Deferred Profit Sharing Plan

Post on: 16 Март, 2015 No Comment

Deferred Profit Sharing Plans (DPSP)

Introduction

A Deferred Profit Sharing Plan (DPSP) is part of the overall system of legislated deferred tax savings which also includes Registered Retirement Savings Plans (RRSP’s) and Registered Pension Plans (RPP’s) like Individual Pension Plans (IPP’s). The key element in all of these Plans is the tax deduction of allowed contributions and deferral of tax while the investments reside in the Plans. DPSP’s differ from IPP’s in that the plan cannot have as a beneficiary of the plan, non-arm’s length employees. This condition negates a great deal of tax planning for small closely held corporations, proprietorships and partnerships.

How DPSP’s Work

A DPSP is a Plan designed to enable an employer to share a portion of profits with arm’s length employees. Employers can be incorporated, an unincorporated proprietorship, or a partnership. Non-arm’s length employees are excluded from the Plan and include either a person related to the employer, a Specified Shareholder of the corporate-employer, or a person related to a member of a partnership-employer. Specified Shareholders are defined as a shareholder who owns 10% or more of any class of shares of the corporate-employer or a related corporation and includes the shareholder’s spouse and any other non-arm’s length person like a child. Employer contributions which violate these non-arm’s length employee exclusions will result in the contributions not being deductible to the employer and will become taxable in the employee’s hands.

A DPSP consists of two elements. The first element is the DPSP Plan itself which must be submitted and accepted by the Minister of National Revenue before contributions are made. There are numerous conditions which must be satisfied in order for the Plan to be accepted for registration. These are complex and beyond the scope of this discussion but include the provision that non-arm’s length employees cannot benefit from the plan, restrictions on investments in the Plan, and the types of trustees required to administer the Plan. The second element is the DPSP Trust which has to be legally established. The Trust must have either three Trustee individuals (one of which is arm’s-length to the employer) or one trustee that is a Canadian trust company. An EPSP can be registered as a DPSP as long as the Plan documentation satisfies the DPSP registration requirements.

Contributions by the employer are made to the Trustee who deposits the amounts in the Trust and invests the contributions for employee-beneficiaries. Contributions by the employer are tax-deductible to the employer and do not attract tax, CPP, or EI withholdings. The employee-beneficiary is not taxed on the contributions nor on the investment earnings while in the Trust. The employee-beneficiary is taxed when the funds are distributed out of the Trust. This is in contrast to Employee Profit Sharing Plans (EPSP’s) which tax the employee on employer contributions and Trust earnings but have tax-free distributions from the EPSP Trust.

Contributions must be made within 120 days after the employer’s year end in order to be deductible and are subject to annual limits. Currently the annual limit is the lesser of 50% of the annual dollar limit for RRSP’s and 18% of pensionable earnings. Employee contributions are prohibited. Contributions create Pension Adjustments (PA’s) which erode RRSP contribution limits.

like IPP’s and RRSP’s, investment returns in the Trust are hampered by strict rules on foreign investment and restrictions on eligible investments. Investments that are offside will create taxable income in the Trust.

The Trust must file an annual T3D information return and financial statements with the tax department.

Distributions from the DPSP are taxable to the employee-benficiary and lose the tax characterization of income that an EPSP provides. For example, a capital gain in an EPSP is taxed as a capital gain to the employee (at 50%), but a capital gain earned in a DPSP and distributed to an employee is taxed at the full amount.

The Plan may be revoked under many conditions including:

The existing Plan has been revised or amended and no longer complies for registration.

A provision of the Plan was not complied with.

Contribution limits were exceeded.

Failure to file the T3D information return.

These conditions are strict and deregistration results in the inability to make tax-deductible contributions, income within the DPSP Trust becomes taxable, and employer contributions are taxed in the employee’s hands (similar to EPSP result).

Tax Planning

None available to non-arm’s length employees. Mostly used as a tool to motivate arm’s-length employees.

Pro’s

Employer contributions can be very flexible and may be suspended in unprofitable years.

Income earned in the Plan is tax-deferred until withdrawn and will therefore may grow more quickly than the investments in an EPSP .

Contributions are tax deductible to the employer.

Incentive to employees to increase revenues/control costs.

Reduced employer remittances on EI and CPP.