Attracting highly skilled professional athletes to sign contracts with Canada-based sports teams can be a challenge with Canadian income tax rates generally higher than those in its neighbour to the south.
Canada tax planning for athletes
Canadian combined federal/provincial income tax rates for highly compensated professional athletes will typically range from 48% up to close to 53.5%. When compared to combined U.S. combined federal and state income tax rates, which range from 37% up to near 50%, it can be hard to attract foreign athletes to choose Canada over the U.S. for a period of their professional career. While income tax rates are not the sole factor determining where an athlete may choose to sign a professional employment contract, the level of taxation certainly plays an important role.
Over the years, some Canadian tax planning strategies have been utilised to reduce the overall Canadian income tax burden arising on employment income to a more competitive and comparable level. By levelling the income tax rate playing field as much as possible, Canadian professional sports teams have been successful in attracting some of the top athletic talent.
Two such strategies include the use of a retirement compensation arrangement (RCA) and the structuring of employment contracts to include a signing bonus that benefits from the provisions of the Canada-U.S. income tax convention.
An RCA typically allows a professional athlete to defer for Canadian income tax purposes a portion of their current wages into a special plan set up for future retirement or loss of employment. Such income deferral can reduce the overall tax impact on the deferred compensation from Canadian income tax rates of 50%+ down to potentially 25%, thereby lowering the overall average Canadian tax rate on their employment compensation.
The second technique -- a properly structured signing bonus built into an athlete’s employment contract -- can lower their effective tax rate from 50%+ down to a rate of approximately 15%.
The Canada Revenue Agency recently has been scrutinizing the use of these two common tax planning techniques that have helped to close the tax divide between Canada and the U.S. This review has led to a number of legal cases that are pending before the Tax Court of Canada. Given that legal hearings in those cases have yet to be held, decisions are likely to be many months or even possibly years away, creating significant uncertainty for tax planners working with athletes.
In the meantime, Canadian professional sports teams will need to work a little harder to attract top athletic talent to sign employment contracts in Canada.
In light of the uncertainly these pending cases impart, it would be advisable to review the current planning in place for athletes signed to Canadian teams.
Daren Raoux
Debra Moses
BDO in Canada