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A closed store front boutique business called Francis Watson pleads for help displaying a sign in Toronto on April 16, 2020.Nathan Denette/The Canadian Press

The federal Liberals have warned businesses several times in recent weeks against trying to game the wage subsidy program that launches on Monday, under which Ottawa will pay up to 75 per cent of employees’ pay.

Now, the government is making that warning into something more explicit, drawing a line between arm’s-length employees (a category that would include most workers) and those with a relationship to the employer, usually through family ties or ownership stakes.

Under the rules of the Canada Emergency Wage Subsidy (CEWS) program, an employer receives a subsidy of 75 per cent of the current gross weekly pay of an arm’s-length worker, assuming that the employer qualifies on other criteria, including suffering a loss of business after March 15.

If such an employee got a raise, worked longer hours or otherwise earned more during the coronavirus crisis than they did between Jan. 1 and March 15, the subsidies paid to the employer rise commensurately.

But if the employee is not arm’s length, different rules apply. For non-arm’s-length employees, the subsidies are based on the lower of current weekly gross pay and the average weekly gross pay between Jan. 1 and March 15. So the subsidies would not apply to any increase in compensation.

The Finance Department did not answer when asked why the distinction is being made. But the rule would prevent privately held corporations from plumping up their payroll by increasing pay to family members or other employees with close ties to the company and then receiving larger subsidies. It also means that two companies that gave higher pay to workers because of the coronavirus would be treated differently, depending on the relationship of those employees to their companies.

Employers receive the subsidy funds and are encouraged but not obligated to pay the remaining 25 per cent of employee wages. An employer who inflated their payroll could be able to pocket the subsidy, and not top up wages, and end up better off.

Bhuvana Rai, senior associate at Borden Ladner Gervais’s tax group, said the distinction between arm’s-length and non-arm’s-length employees is nothing new. Its is already used extensively in tax law. Employment Insurance regulations, for instance, typically deny benefits to non-arm’s-length employees. Ms. Rai said that reflects the reality that their employment status is not truly beyond their control.

However, she said, there are provisions that allow non-arm’s-length employees to receive EI benefits if the Canada Revenue Agency is satisfied that the worker’s employment is “substantially similar” to what they would have as an arm’s-length employee.

Ms. Rai said that is a key difference between EI and the CEWS program. “You cannot get an exemption.”

On the other hand, she noted, the rules for the CEWS program also deny subsidies for increased compensation to arm’s-length workers if it can be shown that the primary reason for the extra pay is so the company can receive additional subsidies.

Heather Evans, executive director and chief executive officer of the Canadian Tax Foundation, said the CEWS program is “reasonably generous" and significant in scope, and that the arm’s-length test is a familiar one. “I think they have to draw a line somewhere.”

Tax and Spend is a new series that examines the intricacies and oddities of taxation and government spending.

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