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McNeeley: Taxing Employee Share Ownership Trusts

The case of McNeeley v. Canada (2021 FCA 218) highlights the complexities involved in establishing an employee remuneration arrangement, especially if it involves the use of a trust. At issue in McNeeley was whether the particular trust involved was a “prescribed trust” or an “employee benefit plan.” This distinction was crucial to the arrangement, given that the tax treatment of a prescribed trust is different from that of an employee benefit plan. Specifically, amounts received under the former are taxed as capital distributions from a trust, while amounts received under the latter are taxed as employment income. 


A trust was established for the employees of a learning software business; it was known as the Desire2Learn Employee Stock Trust (“D2LT”). Essentially, under this arrangement, D2LT would acquire shares of the parent corporation, hold them on behalf of certain named employee beneficiaries, and then distribute them to the beneficiaries. The goal was that shares would flow from the corporation to the employee beneficiaries as capital, not as employment income. 

The arrangement was premised on the classification of D2LT as a prescribed trust pursuant to section 4800.1 of the Income Tax Regulations and the application of section 107 of the Income Tax Act. When the shares were distributed to the beneficiaries, D2LT elected out of the subsection 107(2) rollout, triggering a deemed disposition at fair market value pursuant to subsection 107(2.1), and allocated the taxable capital gain to the beneficiaries; the beneficiaries claimed their lifetime capital gains exemption per subsection 110.6(2.1). 

The CRA disagreed with the taxpayers’ position on the application of subsection 107, and reassessed the beneficiaries on the basis that D2LT was an employee benefit plan. 

The TCC held that D2LT was an employee benefit plan. The FCA agreed with the TCC, but it disagreed with the lower court’s reasoning. The FCA decided the case on the basis of paramountcy—that is, the principle that definitions in the Act prevail over those in the regulations. Leave to appeal to the SCC was dismissed. 

Employee Benefit Plan and Prescribed Trust 

The definition of “employee benefit plan” is found in subsection 248(1) of the Act. It essentially involves an arrangement in which an employer or a person not at arm’s length with the employer makes payments to a custodian for the benefit of employees. The end result is that payments received under an employee benefit plan are included in the taxpayer’s income as employment income per paragraph 6(1)(g). Paragraphs (a) to (e) of the subsection 248(1) definition include a number of carveouts for other employee remuneration plans, but none of these were relevant to this appeal. 

A “prescribed trust” is defined in section 4800.1 of the regulations for the purposes of section 107 of the Act. There are three types of prescribed trusts, but the one relevant to this appeal is found in paragraph (a). It essentially involves a trust that is maintained primarily for the benefit of employees of a corporation and that has, as one of its main purposes, the aim of holding interests in shares of the capital stock of the corporation. The end result is that payments received under a prescribed trust are treated as capital distributions from a trust per subsection 107(2) and are ultimately taxed as a capital gain. 

The FCA commented that these two definitions overlap but that it is possible to have an employee benefit plan that is not a prescribed trust, and vice versa. In McNeeley, the court found that D2LT met the definitions of both an employee benefit plan and a prescribed trust. This created a conflict, because the trust could not be both things simultaneously. Therefore, the court had to resolve this conflict. 

Paramountcy of the Act 

The FCA relied on the principle of law according to which subordinate legislation cannot conflict with its parent legislation: parent legislation will prevail over inconsistent or conflicting subordinate legislation. Applying the principle of paramountcy to income tax legislation, the Act is the parent legislation and the regulations are the subordinate legislation. Therefore, the court held that the Act’s definition of “employee benefit plan” must prevail over the conflicting definition of “prescribed trust” in the regulations; therefore, the trust was an employee benefit plan. 

Not a Trust Under the Act 

Subsection 108(1) provides a definition of a trust that applies to sections 104 to 108. Importantly, if the trust does not satisfy the definition in subsection 108(1), it will not be taxed as a trust under section 107. 

There are various exclusions from this definition of a trust. An employee benefit plan is excluded from the definition of “trust” under paragraph (a). Further, a trust that is designed to benefit employees is excluded from the definition of “trust” under paragraph (a.1). However, a prescribed trust is an exception to this paragraph (a.1) exclusion. D2LT unsuccessfully argued 

that being a prescribed trust brought itself under the definition of “trust” notwithstanding the paragraph (a) exclusion of an employee benefit plan. Therefore, even though D2LT was a trust under the general law, it would not be taxed as one under the Act. 

No Excluded Payments 

An additional argument raised by the founder, president, and CEO of the business, who not only was a shareholder but also received payments from D2LT, was that it is possible to receive payments from an employee benefit plan that are not included as employment income. His argument was that D2LT’s share distributions to him were not in respect of, in the course of, or by virtue of employment. The FCA rejected this argument and held that if the arrangement includes at least one payment made to employees, then the entire arrangement is to be treated as an employee benefit plan, with the result that every payment will be included as income under paragraph 6(1)(g). 

The only exceptions to this treatment apply if any part of the arrangement satisfies the carveouts found in paragraphs (a) to (e) of the definition of “employee benefit plan.” The court held that in this event, there would be separate arrangements for tax purposes (essentially bifurcating the same arrangement into an employee benefit plan and one of the exceptions in paragraphs (a) to (e) for tax purposes). 

Applying this reasoning, the court held that even trust distributions to the founder of the business are to be considered payments received under an employee benefit plan, with the resulting employment income inclusion. 


The key lesson of McNeeley is that any tax plan that relies on a definition in the regulations should be carefully reviewed to ensure there is no conflicting—and governing—definition in the Act. This applies to all tax plans, not just plans related to employee remuneration. 

More specifically, this case illustrates that any employee remuneration arrangement must be carefully scrutinized to determine whether any payment would be captured by the definition of “employee benefit plan.” If so, it must be determined whether any of the exceptions in paragraphs (a) to (e) apply. If any of these exceptions apply, there will be two employee remuneration arrangements. Otherwise, one payment could cause an entire arrangement to be captured in the definition of an employee benefit plan, with all payments being included as employment income. 

Lawyer Graham Morton has written this article, originally published in the October 2022 issue of Tax for the Owner Manager.

Oct 03, 2022