Is a DPSP Right For Your Business?

Recently I met with a client who owned a small business. For the last ten years he had been paying bonuses to his employees based on his profits. The problem he felt was that after he took off all the required taxes that he had remitted to CRA on his employees' behalf, the result was most of his people were left with little more than half of what he had indented to share with them. He asked me if there was an employee benefits plan that:

1) Contributions could easily reduced in years he was not profitable?

2) Allowed his employees to receive their entire bonus in a tax effective way?

The answer that immediately popped into my head was the Deferred Profit Sharing Plan (DPSP)!

These plans are not widely used in Canada today. However, DPSPs are one of the most powerful employee benefit tools available today that an employer can include in their arsenal to attract and retain top notch personal. In a nut shell, employers and employees appreciate the DPSP because it rewards employees for helping a company earn profits. A Deferred Profit Sharing Plan is a simple and flexible arrangement, a company/plan sponsor distributes a portion of the company's pre-tax profits. DPSPs are arrangements where an employer may share with either all or a designated group of employees the profits from the employer's business.

Contributions and administration fees are tax deductible for the employer and accumulate tax-sheltered in the plan for the benefit of the employee/s or former employee/s, until paid out of the DPSP as stated in subsection 147(1) of the Income Tax Act. In years that a DPSP sponsor is not profitable the employer only needs to contribute 1% of an employee's income.

Usually the amounts payable by the employer under a DPSP are normally calculated as a portion of profits (e.g., 10% of profits as defined in the plan), but can be a fixed dollar amount per plan member or fixed percentage of payroll.

DPSP Miscellaneous

• A connected person (an individual who owns directly or indirectly more than 10% of a company) is not eligible to participate in a DPSP.
• Employer contributions into a DPSP are limited to the lesser of 18% of the employee's compensation for the year or a dollar limit equal to one half of the defined contribution pension plan limit as follows: 2006 - $9,500, 2007 - $10,000, 2008 - $10,500, 2009 - $11,000, 2010 - indexed.
• Contributions are not added to members' earnings and are not subject to payroll taxes such as EI & CPP.
• Unlike a Group RRSP or pension plan, only employer contributions are allowed under a DPSP. Most employers use a DPSP as a complement to a non-contributory Group RRSP ( i.e. an RRSP with no employer contributions).
• DPSP contribution reduces the employee's RRSP room for the following year (allows full RRSP contribution for the current year). The reduction shows up as a Pension Adjustment (PA) amount on the employee's T4.
• Contributions vest in members after two years and are not locked-in. Usually a DPSP member has the right to withdraw vested benefits from the plan at any time. Contributions can be cashed out or used to purchase an annuity.
• Depending on the plan, DPSP members may withdraw their holdings while still employed. Terminated employees can withdraw the full vested amount subject to taxation.
• The DPSPs requires trustees with at least one trustee being fully independent of the employer and plan member(s) and all trustees must be residents of Canada.
• All DPSPs must comply with the rules laid out in CRA's Informational Circular 77-1R4.

DPSPs require specialties in areas as diverse as pension legislation, employment law, and employee benefit plan construction. Many employers and their accounting professionals who think they would benefit from implementing a DPSP will need to seek education services to aid them in its set-up and maintenance stages. Therefore, it worth the time to invest in learning more about the DPSP to assist clients to take advantage of this underutilized compensation strategy.