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By Trevor R. Parry, M.A., LL.B,LL.M (Tax), TEP
Special to the Financial Independence Hub
For many Canadians, the state of our beloved national game reached a nadir when none of the seven NHL franchises qualified for last year’s playoffs. This wholesale failure has given rise to the over-analysis and questioning that only a nation of amateur general managers could produce.
What’s the armchair consensus about the source of Canada’s poor performance? Some would-be GMs decry economic maladies they believe are unique to the Canadian franchises, while others bemoan the current lacklustre state of the Canadian dollar — while still others point to punitive rates of taxation introduced by federal and provincial governments in recent years.
While the first two factors may be the likely cause in the delay in awarding an expansion franchise to Québec City — which, as a Habs fan, I am particularly distressed by as we await the return of our primordial enemy — the latter factor, whilst a reality, can largely be eliminated through recourse to a financial strategy that has now existed for fully 30 years.
Introducing the RCA
In 1986 the federal government amended the Income Tax Act to include the Retirement Compensation Arrangement rules. Better known as an “RCA,” this is the only structure available in Canada that allows supplemental retirement benefits to be funded on a tax-deductible basis. It is my experience that many of the Canadian NHL teams are acquainted with the RCA structure, and many have implemented them for their players. Here’s why: In a tax reality where almost all of a player’s annual compensation is taxed at rates near or in excess of 50% (53.51% in Ontario and 53.3% in Québec, 50% in Manitoba, 48% in Alberta and 47.7% in British Columbia) the RCA is a structure that will demonstrably reduce taxation for professional athletes playing for Canadian teams.
The RCA itself is a special trust registered with the Canada Revenue Agency (CRA). Contributions are made by the team on a tax-deductible basis, and half of the contribution is held by CRA while the structure is in place. In exchange, the amount contributed is not counted in the player’s salary for that year, but is taxed as income when they begin withdrawing — which is also when CRA returns the portion they held (surprise, they pay no interest while they hold the contributed funds).
If a player is traded, signs as a free agent with a U.S.-based team, or returns home to Europe or the U.S., their withdrawals are subject to the terms of the relevant bilateral tax treaty their home country has negotiated with Canada. As a result of these tax treaties, withdrawals are often taxed at rates of between 15 to 25 per cent in Canada, with no further taxation in the player’s home country.
An on-ice example
Let’s take the case of a U.S. player who has signed with the Toronto Maple Leafs for a contract that pays a salary of $7 million per year for five years, for a total of $35 million. That player is now subject to Canadian tax on his salary, but as a U.S. citizen is also taxed in the United States at the federal, state and even municipal levels. Suffice it to say that if no tax planning is undertaken, the player will likely surrender over 50 per cent (or more) of their annual salary to tax authorities!
While in the current environment — in which conversations about “tax fairness” dominate tax policy — the common man may not have any sympathy for the plight of the player, given the relatively short career of a professional athlete players may find themselves in an adverse situation not too long after retiring, as the income from their active years must now stretch over a considerable number of retirement years.
If, however, the player had directed that the RCA was established at the time they were negotiating their new contract, the very high rates of taxation that would otherwise apply can be avoided. For example, if that player directs that $2 million per year is contributed to an RCA established for them, they would be taxed (only) on the remaining $5 million of compensation.
If $2 million in contributions are made for each year of their contract, and the funds in the RCA are invested prudently, that player would likely have between $10 and $15 million in their RCA at the end of their five-year contract — funds that are now available to “smooth” their standard of living from their playing days over the remainder of their lifetime. Then, if they finish their career as a Florida resident (for example), they can collapse the RCA and pay a 25 per cent withholding tax to the CRA; the payment of which may even generate U.S. tax credits for further tax relief.
Instead, if the player does not use an RCA to smooth their income over their playing and retirement years, over the five years they will pay at least $17.5 million to the CRA in tax (that is, salary of $7 million per year for five years for a total salary of $35 million—all taxed at 50%). In contrast, in the RCA scenario, even with no growth on the invested assets the player would save $2.5 million in taxes.
Keep your head up: focus on tax-savings opportunities
In short, the RCA opportunity can provide considerable tax relief to athletes playing in Canada. It is widely used in the NHL and by professional baseball teams, and is now being considered by the NBA. In fact, professional leagues have even implemented rules concerning limits on RCA contributions so that the strategy allows a player to equalize their tax situation with that of the U.S. In most cases, therefore, as a result of the RCA the player is in the same situation as their counterparts playing south of the border.
The bottom line? Canadian fans will continue to lament the malaise that is Canadian professional hockey. They however should focus their attention on the on ice play . . . rather than their incorrect perceptions of the economic environment in which the teams exist. With the careful use of the structures available to ameliorate high rates, taxation matters should not and do not have to stand in the way of a Canadian team hoisting Lord Stanley’s cup.
Trevor Parry is the President of the TRP Strategy Group, specializing in owner manager tax and compensation planning, executive compensation, philanthropic strategies, enhanced retirement planning and professional corporation planning. Trevor was formerly the National Sales Director of GBL, a boutique actuarial consulting firm. In addition to his practice he speaks and writes extensively on financial strategy, planning and tax issues.
