Employee Profit Sharing Plans – Sham in family income splitting

Dimane Enterprises Ltd v The Queen, 2014 TCC 334

The Taxpayer, after retiring, set up a company to provide consulting services to oil and gas companies.  He employed his wife, two adult and two minor children in the business. On the advice of a consultant, he set up an employee profit sharing plan (EPSP) and used this to split income as between the family members.

The MNR reassessed and asserted that (1) the EPSP was not validly implemented, (2) the EPSP was a sham; and (3) that the contributions to the EPSP were not reasonable and not related to the taxpayer’s business.

The Court stated that the only issue was whether the arrangement was a Sham.

ANALYSIS

Subsection 144(1) of the Income Tax Act (ITA) defines an EPSP and generally requires:

• that payments to the EPSP be calculated by reference to the employers, and/or non-arm’s length company’s, business profits; and
• that the trustee of the EPSP assigns, contingent or absolute, amounts to the employees in accordance with ITA 144(1)(b).

The Court referred to the decision in Saint & Associates Insurance Agencies Ltd. v. The Minister of National Revenue, 2010 TCC 168, to identify the three conditions that must be satisfied for a valid EPSP to exist, being that:

(a)  Payments must be computed by reference to the profits of the employer’s business.

(b) Such payments must be made to a trustee under the arrangement.

(c)  All amounts received by the trustee must be allocated each year by the trustee to the employees who are beneficiaries under the arrangement.

The ITA, at subsection 144(10), provides that the employee may elect to pay the amounts out of profits of the employer (or related business), and that such payments will be treated as if they were payments with reference to the employer’s profits under 144(1): See Gary Jackson Professional Corporation v. MNR, 2013 FCA 142.

The court recognized that taxpayers are entitled to arrange their affairs to minimize their tax liability, and that taxpayers should be taxes on the basis of what they actually do not what they could have done (unless the ITA requires otherwise): Shell Canada Ltd. v. Canada,  [1999] 3 S.C.R. 622.

For a sham to exist, there must be an element of deceit: Antle v. Canada, 2010 FCA 280.  Deceit, for this purpose, requires only that the parties present the transaction to be different from what they know the transaction to be.

In this case, the documents provided that the profit of the company be shared by the parents and children (employees), but in fact the amounts were not allocated to these parties. Rather the father merely moved money between bank accounts that he controlled, never giving up control over the funds contributed to the EPSP. The purported employees never controlled the funds.  This was done, the court concluded, to hide the real transaction, making the arrangement a sham.

– Sas Ansari

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