Digest of Benefit Entitlement Principles - Chapter 5
CHAPTER 5
EARNINGS
5.15.0 PROFIT SHARING PLANS
5.15.1 Cash or Current Distribution Profit Sharing Plans
5.15.2 Employee's Profit Sharing Plans
5.15.3 Deferred Profit Sharing Plans (DPSP)
5.15.4 Registered Profit Sharing Pension Plans
5.15.5 Profit Sharing Plan Comparison
Employers use profit sharing plans as a way of rewarding the good performance of their employees and to instill a sense of partnership between the employer and each participating employee in the pursuit of maximum profits.
The four types of profit sharing plans are: Cash Profit Sharing Plans,1 Employee's Profit Sharing Plans,2 Deferred Profit Sharing Plans,3 and Registered Profit Sharing Pension Plans4. The plans vary from immediate compensation and taxation to having both compensation and taxation deferred until the moneys are withdrawn.
Knowing under which section of the Income Tax Act these plans are registered is essential to identify the type of profit sharing plan that the employer has established.
________________________
- see 5.15.1, "Cash or Current Distribution Profit Sharing Plans";
- see 5.15.2, "Employee's Profit Sharing Plans";
- see 5.15.3, "Deferred Profit Sharing Plans (DPSP)";
- see 5.15.4, "Registered Profit Sharing Pension Plans."
5.15.1 Cash or Current Distribution Profit Sharing Plans
Cash or Current Distribution Profit Sharing Plans are designed to provide periodic cash distribution to plan members based on the profits of the employer. Occasionally company stock may be distributed rather than cash. The distribution schedule is determined by the employer. As the distribution is made periodically rather than held until the participant leaves employment, this plan is a form of direct compensation.
This is the simplest form of profit sharing plans. It does not require registration with Canada Customs and Revenue Agency as all profit sharing payments are made directly to the employee in cash or stock certificates. Taxation is not deferred and occurs in the year that these moneys are paid.
Any cash or the value of any stock distributed to the employees is earnings that arise out of employment.1 Like all profit sharing plans, the payment of these moneys is linked to the services provided by the employees in their daily work that assist their company in earning the profits. As the share in the profits arose from the performance of services, these earnings will be allocated to the week or weeks in which the services were performed.2
________________________
5.15.2 Employee's Profit Sharing Plans
In Employee's Profit Sharing Plans, a share of the profits each year is placed in a trust fund and is allocated to participating employees along with their share of the accumulated interest in the fund for that year. The allocation may be in proportion to the employee's earnings, length of service, or some other formula.
These moneys generally remain in the trust account until the participant's employment is terminated, however, some plans may allow cash withdrawals by the employee while still employed. Employees may also make contributions to this fund; however, these contributions are not tax deductible.
Vesting of the employer's profit sharing contributions1 can vary from immediate to vesting only on death, termination of employment, or retirement. In cases where vesting is not immediate, cash withdrawals cannot be made while employed, as the employee has no right to these payments.
Although a participant may not normally receive a distribution from this trust fund until retirement or until employment is terminated, the employee is taxed each year on his or her share of the profits, the interest accruing in the trust, and any realized capital gains, as if he or she was in immediate receipt of such moneys. There is no income tax payable on any employee contributions made to this fund as these moneys come from the employee's after-tax income. This profit sharing plan is registered under section 144 of the Income Tax Act.
These moneys are earnings that arise out of employment.2 However, these earnings are not considered as payable until the actual distribution of them is made to the employee. Like all profit sharing plans, the payment of these earnings is linked to the services provided by the employees in their daily work that assist their company in earning the profits. These earnings will be allocated to the week or weeks in which the services were performed,3 because the share in the profits arose from the performance of services, if the amount of the interest is known, this amount is deducted.
________________________
5.15.3 Deferred Profit Sharing Plans (DPSP)
In a Deferred Profit Sharing Plan (DPSP), the employer allocates a share of the profits to all participating employees each year and places it in a trust account. These moneys remain in this trust account until the participant's employment is terminated. Effective 01 January, 1991, employee contributions to this plan are no longer allowed except for direct transfers from other registered tax-assisted plans.
Taxation of the employee's share of the profits and the interest accrued in the trust fund is deferred until the employee is in receipt of these moneys. These plans are registered under section 147 of the Income Tax Act, and are subject to greater regulation and control than Employee's Profit Sharing Plans1. To qualify for registration the Deferred Profit Sharing Plan must:
- provide for full vesting2 within two years, or immediately at retirement on account of age or disability. However, contributions made on or after 01 January, 1991, must vest immediately if the member has completed twenty-four (24) months of DPSP membership;3
- define a normal retirement age, with annuity or instalment payments to begin no later than age 69;4
- follow strict investment rules comparable to those for pension plans; and
- provide for significant employer contributions when profits are realized.
Although a DPSP may have some of the same characteristics of a pension plan, it does have some important differences. A DPSP may allow for withdrawal of all or part of an employee's account (including the vested employer share) while still in active employment. This is not allowed under a pension plan. The entire withdrawal above the employee's own contributions is then taxed as income. At termination or retirement, lump-sum payments out of a DPSP are similarly taxed as income, but may be tax-sheltered by the purchase of an annuity or a transfer to an individual RRSP. This payment in a lump sum is not normally available at termination or retirement under a pension plan5.
These moneys are earnings that arise out of employment.6 However, these earnings are not considered as payable until the actual distribution of them is made to the employee. Like all profit sharing plans, the payment of these earnings is linked to the services provided by the employees in their daily work that assist their company in earning these profits. As the share in the profits arose from the performance of services, these earnings will be allocated to the week in which the services were performed.7
________________________
- for more information on how these plans are structured, see 5.15.2, "Employee's Profit Sharing Plans";
- this means full ownership of employer contributions;
- the requirement for immediate vesting on retirement on account of age or disability is even more demanding than that of pension plans;
- this rule is similar to the one for pension plans
- for pension plans, lump-sum payments on retirement or termination of employment are only allowed if the contributions have not been locked in; the annuity amount due is below a set limit; there is a shorter than normal life expectancy, partial commutation is allowed by legislation, Additional Voluntary Contributions are being returned, and refunds under the Maximum Funding by Employee Contributions provisions;
- EIR 35(2);
- EIR 36(6).
5.15.4 Registered Profit Sharing Pension Plans
A Registered Profit Sharing Pension Plan is a type of money purchase pension plan in respect of which employer contributions are related in some way to profits. The provisions under which these plans operate are the same as for other pension plans1 and they are subject to the same pension legislation as are all other plans. The profit sharing aspect of the pension plan is solely a method of funding. Any moneys placed in the fund must remain there until retirement or termination of employment.
Profit Sharing Pension Plans are registered under section 147.1 of the Income Tax Act, as are all other pension plans. Employee and employer contributions are tax deductible, the interest income of the trust fund is free of tax, however, all benefits are taxable when paid out. These benefits must normally be paid in the form of annuities and only on retirement, with lump-sum payments available only in exceptional circumstances.2 The maximum amounts of contributions that are deductible from taxable income are the same as for other pension plans.
Payments made from a Registered Profit Sharing Pension Plan are earnings as they have all the characteristics of a pension that arises out of employment.3 Payment from these plans will be handled in the same manner as any payment out of a pension fund: as a periodic pension;4 as a lump-sum pension benefit;5 and as a return of contributions6. If the employee should terminate his or her employment prior to retirement age, any locked-in pension credits transferred directly to a locked-in vehicle, are not considered to be payable until they are paid to the claimant.7
________________________
- for more information on pension plans, see 5.13.0 to 5.13.15;
- for pension plans, lump-sum payments on retirement or termination of employment are only allowed if the contributions have not been locked in; the annuity amount due is below a set limit; there is a shorter than normal life expectancy, partial commutation is allowed by legislation, Additional Voluntary Contributions are being returned, and refunds under the Maximum Funding by Employee Contributions provisions;
- EIR 35(2)(e), for a definition of "pension", see EIR 35(1);
- see 5.13.5, Periodic Pensions";
- see 5.13.6, "Lump-sum Pension Benefit";
- see 5.13.8, "Return of Contributions on Termination of Employment" and see 5.13.9, "Additional Contributions to a Pension Fund";
- see 5.13.7, "Portability of Locked-in Pension Credits."
5.15.5 Profit Sharing Plan Comparison
