23 January 2003 Internal T.I. 2002-0159027 - REIMBURSEMENT OF MEDICAL EXPENSES

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Whether the payment made to a former employee to compensate him for medical expenses that would have been covered under employer's private health services plan would be taxable.

Position: Probably not taxable.

Reasons: Since the other payments made to the employee under the settlement agreement appear to represent employment income, then it is reasonable to conclude that the reimbursement of the medical expenses that would otherwise have been covered under the phsp, would not be subject to tax.

		January 23, 2003

	Ottawa Tax Services Office	HEADQUARTERS
		Wayne Antle
	Attention:  Nicole Guerette	(613) 957-2102
	                  Client Services
		2002-015902

XXXXXXXXXX (the "employee")
XXXXXXXXXX
XXXXXXXXXX Income Tax Return

This is further to your memorandum dated August 21, 2002, and our telephone conversation with XXXXXXXXXX (Antle/XXXXXXXXXX) on January 7, 2003, concerning the tax implications of amounts paid to a former employee to reimburse him for medical expenses that would have been covered by his former employer's private health services plan ("PHSP").

Our understanding of the facts is as follows:

The employee was employed by XXXXXXXXXX (the "employer") until he was laid off on XXXXXXXXXX as part of a restructuring done by the employer. He filed a grievance against the employer alleging that his position had not been eliminated, and was being filled by another person. A settlement agreement was subsequently reached with the employer, which provided that the employee would be reimbursed his salary (net of applicable statutory deductions) for the period from XXXXXXXXXX (the "period"), including any increases to which he would have been entitled. However, the reimbursement was reduced by amounts earned from other sources during the period. In addition, he was reimbursed for the cost of eligible medical expenses (the "medical reimbursement") that he incurred during the period, which would have been covered under the employer's PHSP if his employment had not been terminated. He was also reinstated to the XXXXXXXXXX for the period, and therefore accrued pension benefits for the period. The reimbursement was paid to the employee in two installments; XXXXXXXXXX. The employer issued a T4 slip to the employee with respect to the amounts paid under the settlement agreement. However, it is not clear whether such amounts included the medical reimbursement.

The issue involves the tax treatment of the medical reimbursement paid to the employee. Since the amount would have been non-taxable had it been paid to the employee out of the employer's PHSP, is this amount, paid under the terms of the settlement agreement, required to be included in the employee's income?

Our Comments

In order to determine the tax consequences of the medical reimbursement, it is necessary to establish whether the total amount paid under the settlement agreement constitutes employment income or a retiring allowance. Whether an amount received by an employee, upon or after termination of employment, is income from employment, and therefore included in income pursuant to subsection 5(1) of the Income Tax Act (the "Act"), or a retiring allowance, as defined in subsection 248(1) of the Act, and therefore included in income pursuant to subparagraph 56(1)(a)(ii) of the Act, is a question of fact that can only be determined after a review of the employment contract, other agreements and all of the other circumstances relevant to a particular situation.

In this particular case, it is our view that the amount paid to the employee in XXXXXXXXXX to reimburse him for lost salary is likely employment income. Clearly, the employer considered the payment to be in respect of salary, wages or other employment benefits because a T4 slip was issued for the amount paid, and the applicable statutory deductions for Employment Insurance premiums, and Canada Pension Plan contributions were withheld. In addition, the employee was reinstated to the employer's registered pension plan for the period. As noted in paragraph 4 of Interpretation Bulletin IT-337R3 Retiring Allowances, where pension benefits continue to accrue to an employee, this is an indication that an employment relationship continues to exist. Finally, the settlement agreement acknowledges that the employee's employment is effectively terminated on XXXXXXXXXX.

With respect to the medical reimbursement, subparagraph 6(1)(a)(i) of the Act provides that employment benefits derived from an employer's contributions to a PHSP will not be included in an employee's income. In this case, the employer has reimbursed the employee for medical expenses that would otherwise have been reimbursed to the employee, on a tax-free basis, under the PHSP. On the basis that the medical reimbursement was made because of the employee's employment, it is our view that the medical reimbursement would not be required to be included in the employee's income. In a broad sense, the payment is derived from the employer's contribution to the PHSP because the medical reimbursement would not have been paid had there been no such medical plan. The employee would not be entitled to claim any medical expense tax credit in respect of the expenses for which he was reimbursed pursuant to paragraph 118.2(3)(b) of the Act.

Finally, it should be noted that we were unable to reconcile the T4 slip issued to the employee with the amounts paid under the settlement agreement. Therefore, it is not clear from the information presented to us whether the employer has, in fact, included the medical reimbursement in the employee's income. Accordingly, the T4 slip issued to the employee by the employer should be reconciled to the amounts paid under the settlement agreement before any adjustments are made to the employee's XXXXXXXXXX income tax return. In other words, you should ensure that the medical reimbursement was not already excluded from the T4 slip.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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