9 December 2003 External T.I. 2003-0034505 - CRITICAL ILLNESS INSURANCE

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 payment of premiums on critical illness insurance for employees a taxable benefit?

2. Are lump sum payments paid under a critical illness insurance policy taxable?

3. Can a self-employed taxpayer deduct the cost of business attire?

Position TAKEN:

1. No taxable benefit if provided as part of a group sickness or accident insurance plan.

2. Not taxable unless the lump sum payment is in lieu of periodic payments.

3. No.

Reasons:

1. Exempt under subparagraph 6(1)(a)(i).

2. No taxing provision.

3. Personal expenses.

XXXXXXXXXX 		T. Young, CA
		2003-003450
December 9, 2003

Dear XXXXXXXXXX:

Re: Critical Illness Insurance

We are writing in response to your letter to Mr. Rob McGregor of the Vancouver Island Tax Services Office dated July 23, 2003, which was forwarded to us for reply.

In your letter, you outlined the following scenario:

? A corporation ("ACo") has two shareholders, who are also employees, plus another employee.

? ACo purchases individual critical illness insurance policies on all three employees on a group basis.

? There is a health and welfare trust (the "Trust"), which owns the policies that are paid for by ACo.

Your questions and our comments are set out below.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. The tax consequences of completed transactions can only be determined after a review of all of the relevant facts and documentation, which is the responsibility of the local tax services office. However, we are prepared to provide the following comments, which may be of assistance to you.

When a benefit is provided to a taxpayer who is both an employee and a shareholder of the corporation, there is a presumption that the benefit is made to the individual in his or her capacity as a shareholder. If that is the case, the value of the benefit would be taxable to the shareholder pursuant to subsection 15(1) of the Income Tax Act (the "Act"). Any expenditures incurred by the corporation in providing that benefit would not be deductible to the corporation pursuant to paragraph 18(1)(a) of the Act because the expenditures would not have been made for the purpose of gaining or producing income. On the other hand, if it can be shown that the benefits are conferred on the shareholder-employee in his or her capacity as an employee, subsection 15(1) will not apply and the taxability of the benefits will generally be determined under the provisions applicable to employees. For purposes of this letter, we will address your questions on the presumption that the critical illness insurance is being provided to the shareholder-employees in their capacity as employees.

1. Are the premiums tax-deductible to ACo?

It is presumed that the premiums are being paid by ACo to the health and welfare trust to cover its cost of providing the critical illness insurance. On that basis, expenses incurred in providing these employment benefits are generally deductible to the employer.

2. Is this a taxable benefit to the employees?

Subparagraph 6(1)(a)(i) of the Act excludes from employment income benefits "derived from the contributions of the taxpayer's employer to or under a registered pension plan, group sickness or accident insurance plan, ...". On the basis that the critical illness insurance constitutes a "group sickness or accident insurance plan", it is our view that the exemption in subparagraph 6(1)(a)(i) would likely apply to premiums on critical illness insurance policies provided on a group basis, as long as the policies only provide for critical illness insurance and do not contain any return of premium ("ROP") benefits (see our response below to question 4).

3. If the policy is paid out, what is the tax status of the lump sum that is paid to the individual?

For general information on the taxable status of payments under a group sickness or accident insurance plan, see interpretation bulletin IT-428, Wage Loss Replacement Plans. As stated in paragraph 1 of the bulletin, paragraph 6(1)(f) of the Act provides that amounts received on a periodic basis by an employee or former employee, as compensation for loss of income from an office or employment that were payable under a sickness, accident, disability or income maintenance insurance plan to which the employer made a contribution, must be included in income. Whether or not amounts received under a group sickness or accident insurance plan are taxable is a question of fact. However, we understand that critical illness insurance policies do not provide for payments on a periodic basis. Therefore, it is our general view that a lump sum payment under such a critical illness insurance policy is non-taxable.

4. What is the impact of a ROP option if it is included in the policy?

Critical illness insurance policies may provide for additional benefits, referred to as ROP benefits, for an additional premium. ROP benefits, we understand, may be payable in the event of the policyholder's death, the maturity of the policy, or periodically.

We have no general conclusion to offer at this time on the appropriate treatment of policies providing ROP benefits in addition to critical illness benefits. Some ROP benefits may well be life insurance. We have undertaken a comprehensive review of the tax implications of ROP benefits provided as part of critical illness insurance policies. However, our review is not yet complete.

5. What are the tax consequences if the critical illness payout remains in the Trust?

Without more information, we do not wish to comment on the tax consequences of paying the benefits of a critical illness insurance policy into the Trust. For general information on a number of the tax implications to ACo and to the Trust, please refer to interpretation bulletin IT-85R2, Health and Welfare Trusts for Employees.

6. If the beneficiaries of the Trust are Aco(50%) and the employees(50%), does this change the taxability?

As funds held by a health and welfare trust cannot revert to the employer, we cannot envision a scenario where the Trust could qualify as a health and welfare trust if ACo were a beneficiary of the Trust.

7. TransAmerica Life has a product that, if a person is deemed critically ill, there are two types of payment options:

(a) Medical expense reimbursement paid to the provider of all treatment deemed necessary; or

(b) A $25,000 cash payout.

You have asked us to confirm that option (a) would be non-taxable and option (b) would be taxable.

We are unable to comment on the taxability of a specific product except in the context of an advance income tax ruling.

8. As a self-employed person, you put on seminars across the country. You have asked us if the cost of the clothes you have to purchase to maintain a professional image is deductible?

It is our view that the expenses incurred in purchasing clothing are personal and living expenses, which are not deductible pursuant to paragraph 18(1)(h) of the Act. The only deduction permitted for clothing costs for self-employed individuals earning business income is capital cost allowance in respect of a uniform (Class 12 of Schedule II of the Income Tax Regulations). Since the business attire to which you refer appears to be the normal clothing worn in an office, the expenses incurred to acquire the clothing would not be deductible.

The documents referred to above may be found on our web site at www.ccra.gc.ca. We trust our comments will be of assistance to you.

Yours truly,

Randy Hewlett
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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