18 February 2003 Internal T.I. 2002-0177447 - Non-resident Health and Welfare Trust

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:

1- Is the employer and trust dealing at arm's length?

2- Is the arrangement an employee benefit plan?

3- What provisions can be relied upon to disallow the deduction of the contributions?

4- Can a penalty be levied?

5- Is it gaarable?

6- Attribution rules applicable?

Position:

1- No.

2- No.

3- It will depend on the plan under review.

4- Dealt verbally.

5- Not considered.

6- Yes.

Reasons:

1- Subsection 251(1) of the Income Tax Act (the "Act").

2- Paragraph (a) of the definition of employee benefit plan.

3- Paragraph 18(1)(b) and subparagraph 18(9)(a)(iii) of the Act.

4- Dealt verbally.

5- In light of the above.

6- Subsection 75(2) of the Act.

February 18, 2003

Mr. André Turgeon Pascal Tétrault

Offshore Trust Project (613) 957-4363
Laval Tax Services Office
3131 St-Martin Blvd. West, Suite 520
Laval (Quebec) H7Z 2A7
2002-017744

Non-Resident Health and Welfare Trust

We are writing in response to your memorandum dated July 12, 2002, requesting our views on several questions regarding the interpretation of the Income Tax Act (the "Act").

The facts in issue involve a professional, XXXXXXXXXX, who operates his business as a sole proprietorship. XXXXXXXXXX created a trust (the "Trust") in XXXXXXXXXX to provide for his wife, XXXXXXXXXX, who is also his only employee with certain benefits. Under this arrangement, XXXXXXXXXX will be reimbursed for all dental expenses, all health care services or supplies and XXXXXXXXXX% of her salary when prevented from performing her employment due to sickness or accidental bodily injury. The benefits are limited to $XXXXXXXXXX yearly. However, you have indicated that the Trust has made no payment to the beneficiary since its creation in XXXXXXXXXX.

The Trust was established by the Memorandum of Agreement (the "Memorandum"), made as of XXXXXXXXXX, and by the Health and Welfare Insurance Plan (the "Plan") dated XXXXXXXXXX. The funding requirements of the Trust is circumscribed in the Initial Actuarial Valuation.

The Trust is resident of XXXXXXXXXX and all of the interested parties are Canadians. XXXXXXXXXX made lump sum contributions to the Trust in the amounts of $XXXXXXXXXX which he deducted from his income from business in the respective years.

The Memorandum provides that the trust fund shall be dealt with in accordance with the provisions of the Memorandum and the Plan.¹ The Memorandum is to the effect that the contributions shall not be returned to the employer.² However, the Plan provides that the employer can terminate it at any time and that the contributions shall be returned to the employer.³

YOUR POSITION

You have reassessed the employer for the XXXXXXXXXX years on the basis that the contributions can revert back to him and that as such, the contributions are not deductible because the arrangement cannot be viewed as a health and welfare trust.

TAXPAYER'S POSITION

The taxpayer's representative submits in a letter dated May 3, 2002, that the reversion of surplus funds to the taxpayer is not prohibited by statute or jurisprudence. The taxpayer further submits that an indication of an arm's length relationship is the terms of the Memorandum and the Plan that the trustee and the employer be at all times independent and dealing at arm's length.

OUR POSITION

This letter is based on the written documents provided to us and our analysis may vary according to facts not provided to the author. We were unable to do a complete analysis of the situation presented because information and documents were missing. For instance, we have had to assume that a trust was validly created, that the taxpayer's wife was a real employee and that she was the only one working for him. Assuming that the taxpayer files an appeal to the Tax Court of Canada, an examination for discovery would provide the necessary information in this regard.

What can be inferred from the establishment of the Trust is that the employer wanted to avoid tax on the passive income earned in the trust while being eligible to have the contributions deducted from its income as contributions to a health and welfare trust. This purpose can be inferred from the fact that the only connecting factor to the tax haven jurisdiction of XXXXXXXXXX is the trustee and that all of the other interested parties involved are Canadians.

The factual scenario in this request is similar to the one dealt in our letter of January 2, 2003, document number 2002-015262. Accordingly, we refer you to the said letter to further support our opinion. You have asked several questions which will be dealt with in the order they were submitted.

QUESTION 1: IS THE EMPLOYER AND THE TRUST DEALING AT ARM'S LENGTH?

Your first question is whether the employer and the Trust are dealing at arm's length. The facts in this case are nearly identical to the facts in our letter of January 2, 2003. Accordingly, we conclude based on the facts in issue that the Trust and the employer are not dealing at arm's length.

The taxpayer's representative argues that an indication of an arm's length relationship is that the terms of the Memorandum and the Plan require that the Trustee and the employer be at all times independent and dealing at arm's length. With respect to this argument, we find that the legal reality must prevail and that in order to ascertain the true nature of a relationship we must take into consideration the overall scheme of things. We conclude that the Trust and the employer are not dealing at arm's length when considering all of the facts of the situation under review.

We came to the conclusion that the Trust and the employer are not dealing at arm's length based upon the judicial pronouncements in Swiss Bank Corp. v. Minister of National Revenue, [1972] C.T.C. 614 (S.C.C.), Minister of National Revenue v. Merritt, [1969] C.T.C. 207 (Ex.Ct.), Robson Leather Co. v. Minister of National Revenue, [1977] C.T.C. 132 (F.C.A.), , Noranda Mines Ltd v. Minister of National Revenue, [1987] 2 C.T.C. 2089 (T.C.C.), May Estate v. Minister of National Revenue, [1988] 1 C.T.C. 2303 (T.C.C.). For your convenience, we are restating the salient points of our analysis expressed in our letter of January 2, 2003.

In the situation under review a number of elements indicate that the employer is not dealing at arm's length with the Trust. The employer can terminate at any time and for any reason the Plan, which forms an integral part of the Memorandum because of the requirement that the trust fund be dealt according to the Plan and of the Memorandum. The Memorandum, for its part, provides that the employer and the trustee may amend the Memorandum by mutual agreement. However, the Memorandum also provides that the employer may replace the trustee simply by giving a notice.

The Federal Court of Appeal in Robson Leather Co. v. Minister of National Revenue, [1977] C.T.C. 132, looked at the concept of arm's length dealings in the context of a trust. More specifically, the court looked at the power which could result from the removal of a trustee by another trustee. The three trustees had to be unanimous in exercising their powers. The taxpayer argued that:

[...] it could not be assumed that the trustees would not carry out their duties as trustees in accordance with the legal obligations imposed on trustees to formulate their own judgments in matters affecting the trusts, but rather would follow Robson's instructions merely because he had the power to cause the retirement of either or both of the other two trustees if they did not do so.⁷

The Federal Court of Appeal rejected this argument and adopted the pronouncement of the Federal Court - Trial Division which is useful in the present case and which reads as follows:

In my opinion, however, in deciding the larger issue before me, I must look at the practical and business reality of the operation of the trust. By demanding retirement of trustees, or even the threat of such a demand, or the knowledge in the co-trustees that the ultimate power was always in Mr. Robson, I have no doubt that Mr. Robson, for practical and legal purposes, controlled the trust and, therefore, controlled Robson Leather. I add the caveat here, that share control alone (or absence of it) is not necessarily conclusive; it is a factor to be considered in determining questions of "arm's length".⁸

The present case is different from the underlying facts of the Robson Leather Case, however the essence of the above excerpt can be applied here. It is reasonable to conclude that from a practical and business reality, the employer, which appears to be the settlor of the Trust, is dictating the terms of the bargain on behalf of the employer and the Trust and that the employer is acting without separate interest with the Trust. What greater degree of influence and control can an entity have over another when it can, at any time, dictate the rules under which the other entity is governed and even trigger its collapse. The fact that the Memorandum provides that an amendment requires the mutual agreement of the trustee and of the employer does little to limit the degree of influence of the employer over the Trust. In the event that the trustee would oppose an amendment, the employer could demand the replacement of a "difficult" trustee by another who would comply with the wishes of the employer. By analogy with the Robson Leather Case, the only threat of retirement or the knowledge by the trustee of the power to be removed by the employer is sufficient for the employer to have the necessary influence over the trustee.

QUESTIONS 2 & 3: CAN THE ARRANGEMENT UNDER REVIEW BE CONSIDERED AS AN EMPLOYEE BENEFIT PLAN?

You have expressed concern about the fact that only one employee is covered by the Plan and accordingly you wonder whether the Plan could qualify as an "employee benefit plan" or as a "group sickness or accident insurance plan". The definition of "employee benefit plan" found under subsection 248(1) of the Act states:

"employee benefit plan" means an arrangement under which contributions are made by an employer or by any person with whom the employer does not deal at arm's length to another person (in this Act referred to as the "custodian" of an employee benefit plan) and under which one or more payments are to be made to or for the benefit of employees or former employees of the employer or persons who do not deal at arm's length with any such employee or former employee (other than a payment that, if section 6 were read without reference to subparagraph 6(1)(a)(ii) and paragraph 6(1)(g), would not be required to be included in computing the income of the recipient), but does not include

(a) a fund or plan referred to in subparagraph 6(1)(a)(i) or paragraph 6(1)(d) or (f),

(b) a trust described in paragraph 149(1)(y),

(c) an employee trust,

(c.1) a salary deferral arrangement, in respect of a taxpayer, under which deferred amounts are required to be included as benefits under paragraph 6(1)(a) in computing the taxpayer's income,

(c.2) a retirement compensation arrangement,

(d) an arrangement the sole purpose of which is to provide education or training for employees of the employer to improve their work or work-related skills and abilities, or

(e) a prescribed arrangement.

It is difficult to come to a definite answer as to what classification the arrangement under review falls under because crucial facts are missing from the materials sent.⁴ However, assuming that the Plan is a combination of a sickness or accident insurance plan and a private health services plan, the Plan would be prevented from being an employee benefit plan by the exclusion of paragraph (a) in the above definition.

Firstly, the Plan appears to provide for benefits in the event of sickness or accident in which case the employee would receive "income maintenance".⁵ However, the Plan cannot be a "group sickness or accident insurance plan" because there is only one employee covered by the arrangement.⁶ This arrangement could still be considered as a "sickness or accident insurance plan" for which amounts received by an employee under such plan would be subject to tax according to paragraph 6(1)(f) of the Act. Accordingly, this part of the arrangement is excluded from qualifying as an employee benefit plan when reading paragraph (a) of the definition of employee benefit plan.⁷

As noted in paragraph 20 of Interpretation Bulletin IT-428 - Wage Loss Replacement Plans, the premiums paid regarding the non-group sickness or an accident insurance have to be included in the employee's income in the year the contributions are made.

Secondly, we find that the remaining benefits covered by the Plan are with respect to hospital care and medical care which qualify as medical expenses under subsection 118.2(2) of the Act. Accordingly, this part of the Plan can reasonably be qualified as a private health services plan as defined under subsection 248(1) of the Act.⁸ As private health services plans are referred to in subparagraph 6(1)(a)(i) of the Act, the Plan is expressly carved out of the definition of employee benefit plan of subsection 248(1) of the Act. Furthermore, an arrangement that combines two types of plans that are excluded from the definition of employee benefit plan does not bring the arrangement within the ambit of the definition employee benefit plan.⁹

Consequently, based on the information available, we conclude that the Plan is a plan described in paragraph (a) of the definition of "employee benefit plan" and as such, is excluded from being an employee benefit plan.

QUESTIONS 4, 5 & 6: WHERE THE ARRANGEMENT UNDER REVIEW IS NOT A HEALTH AND WELFARE TRUST WHAT PROVISION OF THE ACT CAN BE RELIED UPON TO DISALLOW THE DEDUCTIONS OF THE CONTRIBUTIONS?

As mentioned in our letter of January 2, 2003, the tax treatment afforded to health and welfare trusts is described in Interpretation Bulletin IT-85R2 - Health and Welfare Trusts for Employees. Where the conditions found in IT-85R2 are not complied with, the tax consequences may vary according to each situation.

In the present case, the conditions in IT-85R2 are not satisfied because the contributions can revert back to the employer. In applying Canadian tax law to this situation, it can be concluded that the two lump sum payments made by XXXXXXXXXX to the Trust are payments on account of capital for which no deduction can be taken from the employer's income from business according to paragraph 18(1)(b) of the Act.¹⁰ Subparagraph 18(9)(a)(iii) of the Act could also be relied upon as an alternative argument.

QUESTION 7: CAN A PENALTY BE LEVIED?

We already have addressed this concern with you verbally.

QUESTION 8: IS GAAR APPLICABLE?

In light of the answers given above, we have not considered the application of section 245 of the Act.

OTHER COMMENTS

We would like to stress the application of subsection 75(2) of the Act in the present case which would operate to allocate the income from property and taxable capital gains generated from the contributions back to the employer.

In the present case, the Memorandum provides that the trust fund shall be dealt with in accordance with the provisions of the Memorandum and the Plan. The Memorandum is to the effect that the contributions shall not be returned to the employer. However, the Plan provides that it can be terminated at any time by the employer and that the contributions shall be returned to the employer. Notwithstanding the prohibition under the Memorandum that the contributions to the Trust shall not return to the employer, the Memorandum refers to the Plan which becomes an integral part of the Memorandum. Accordingly, the property transferred to the Trust can be said to be held on the condition that it may revert to the employer for the purposes of subsection 75(2) of the Act.

Subsection 75(3) was amended to exclude from the application of 75(2) of the Act arrangements of the type under review. However, the amendment was not in force for the XXXXXXXXXX taxation years.

We would like to refer you to our letter of January 2, 2003, for further comments on the application of 75(2) because the factual scenario in the said letter is nearly identical to the present case.

For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CCRA'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 to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

If additional comments are needed with respect to the position taken in this letter, please contact the author at (613) 957-4363.

Alain Godin
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTES

¹ Clause XXXXXXXXXX of the Memorandum. See also the second "XXXXXXXXXX" of the Memorandum.

² Clause XXXXXXXXXX of the Memorandum.

³ Article XXXXXXXXXX of the Plan.

⁴ This information was requested and you advised us that the taxpayer involved was not collaborating and that he was deliberately not sending the information. For example, only part of the Plan was submitted to our attention.

⁵ We are making this assumption based on the benefits covered as stated in the Initial Actuarial Valuation.

⁶ Meyer v. Minister of National Revenue, [1977] C.T.C. 2581 (T.R.B.).

⁷ However, it should be mentioned that the CCRA has indicated in Interpretation Bulletin IT-428 - Wage Loss Replacement Plans that where the premiums are paid regarding non-group sickness or an accident insurance, the employee would not be subject to the application of paragraph 6(1)(f) of the Act when receiving amounts from the plan.

⁸ See paragraph 4 of Interpretation Bulletin IT-339R2 - Meaning of "Private Health Services Plan".

⁹ See by analogy, the position taken in paragraph 1 of Interpretation Bulletin IT-85R2 - Health and Welfare Trusts for Employees.

¹⁰ See: British Insulated And Helsby Cables, Ltd. v. Atherton, [1925] All E.R. 623 (U.K. H.L.).