24 February 2010 External T.I. 2009-0342701E5 - Flexible Benefit Plan Issues

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.

Principal Issues: What are the tax implications concerning an employer's flexible benefit plan and health care spending account plan?

Position: General discussion, but it appears that the employer's flexible benefit plan would not be an acceptable flex benefit plan described in IT-529.

Reasons: We don't have all facts but the allocated flex credits under the flexible benefit plan appear to have a redemptive value (i.e., they can be exchanged for additional salary).

XXXXXXXXXX 							2009-034270
								Michael Cooke, C.A.
February 24, 2010

Dear XXXXXXXXXX :

Re: Flexible benefit plans

We are writing in response to your letter of September 22, 2009, that was forwarded to us by Brenda Garvie of the St. Catharines Taxation Service Office ("TSO"). We understand that our views on the taxability of certain amounts under an unnamed employer's (the "Employer") flexible benefit plan (the "Flex-plan") and health care spending account ("HCSA") are required in order for the Employer to determine whether it should make a voluntary disclosure in accordance with the procedures described in Information Circular IC00-1R2, Voluntary Disclosures Program.

We have not been provided with any supporting documents or details concerning the specific types of the benefits offered under the Flex-plan or whether the HCSA is considered to be separate benefit plan from the Flex-plan. Moreover, since we do not know what specific types of expenses are covered under the HCSA, we are unable to comment on whether the HCSA would otherwise qualify as a "private health services plan" ("PHSP") as that term is defined in subsection 248(1) of the Income Tax Act (the "Act"). For the CRA's general views on PHSPs, please refer to Interpretation Bulletin, IT-339R2, Meaning of 'private health services plan' (1988 and subsequent taxation years).

Notwithstanding the above-noted uncertainties, our basic understanding of the key facts is as follows:

• Under the terms of the Flex-plan, the Employer allocates a fixed amount of credits ("Flex Credits") to qualifying employees. The amount of Flex Credits so allocated is based on a percentage of the particular employee's salary.
• Each qualifying employee is allowed to purchase various benefits offered by the Employer by using the Flex Credits so allocated.
• The Employer uses an independent plan administrator ("Plan Administrator") for assessment and payment of the various benefits offered under the Flex-plan and the HCSA.
• If an employee does not use all of the allocated Flex Credits, such unused Flex Credits (referred to as "Excess Credits"), can be paid to the employee by the Employer as additional compensation ("Additional Compensation") or applied to purchase additional HCSA credits. The Employer withholds and remits income tax, CPP and EI (referred to as "source deductions") on the amount of any Additional Compensation.
• An employee is also allowed to purchase additional HCSA credits by contributing an additional amount of gross salary to the HCSA, subject to an annual maximum contribution of $XXXXXXXXXX (referred to as "Additional Contributions"). These Additional Contributions are also managed by the Plan Administrator. If additional HCSA credits are purchased by making Additional Contributions the employee receives no cash or any other amount for any unused HCSA credits at the end of the year (i.e., these unused HCSA credits expire at the end of the year and are not carried forward to another year).
• An internal review of the Employer's Flex-plan in 2005 resulted in a concern that the Employer might have failed to withhold and remit appropriate source deductions on the Additional Contributions. For the years 2000 to 2008, the total Additional Contributions made by its employees was $XXXXXXXXXX (approximately $XXXXXXXXXX per employee).

Our Comments:

Paragraph 6(1)(a) of the Act generally taxes the value of any benefits an individual may receive or enjoy in the year by virtue of employment subject to certain listed exceptions. As described in IT-529, Flexible Benefit Plans, plans described as "flexible benefit plans" or "cafeteria plans" are not defined in the Act and although the Act does not contain provisions that specifically apply to these types of benefit plans as a whole, the design of such a flexible benefit plan must satisfy certain required administrative conditions in order to avoid adverse tax consequences for all benefits provided under the particular flexible benefit plan or arrangement.

For instance, as described in paragraph 5 of IT-529, in order for an employer to be entitled to segregate the taxable and non-taxable benefits offered under the umbrella of a flexible benefit plan, employees are required to irrevocably choose which benefits will be provided under the flexible benefit plan and how the benefits will be funded prior to the beginning of the plan year. However, where the conditions for segregating the various components of the plan have not been met, then if one part of a flexible benefit plan could be regarded as a health and welfare trust (refer to Interpretation Bulletin, IT-85R2, Health and Welfare Trusts for Employees) or a similar arrangement and another part could be regarded as a salary deferral arrangement, a retirement compensation arrangement, an employee benefit plan or an employee trust, the statutory rules applicable to salary deferral arrangements, retirement compensation arrangements, employee benefit plans or employee trusts, as the case may be, will apply to the entire flexible benefit plan.

In the past, the CRA has generally accepted that where flex credits have no redemptive value and nothing of value is forfeited by the employee to acquire such flex credits, and all the other conditions described in IT-529 have been met, the particular flexible benefit plan will not be considered to be an employee benefit plan. Accordingly, the allocation of such flex credits would not, in and by itself, normally give rise to a taxable benefit in the hands of the employee. However, if the flex credits actually have a redemptive value or if something of value is forfeited by the employee to acquire such flex credits, the tax consequences described in paragraph 8 of IT-529 could possibly apply (i.e., the employee could be considered to have constructively received employment income equal to the value of the allocated flex credits unless the entire flexible benefit plan can be considered an employee benefit plan).

Where, however, the particular flexible benefit plan is determined to be an employee benefit plan the amount an employer may deduct is limited by paragraph 18(1)(o) and section 32.1 of the Act to the amounts included in the income of its employees in the year. In addition, although the employer's contributions to an employee benefit plan would not be taxable to the employee because of a specific exception in subparagraph 6(1)(a)(ii) of the Act, all amounts received out of or under an employee benefit plan would be included in the employee's income by virtue of paragraph 6(1)(g) of the Act (subject to certain exceptions). Please refer to Interpretation Bulletin, IT-502, Employee Benefit Plans and Employee Trusts for additional comments on employee benefit plans.

Therefore, in order to ascertain the income tax implications of the Employer's Flex-plan and HCSA with any degree of specificity, the CRA would need to review all of the facts and documentation relating to such plans, including the existing employment contracts entered into between the Employer and its employees. Such a determination would need to be made by the relevant TSO.

Notwithstanding the above, under the Employer's Flex-plan, the Flex Credits allocated to the employees appear to have some redemptive value because an employee is allowed to receive all or a portion of such credits as Additional Compensation. It also appears that it may be possible for an employee to change a previous Flex Credit allocation to a HCSA allocation in circumstances other than those described in paragraph 6 of IT-529. Accordingly, the Employer's Flex-plan would not appear to be a plan that meets all the administrative requirements to avoid the adverse income tax consequences described in IT-529.

In respect of any Voluntary Contributions that have been deducted from the employees' salary and used to purchase additional coverage under the Employer's HCSA, as described in Paragraph 3 of IT-529, where additional benefits are purchased by an employee by means of payroll deductions, the particular employee is still required to be taxed on the gross amount of his or her salary under section 5 of the Act. As such, in our view, the Employer should have withheld and remitted source deductions on these Voluntary Contributions and reported the appropriate amount on the particular employee's T4 slip.

We trust our comments will be of assistance to you.

Yours truly,

Renée Shields
Manager
Business and Personal Section
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

cc: Brenda Garvie