13 November 1996 External T.I. 9633255 - SALARY ROLLBACKS AND INCREASED BENEFITS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

renegotiation of employment contract to reduce salary in exchange for increased (non-taxable) benefits both in and outside of a flexible benefit plan

Position:

diversion of existing salary entitlements to pay for benefits is taxable but, provided that a valid renegotiated contract has been substituted for the former contract, additional benefits provided outside a flex plan will not be taxed as salary - if an employee's salary entitlement under a contract that has not expired is diverted to create credits under a flex plan, the plan will be considered to be funded by means of employee contributions

Reasons:

once a contract of employment has expired (as is common in a collective agreement which is renegotiated at regular intervals), the employee's right to maintain the level of salary is open to negotiation; with the result that a salary rollback combined with increased benefits does not involve a forfeiture of an existing entitlement. When a contract of employment has not expired (as is likely in the case of a verbal contract since the statute of frauds requires that an employment contract for a specified period of more than 1 year be in writing, thus verbal contracts tend to be open-ened), the facts must show that a new contract replaces the old (i.e. substitution of a written contract for a verbal) and that the new contract has been unilaterally imposed by employer. If so, the employee will be taxed on salary and benefits according to the terms of the new contract. However, if the new contract includes a flexible benefit plan, the employee's concurrance with an diversion of salary is established through the choices made by the employee under the flex plan.

A. Humenuk
XXXXXXXXXX							963325

Attention: XXXXXXXXXX

November 13, 1996

Dear Sirs:

Re: Flexible Benefit Plans

We are replying to your letter of October 3, 1996, in which you ask for further clarification of our position as set out in our previous letter to you dated April 16, 1996, concerning the redirection of salary to a flexible benefit plan.

We note your observation that a technical interpretation dated May 28, 1996 on this subject seems to reflect a change in our position. You ask for clarification of this apparent change. You also ask for our comments as to whether a unilaterally imposed reduction of salary by an employer in exchange for increased private health services coverage would result in a requirement to include the value of the employer's contribution for such increased coverage in the employee's income when the employee does not have an option to choose cash instead of the increased private health services plan coverage.

The technical interpretation dated May 28, 1996 does not represent a change in our position with respect to flexible benefit plans since the situation contemplated therein was not made in the context of a flexible benefit plan arrangement. Generally, when an employee has an entitlement to salary or benefits under a valid existing contract of employment, the forfeiture of all or part of such entitlements in exchange for flexible credits in a flexible benefit plan will result in an income inclusion under subsection 5(1) or paragraph 6(1)(a) of the Act.

The tax consequences arising from a decrease in an employee's salary as part of an amended employee compensation arrangement depends on the employee's legal entitlements under the contract of employment. When a contract of employment is renegotiated upon the expiry of a former employment contract to incorporate a decrease in the level of salary or wages to be paid to an employee over the term of the contract, the salary and benefits provided under the new contract must be included in the employee's income to the extent provided by sections 5, 6 and 7 of the Act. Accordingly, a corresponding or coincident increase in the amount of premiums paid by the employer in respect of a benefit plan described in paragraph 6(1)(a)(i) of the Act, will not be treated as a taxable benefit to the employee and added to the amount of the decreased salary.

On the other hand, if an employee has a legal entitlement, pursuant to the terms of an existing employment contract, to a certain level of salary which is taxable as income from employment, the diversion of a portion of that salary towards the payment of premiums in respect of private health services plan coverage will not serve to reduce the amount of salary that is subject to tax. In such circumstances, the amounts withheld from income by the employer and used to cover the premium obligations will not be considered as employer contributions, but rather after-tax employee contributions. If the previous contract of employment is only verbal, the onus will be on the employer to satisfy the Department that a valid renegotiated employment agreement is in place and that the increased benefits are funded by the employer.

When a renegotiated increase in private health services plan coverage is not provided through a flexible benefit plan and the employee could not choose less coverage throughout the term of the employment contract, the amount established to be the employer's contribution will not be included in the employee's income by reason of the exception in subparagraph 6(1)(a)(i) of the Act, even if the employment contract also includes a salary reduction. It should be noted that the facts must show that the previous employment contract has been renegotiated thereby effecting a change in the employee's legal rights.

When the provisions of an employment contract are modified during the term of the contract, by paying less salary in order to fund the creation of a flexible benefit plan (or to offer additional flex credits under an existing plan), it is reasonable to conclude that such benefits are funded by the employees. As a result, the exception in subparagraph 6(1)(a)(i) of the Act would not have any application with respect to the benefits provided under the plan and the employee would be taxed on the full amount of the salary, including the amount applied to fund benefits selected under the flexible benefit plan for the reasons stated in our previous letter to you.

While we trust that our comments will be of assistance to you, we caution you that they do not constitute an advance income tax ruling and accordingly, are not binding upon the Department with respect to any particular plan or transaction.

Yours truly,

John F. Oulton
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch