RETIREMENT COMPENSATION ARRANGEMENTS
1. Key Features of RCAs
- Purpose: RCAs are designed to provide retirement benefits for employees or their beneficiaries, particularly those whose retirement income needs exceed the limits of registered pension plans.
- Structure: Contributions are made to a custodian, who holds the funds in trust. These funds are distributed as retirement benefits when the employee retires or loses their job.
- Flexibility: RCAs can be tailored to meet specific retirement needs, making them an attractive option for executives and other high-income employees.
2. Contributions and Refundable Tax
Contributions to an RCA are subject to a 50% refundable tax. This tax ensures compliance and discourages premature use of RCA funds. The refundable tax is remitted to the CRA and held in a special refundable tax account.
Key Points About Refundable Tax:
- Calculation:
- 50% of all contributions made to the RCA (excluding excluded contributions).
- 50% of net investment income or capital gains earned by the RCA, minus any losses.
- Refund Eligibility: The refundable tax can be returned to the RCA trust when:
- Distributions are made to beneficiaries.
- Losses are incurred, such as investment or capital losses.
- Custodian Responsibilities: The custodian must:
- Remit the refundable tax by the 15th day of the month following contributions or income generation.
- File the necessary forms and maintain accurate records of all refundable tax remittances.
3. Special Rules
Special rules exist to address unique RCA scenarios and maintain compliance:
- Recovery of Refundable Tax: Refundable tax can be recovered under specific circumstances, including:
- When an RCA incurs significant investment or capital losses, allowing the custodian to request a refund proportional to the losses incurred.
- In the event of RCA termination, any remaining refundable tax can be claimed back after fulfilling all reporting obligations.
- Creation of an Implied Trust: If no formal trust has been established, the CRA may determine the existence of an inter vivos trust for the purposes of RCA taxation. This ensures that contributions and benefits are subject to the appropriate rules, even in the absence of explicit trust documentation.
- Foreign Plan Restrictions: Special restrictions apply to contributions made to foreign plans that provide RCA benefits. To qualify:
- The contributions must be made on behalf of employees who are Canadian residents.
- The services rendered must be performed primarily in Canada or in connection with a Canadian business.
- Contributions for employees who were Canadian residents for fewer than five of the preceding six years may be excluded from RCA tax under certain conditions.
- Prohibited Practices: Certain practices are explicitly disallowed under CRA rules to maintain the integrity of the RCA framework:
- Personal service corporations or similar entities cannot establish RCAs for their shareholders or employees.
- Foreign custodians cannot avoid RCA rules by shifting the residency of the trust or its contributors.
- Limits on Life Insurance Policies: If an RCA includes a life insurance policy or annuity as part of its funding, special rules determine the tax treatment of contributions and benefits. These include:
- Contributions used to fund the insurance policy are subject to refundable tax.
- The fair market value of the policy may be included in the custodian’s reporting obligations.
- Terminations and Windups: When an RCA is terminated or wound up, specific rules ensure that:
- Any remaining refundable tax is recovered by the custodian or employer.
- Distributions to beneficiaries are taxed as income in their hands.
- Special Provisions for Contributions: Contributions made by an employer on behalf of employees must meet strict guidelines to avoid penalties:
- All contributions must be reasonable and align with the employee’s service period and compensation structure.
- Contributions made for individuals who are not employees (e.g., shareholders) may be disallowed and subject to penalties.
By adhering to these special rules, employers and custodians can ensure that their RCAs remain compliant with CRA guidelines while maximizing the benefits for employees and retirees.
4. Income Inclusion
All amounts received from an RCA are included in taxable income under specific circumstances:
- Non-Deductible Contributions: Contributions not previously deducted must be reported as income.
- Inheritance or Transfers: Payments made to estates or beneficiaries upon death must be included in their taxable income.
- Property Distributions: Recipients must include the FMV of distributed property and any capital gains or recapture in their income.
5. Reporting Obligations
- Custodians must file T3-RCA tax returns annually.
- Employers must issue T737-RCA slips for all contributions and distributions.
6. Examples
- Example 1: An employer contributes $100,000 to an RCA. A refundable tax of $50,000 is remitted to the CRA, leaving $50,000 in trust.
- Example 2: A retiree receives a $30,000 distribution from an RCA. The amount is reported as taxable income, and a T4A-RCA slip is issued.
7. Advantages of RCAs
- Provide supplemental retirement benefits for high-income employees.
- Offer flexibility to design tailored retirement plans.
- Ensure compliance with CRA regulations through refundable taxes and reporting.
