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Profit-sharing

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Canadian employers are always seeking meaningful ways to motivate and retain talent. One proven approach, especially for established companies with steady revenue, is implementing an employee profit-sharing plan. Profit-sharing connects individual and team performance to company success, strengthening alignment with business objectives. When included as part of a total rewards package, it can serve as a compelling factor in attracting top talent.

Table of Contents

What is profit-sharing?
What is a deferred profit-sharing plan?
How does profit-sharing work?
Who can offer a profit-sharing plan?
Profit-sharing plan vs. group RRSP vs. pension plan
Types of DPSPs
Benefits of profit-sharing
Disadvantages of profit-sharing
How to calculate profit-sharing
How to create a profit-sharing plan
Reporting profit-sharing plans
FAQs

What is profit-sharing?

Profit-sharing is a compensation strategy where employers voluntarily distribute a portion of company profits to employees. These payments can be made in cash, bonuses or contributions to a deferred profit-sharing plan (DPSP), a tax-advantaged retirement plan recognized by the Canada Revenue Agency (CRA).

For employers, profit-sharing means more than just bonuses. When structured correctly, it becomes a powerful incentive that can encourage performance, loyalty and retention.

What is a DPSP?

A deferred profit-sharing plan, or DPSP, is a registered plan in which only the employer contributes a share of company profits to employees’ accounts. DPSPs are regulated by the CRA and have specific annual contribution limits. Contributions and investment growth are tax-deferred until the employee withdraws funds, usually upon retirement or termination.

Key features of a DPSP include:

Employer-only contributions, up to the CRA limit
Tax-deferred investment growth
Vesting schedules for retaining talent
Portability for employees, subject to vesting rules

How does profit-sharing work?

Profit-sharing offers flexibility. Employers decide yearly how much of the company’s profits, if any, are to be distributed to employees. There is no requirement to make minimum contributions, so employers can opt not to fund the plan when revenue is low. If they do share profits, they must establish a clear formula for calculating and distributing the contributions among their workforce.

Who can offer a profit-sharing plan?

Businesses of all sizes can offer profit-sharing; however, the decision to implement a profit-sharing agreement should consider profitability, workforce size and strategic goals. Generally, companies wait until they have recorded revenue for a specific period before sharing it with employees.

Profit-sharing plan vs. group RRSP vs. pension plan

When comparing a profit-sharing plan, group registered retirement savings plan (RRSP) and pension plan, the key differences lie in funding, flexibility and administration. A DPSP is funded solely by the employer, offers tax-deferred growth and allows for customizable vesting schedules, making it ideal for performance-based incentives. In contrast, a group RRSP permits both employee and optional employer contributions but requires immediate vesting and employee payroll deductions. Pension plans are more rigid and usually come with mandatory employer funding and stricter regulatory oversight.

Types of DPSPs

While all DPSPs follow the same basic structure, there are a few variations in how they can be designed to fit different business needs.

Standalone DPSP
This is a traditional profit-sharing plan in which the employer deposits a portion of the company's profits directly into a registered DPSP account for eligible employees. It is often used by small to midsized businesses seeking a flexible and tax-efficient incentive program.
DPSP paired with group RRSP
Many Canadian employers offer a combined DPSP and group RRSP. Employees contribute to their RRSP through payroll deductions, while employers match all or some of those contributions into the DPSP. This dual-plan setup enhances retirement savings while reducing employer tax liabilities, as employer contributions to a DPSP are not subject to Canada Pension Plan (CPP) or Employment Insurance (EI) premiums.
DPSP as a bonus distribution mechanism
Some employers use a DPSP to defer bonuses instead of paying them as taxable cash. When profits are high, a bonus or share of profit can be deposited into the DPSP instead of directly in pay cheques, offering tax deferral benefits to employees and cost savings to the employer.
Tiered DPSP structure
Employers can establish tiered eligibility or contribution levels within the DPSP based on role, tenure or performance, if the plan complies with the CRA’snondiscrimination rules. This approach makes it easier to tailor incentives without creating separate plans for each group.

Benefits of profit-sharing

Profit-sharing plans offer benefits for both employers and employees. Here are some of the main advantages:

Tax efficiency: Contributions to DPSP are tax-deductible for employers and tax-deferred for employees.
Talent retention: Vesting schedules reward long-term commitment.
Flexibility: No obligation to contribute every year. Employers can wait until the end of the year to decide whether they can afford to share profits with employees.
Employee motivation: Aligns work with business outcomes.

Disadvantages of profit-sharing

While profit-sharing plans offer many advantages, they do come with some drawbacks. One challenge is administrative complexity, as employers must prepare formal plan documentation, maintain accurate records and comply with CRA regulations. Additionally, profit-sharing can be more costly to administer than simple retirement savings options like group RRSPs. Employers must also navigate nondiscrimination rules, ensuring the plan does not unfairly favour executives or highly compensated employees over the broader workforce.

How to calculate profit-sharing

Adding up all employee compensation
Dividing each employee’s salary by the total compensation
Multiplying the result by the total profit-sharing amount

Other methods include age-weighted formulas or flat dollar amounts per employee.

Profit-sharing example

A business earns a profit of $400,000. At the end of the year, company management decides to distribute 10% of that amount to employees. If the total compensation for the workforce is $200,000, how much of the profit will an employee with an $80,000 salary receive?

($80,000/$200,000) x ($400,000 x 0.10) = $16,000

How to create a profit-sharing plan

Employers interested in profit-sharing must first decide whether to establish and manage the plan themselves or to seek assistance from a financial institution. Since smaller organizations may face challenges in managing this process due to limited resources, it's often beneficial to seek financial advice or institutional support. After that, there are four main steps:

1. Drafting the profit-sharing plan document

The first step is to create a formal plan document that outlines the rules and structure of your profit-sharing plan. This includes defining employee eligibility criteria, contributions, formulas, vesting schedules and ensuring compliance with CRA regulations. This document serves as the legal foundation of the plan and may require periodic updates as your business develops. Given the complexity involved, it is advisable to seek advice from a financial advisor or institution, especially as many smaller organizations are not equipped to do this themselves.

2. Setting up a trust for plan assets

Since a DPSP holds contributions in trust for employees, you must establish a legal trust account to manage the plan’s assets. This trust ensures that the funds are protected and used solely for the benefit of plan members. You’ll also need to appoint a trustee, either an individual or a professional firm, who will be responsible for managing contributions, investments and benefit payments in accordance with the plan’s terms.

3. Choosing a recordkeeper or provider

To streamline administration, most employers partner with a financial institution, payroll provider or benefits administrator to manage the day-to-day operations of the plan. The recordkeeper is responsible for tracking employee accounts, managing investment allocations, preparing reports and ensuring accurate filing with regulatory bodies. Working with an experienced provider can help reduce compliance risk and simplify plan management. Seeking the right financial advice can also aid in selecting the most suitable provider for your organization’s needs.

4. Notifying eligible employees

Once the plan is in place, employers must communicate the details to all eligible employees. This includes providing a summary plan description (SPD) that clearly explains how the profit-sharing plan works, the benefits it offers and how contributions are managed. Transparent communication helps ensure employees understand the value of the plan and their rights under it, helping boost engagement and participation.

Reporting profit-sharing plans

Canadian profit-sharing plans must comply with CRA and pension legislation in relevant provinces. Employers are required to report employer contributions, withdrawals or terminations, CRA registration and annual filings for the trust. Collaborating with your payroll provider or benefits consultant is essential to ensure accurate reporting. Additionally, seeking the assistance of a third-party administrator can be highly advisable, especially for smaller organizations. A third-party administrator can help streamline the reporting process, maintain compliance with regulatory requirements and reduce the administrative burden on your internal team, allowing your organization to focus on its core operations.

Ready to make profit-sharing a part of your payroll strategy?

Profit-sharing can be a powerful way to reward employees, support retention and align your team with business goals. Whether you're designing your first plan or refining an existing one, choosing the right tools and approach is key. Learn how ADP helps Canadian businesses streamline payroll and benefits management.

FAQs

To establish a profit-sharing plan, employers must create a formal plan document, set up a trust for plan assets, choose a recordkeeper or financial provider and notify eligible employees about the benefit. These steps can be handled in-house or with assistance from professionals, such as payroll providers, insurance companies or financial institutions that offer retirement plan administration services.

Profit-sharing plans are typically tax-deferred investments. In other words, employees do not pay tax on the income until it is withdrawn from the account, usually at retirement age. Withdrawals before retirement may incur penalties.

Employers typically allocate profit-sharing contributions using a salary-proportional formula. This method ensures each employee receives a share based on their relative compensation. Other allocation methods, such as flat amounts or age-weighted contributions, can also be used as long as they meet CRA requirements and remain equitable across employee groups.

Depending on the design of the profit-sharing plan, employees might be able to take their savings with them if they leave the company; however, employers sometimes implement vesting schedules, which require employees to work with the company for a certain period before they have full access to the money saved. It is important that the employer defines these terms clearly when developing the plan document and that the process is clearly defined for the administrators of the plan.

Employers can set reliability rules, for example, full-time and part-time, , but they must ensure the plan complies with nondiscrimination rules and does not unfairly favour executives or higher earners. Plans that do not meet fairness standards could face penalties or CRA scrutiny.

In a small business profit-sharing plan, the employer distributes a portion of the company's quarterly or yearly profits to eligible employees. The funds are usually deposited into a tax-deferred retirement savings account. Additionally, employers may choose whether to share profits at their discretion. This feature makes profit-sharing plans suitable for small businesses with unpredictable cash flow.

While both reward performances, a bonus is a taxable cash payment, whereas profit-sharing is a tax-deferred retirement contribution. Profit-sharing offers long-term savings benefits and is not treated as regular income at the time of contribution. For those organizations that have a matching component, where the employer matches the employee contribution, the organization should be clear that they do not match any bonus contributions, only regular earnings.

This article is intended to be used as a starting point in analyzing the profit-sharing definition and is not a comprehensive resource or list of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.