions must be satisfied:

(a) the person has been living in a conjugal relationship with the individual for a continuous period of at least one year; or

(b) the person is the natural or adoptive parent (whether legally or in fact) of the individual's child (see ¶4).

Where an individual and another person have been living together in a conjugal relationship, they will be considered, at any time thereafter, to be living together in a conjugal relationship unless the couple have been living apart for a period of at least 90 days that includes the particular time because of a breakdown of their conjugal relationship. Once a common-law partnership has been established, it will continue to exist unless the parties are living apart and have been doing so for a continuous period of 90 days due to a breakdown in the relationship. For example, MS X and Mr. Y have been living together in a conjugal relationship beginning in 1997. On January 15, 2001, they begin to live separate and apart as a result of a breakdown in their relationship. On June 30, 2002, they reconcile and resume living together in a conjugal relationship. Ms. X and Mr. Y will be common-law partners beginning June 30, 2002 because they have previously lived together in a conjugal relationship for a continuous period of one year.

Note 1: On December 20, 2002, the Minister of Finance released Legislative Proposals and Explanatory Notes Relating to Income Tax, a package of draft technical amendments to the Income Tax Act. One of the proposals is to amend the definition of “common-law partner” in subsection 248(1) to provide that an individual will be considered a common-law partner of another person at a particular time only where they have lived together in a conjugal relationship throughout the 12-month period that ends at the particular time. In the example referred to above, this would have the effect that Ms. X and Mr. Y will not be considered common-law partners until June 30, 2003. If enacted as proposed, this amendment will apply for the 2001 and subsequent taxation years.

8. In determining whether an individual is a parent of their partner's child, paragraph (b) of the definition of “common-law partner” does not restrict such a determination to the natural child of the partner. Consequently, subsection 252(1) characterizes each individual as a parent of a child when there is a legal or factual adoption of that child. When the facts substantiate that an individual is the adoptive (see ¶ 10) parent of the child of an individual with whom the individual is living together in a conjugal relationship, both individuals would be considered to be the parents of the child and a common-law partnership will be considered to have begun at that time, which could be at the time that the couple began to live together conjugally, or it could be after that time.

For the purposes of paragraph (b) of the definition of “common-law partner”, a child does not generally include a son-in-law or a daughter-in-law. Therefore, for example, a woman who begins to live together in a conjugal relationship with her son-in-law's father would not be the common law partner of her son-in-law's father until they have lived together for a continuous 12-month period.

Other relatives

9. For purposes of the Act, an individual's niece, nephew, aunt, or uncle is not related by blood, marriage, common-law partnership or adoption to the individual unless such person is also the individual's child or parent because of the extended meaning of child as described in ¶ 4. Cousins are not related by blood unless one is the child of the other because of the extended meaning of child (as described in ¶ 4), or is the spouse or common-law partner of the other one's brother or sister. However, under certain circumstances, cousins may be related by marriage, common-law partnership, or adoption.

Adoption

10. According to paragraph 251(6)(c), two individuals are “connected by adoption” if one individual is the adopted child of the other. “Adoption” includes a legal adoption and an adoption in fact. In addition, an individual who is related by blood (except a brother or sister) to another individual will be related by adoption to that person's adopted child. Therefore, individuals are connected by adoption to their adoptive children, parents and grandparents. Whether a factual adoption has occurred at a particular time is a question of fact and has to be determined based on a consideration of the particular circumstances. The fact that an individual is appointed guardian of a child does not, in and of itself, constitute adoption in fact. For a de facto adoption to exist, generally the “adoptive” parent must exercise parental care and guidance on a continuing basis. The factors to look for in determining whether a certain relationship between an individual person and a child constitutes an adoption in fact are actual control and custody, an exercise of parental care and responsibility on a continuing basis, dependency, and proximity to each other.

Content

【A】


Actuarially Equivalent - A benefit of equivalent actuarial present value when computed on the basis of interest, mortality and/or other rates and tables.


【B】



【C】


Canada Pension Plan (CPP) - A governmental pension plan that provides benefits to workers and their beneficiaries in Canada except Quebec in the event of retirement, disability or death.


CRA - Canada Revenue Agency - also known formerly as: Canada Customs and Revenue Agency; Canada Customs, Excise and Taxation; Revenue Canada, Taxation; and Department of National Revenue.


Commuted Value - A lump sum amount that is actuarially equivalent to a pension determined using certain actuarial bases. Most commuted values are determined in accordance with the Canadian Institute of Actuaries Revised Standards of Practice for Determining Commuted Values (CIA Commuted Value Standard), which came into effect April 1, 2011. Prior to April 1, 2011, commuted values were mostly calculated in accordance with the Canadian Institute of Actuaries Standard of Practice for Determining Commuted Values which came into effect on February 1, 2005.


Connected Person- A person who owns directly or indirectly 10% or more of any class of shares of a company or is not dealing at arm's length with such person.


Consumer Price Index (CPI) - A statistic that measures the change in the cost of living for consumers.  It is often used to measure inflation.


【D】


Defined Benefit (DB) - A pension design that defines the benefits payable at retirement.  The contribution amount is determined through actuarial valuation.  If a plan is registered for tax purposes, the maximum pension payable is defined by tax regulations.

Defined Benefit Limit (Defined Benefit Pension Plans) - The maximum amount of annual pension that can be paid from a defined benefit pension plan to a member for each year of pensionable service (or called credited service).  Based on current tax rules, the limit can be found on the CRA website. The limit is defined as the greater of $1,722.22 and 1/9 of the Money Purchase Limit.

2/3 Pensionable - Please note that for pre-1990 pensionable service recognized after June 7, 1990, the limit is only $1,150.00 (instead of $1,722.22) for years up to and including 2003 and 2/3 (two-thirds) of the Defined Benefit Limit for years after 2003.  These years of pre-1990 service are usually referred to as 2/3 pensionable.


Defined Contribution (DC) - A pension design that defines the amount of contributions, usually a percentage of salary.  The benefits payable at retirement depend on factors such as future investment return and annuity rate at retirement.  If a plan is registered for tax purposes, the maximum contribution amount (usually a percentage of earnings or income up to a dollar limit) is defined by tax regulations.


Defined Contribution Limit or Money Purchase Limit (Defined Contribution Pension Plans) - The maximum dollar amount of contribution that can be contributed to a defined contribution pension plan on behalf of a member.  Based on current tax rules, the aggregate contribution limit (the total of employer regular, employee regular and employee voluntary)  can be found on the CRA website. After 2016 the limit will increase at the rate of increase of the Average Industrial Wage Index for Canada.


Designated Plan - A Designated Plan is defined in Income Tax Regulation 8515(1) as a Registered Pension Plan that is primarily for the benefit of Connected Persons and Highly-Paid Employees.

【E】



【F】



Flexible Pension Plan - A defined benefit pension plan that allows plan members to earn Optional Ancillary Benefits by making Optional Ancillary Contributions.


【G】



【H】



Highly-Paid Employee - An employee who is paid at least 2.5 times the Year's Maximum Pensionable Earnings (YMPE) as defined by the Canada Pension Plan. The current YMPE can be found on the CRA website.

【I】



【J】


【K】



【L】


Life Income Fund (LIF) - A type of RRIF under which the owner must withdraw each year an amount that is between a minimum percentage prescribed by the Income Tax Act (Canada) and a maximum percentage prescribed by pension legislation (click here for applicable percentages for B.C.).


Locking-In - A condition imposed by pension legislation that requires funds either be used to provide a pension at retirement or be kept in a locked-in plan such as a Locked-In RRSP, LIRA, LRIF or LIF.


Locked-In Retirement Account (LIRA) - A type of RRSP where the funds are subject to locking-in under pension legislation. These funds must be used to purchase a life annuity, or be transferred to a LIF or an LRIF by the end of the year the owner attains age 71 at the latest. It is available in all jurisdictions except under the federal PBSA which provide for the locked-in RRSP that is very similar to the LIRA.


Locked-In Retirement Income Fund (LRIF) - A type of RRIF under which the owner must withdraw each year an amount that is between a minimum prescribed by the Income Tax Act (Canada) and a maximum amount prescribed by pension legislation. The LRIF is only available in Manitoba and in Newfoundland and Labrador.


Locked-In RRSP - A type of RRSP that is available under the federal PBSA to maintain funds that are locked-in as required by pension legislation. These funds must be used to purchase a life annuity or be transferred to a LIF by the end of the year the owner attains age 71 at the latest.


【M】


Maximum Transfer Limit - The maximum amount that can be transferred from a defined benefit pension plan to a money purchase provision (defined contribution pension plan, RRSP or RRIF) according to Income Tax Regulation 8517.  Please click here for details.


Money Purchase Limit - Refer to Defined Contribution Limit.


【N】


【O】



Office of the Superintendent of Financial Institutions (OSFI) - The entity that ensures pension plans governed by the Pension Benefits Standards Act, 1985 (PBSA) comply with the act and are administered in accordance with its requirements.


Old Age Security (OAS) - A monthly pension paid to Canadians over age 65 out of Government general revenue.


Optional Ancillary Benefits (OAB) - Benefits which are provided by Optional Ancillary Contributions under a Flexible Pension Plan.


Optional Ancillary Contributions (OAC) - Contributions made under a Flexible Pension Plan in order to acquire Optional Ancillary Benefits.


【P】


Past Service Pension Adjustment (PSPA) - Any pension benefits earned in a year after 1989 would reduce an individual's RRSP deduction limit for the following year through the reporting of a Pension Adjustment (PA).  If post-1989 past service benefits are provided or improved, it would trigger a provisional Past Service Pension Adjustment (PSPA) for the pension plan member which must be satisfied through one (or a combination) of the following means before such post-1989 past service benefits can be provided:

1.     Approval by CRA of Form T1004 (Applying For The Certification Of A Provisional PSPA) filed with them.  CRA will approve the form if the individual has sufficient unused RRSP room carried forward to satisfy the PSPA amount.  Please note that the individual's unused RRSP room would be reduced by the PSPA amount upon CRA's approval; or

2.     Transfer (tax-free) an amount from the pension plan member's RRSP or account in a Defined Contribution (DC) Pension Plan to the pension plan that provides the past service benefits.  Such transfer is commonly referred to as a Qualifying Transfer; or

3.     Withdraw an amount from the pension plan member's RRSP using CRA Form T1006 (Designating An RRSP Withdrawal As A Qualifying Withdrawal).

 
Pension Adjustment (PA) - Starting with 1990, a Pension Adjustment (PA) is reported on a pension plan member's T4.  The PA would reduce the member's RRSP deduction limit for the following year.  PA for a Defined Contribution (DC) pension plan member is the total employee and employer contributions made on the member's behalf as well as any forfeitures allocated to the member.  PA for a Defined Benefit (DB) pension plan member is calculated by a formula.  In simplified terms, it is equal to the annual pension amount earned by the member during the year first multiplied by 9 then subtracted by a prescribed amount ($1,000 for years before 1997 and $600 for 1997 and after).


Pension Adjustment Reversal (PAR) - The purpose of a PAR is to restore RRSP contribution room when an employee's membership in a provision of an RPP or DPSP stops and their termination benefit is less than the sum of PAs and PSPAs that have been reported to the Canada Revenue Agency (CRA). The PAR is reported to the CRA so that the employee's RRSP contribution room that was previously reduced by a PA or PSPA can be restored.
A PAR must be reported any time an individual stops being a member of a provision or plan after 1996. An individual does not have to terminate employment, only terminate plan membership.


Portability - The legislated right for an individual to transfer vested benefits to another registered retirement plan upon termination of employment or membership.


【Q】



Qualifying Transfer from RRSP - Transfer from a pension plan member’s personal RRSP to satisfy PSPA. For new plans, the Qualifying Transfer must be processed within 90 days of official registration by CRA.

Quebec Pension Plan (QPP) - A governmental pension plan similar to CPP that provides benefits to workers and their beneficiaries in Quebec in the event of retirement, disability or death.


【R】


Registered Disability Savings Plans (RDSP) - A registered disability savings plan is a trust arrangement between a holder and an issuer (a trust company in Canada). The purpose of such a plan is to provide for the long term financial security of a beneficiary who has a prolonged and severe physical or mental impairment and is entitled to the Disability Tax Credit. The RDSP is being administered jointly with Human Resources and Skills Development Canada (HRSDC).

Registered Pension Plans - A Registered Pension Plan (RPP) in Canada is a plan that is registered with Canada Revenue Agency for tax purposes under Section 147.1 of the Income Tax Act and if applicable the federal or provincial pension regulator.  The plan can be on a Defined Benefit (DB) or Defined Contribution (DC) basis.

Registered Plans - Plans such as Registered Pension Plans, Registered Retirement Savings Plans, Deferred Profit Sharing Plans, etc. that are registered for tax purposes.  Contributions to registered plans by the employer, employee or individual are deductible subject to limits.  Investment income earned by a registered plan is not taxed.  Benefits paid from a registered plan are taxable to the member or beneficiary when received.

Registered Retirement Income Fund (RRIF) - An arrangement under which the owner must withdraw each year a minimum amount prescribed by the Income Tax Act (Canada).  Funds usually originated from matured RRSPs or transfers from other registered plans.

Registered Retirement Savings Plan (RRSP) - A registered savings vehicle under Section 146 of the Income Tax Act arrangement into which an individual makes contributions for retirement savings purposes.

Related Person - Please see 
here for the full definition according to Section 251 of the Income Tax Act.

RRSP deduction limit -
The RRSP deduction limit for a year is the taxpayer’s unused RRSP deduction room at the end of the preceding taxation year, plus 18% of prior year earned income up to the RRSP maximum dollar limit for the current year less the Pension Adjustment (PA) for the prior year.

RRSP maximum dollar limit - The maximum dollar limit for RRSP can be found on the CRA website. Please note that these dollar limits are always one year behind the Money Purchase Limit to allow for reporting of Pension Adjustment (PA) on T4.

Retirement Compensation Arrangement (RCA) - An arrangement defined in subsection 248(1) of the Income Tax Act (Canada) under which an employer, former employer, or in some cases an employee, makes contributions to a custodian.  The custodian holds the funds in trust with the intent of eventually distributing them to the employee (beneficiary) on, after, or in view of retirement, other severance from employment, or any substantial change in the services the employee provides.

【S】

Spouse - See Provincial Pension Acts   – Definition of Spouse.   

【T】

Tax Free Savings Account (TFSA) - Starting in 2009, Canadian residents who are 18 years of age or older are able to earn tax free investment income within a TFSA during their lifetime. The maximum amount that can be contributed to a TFSA can be found on the CRA website. This amount will be indexed to inflation and rounded to the nearest $500 in subsequent years. Unused TFSA contribution room can be carried forward to later years. The total of TFSA withdrawals in a calendar year is added to the TFSA contribution room for the next calendar year. The CRA is responsible for monitoring and operating the TFSA, as applicable under the Act.


【U】




【V】



Vesting - This term refers to the acquisition of an unconditional right to pension benefits by a pension plan member after the completion of a certain period of employment or membership and sometimes the attainment of a certain age.  If a member is not vested at termination, he or she will be entitled to a refund of his or her own contributions, if any, with interest.


【W】




【X】




【Y】



Year's Maximum Pensionable Earnings (YMPE) - The amount of earnings each year as defined for purposes of determining the maximum amount of contributions payable to and the maximum amount of benefits payable from the CPP/QPP.  The amount increases annually at the rate of average wage growth in Canada.


【Z】