Digest of Benefit Entitlement Principles
Chapter 5 - Section 15

5.15.0 Profit sharing plans

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,Footnote 1 Employee's Profit Sharing Plans,Footnote 2 Deferred Profit Sharing Plans,Footnote 3 and Registered Profit Sharing Pension PlansFootnote 4. 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vary from immediate compensation and taxation to having both compensation and taxation deferred until the moneys are withdrawn.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.

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 employmentFootnote 5. 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 performedFootnote 6.

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 contributionsFootnote 7 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 employmentFootnote 8. 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,Footnote 9 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 PlansFootnote 10. To qualify for registration the Deferred Profit Sharing Plan must:

  • provide for full vestingFootnote 11 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;Footnote 12
  • define a normal retirement age, with annuity or instalment payments to begin no later than age 69;Footnote 13
  • 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 planFootnote 14.

These moneys are earnings that arise out of employmentFootnote 15. 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 performedFootnote 16.

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 plansFootnote 17 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 circumstancesFootnote 18. 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 employmentFootnote 19. Payment from these plans will be handled in the same manner as any payment out of a pension fund: as a periodic pension;Footnote 20 as a lump-sum pension benefit;Footnote 21 and as a return of contributionsFootnote 22. 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.Footnote 23

5.15.5 Profit sharing plan comparison

Cash or current distribution plan Employee's profit sharing plan Deferred profit sharing plan Registered profit sharing pension plan
Distribution:
Cash or shares in the stock of the company are periodically distributed
Distribution:
Accumulates in a trust fund along with interest
Distribution:
Accumulates in a trust fund along with interest
Distribution:
Accumulates in a trust fund along with interest
Taxation:
Taxed with wages and other benefits when paid
Taxation:
Taxed each year on share of profits and accumulated interest in the trust fund
Taxation:
Taxed only when money is paid out
Taxation:
Taxed only when money is paid out
Registration:
Not registered under the Income Tax Act
Registration:
Registered under section 144 of the Income Tax Act
Registration:
Registered under section 147 of the Income Tax Act
Registration:
Registered under section 147.1 of the Income Tax Act
Access:
immediately as paid out to employee
Access:
on termination or retirement or sometimes during employment
Access:
on termination or retirement or sometimes during employment
Access:
only on termination or retirement as there is no access while employed
Earnings?
Regulation 35(2)
Earnings?
Regulation 35(2)
Earnings?
Regulation 35(2)
Earnings?
Regulation 35(2)(e)

Allocation:
Regulation 36(6)
Allocation:
Regulation 36(6)
Allocation:
Regulation 36(6)
Allocation:
Regulation 36(14)
Regulation 36(15) and 36(17)
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