19 April 2004 External T.I. 2004-0056871E5 - PHSP and 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.

Principal Issues: The deductibility of contributions to a health and welfare trust set up as a PHSP for a corporate employer and a sole proprietor with employees.

Position: General comments provided.

Bob Naufal, CMA
XXXXXXXXXX (613) 957-2744
2004-005687
April 19, 2004

Dear XXXXXXXXXX:

Employee Health Benefit Plans

We are writing in response to your letter dated January 15, 2004, wherein you asked about the deductibility of amounts paid to a health and welfare trust by a corporation (with and without employees) and a sole proprietor (with and without employees), in respect of a personal health services benefit plan.

In your letter you describe a Health and Welfare Trust plan (the "Trust") as follows:

? A taxpayer (corporation or proprietorship, as the case may be) contributes amounts on a monthly basis, based on estimated annual eligible medical expenses for the employees, into the Trust, which is administered by a trustee pursuant to a trust document.

? The Trust pays for eligible medical expenses incurred by the employees of the taxpayer. In this regard, as actual medical expenses are incurred, the employees will submit a claim to the Trustee.

? The Trustee pays the medical expense claims to the employees out of the Trust account.

? In addition to the amounts contributed in respect of employee medical expenses, the Trustee receives a one-time administration fee of $200 to set up the trust documents and an administration fee of 10% of the medical expenses paid.

? The taxpayer will deduct the amounts contributed plus the administration fees described above in computing taxable income.

? Any unused funds in the Trust are carried over for future years' claims or can be refunded and included in income of the taxpayer, presumably at the end of the taxation year of the business. If medical expense claims exceed the balance of cash in the Trust, the taxpayer is billed and pays for the shortfall.

? Coverage under the plan includes "in province travel medical", which is mandatory for a sole proprietor for an additional premium.

Our Comments

Written confirmation of the tax consequences inherent in a particular transaction or series of transactions is given by this Directorate only where the transaction(s) are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5. Notwithstanding the foregoing, we are prepared to provide the following general comments.

Health and Welfare Trust

In general terms, a health and welfare trust is a benefit plan, provided through a trust arrangement, under which a trustee receives contributions from an employer, and in some cases from employees, in order to provide such health and welfare benefits as have been agreed to between the employer and the employees. The benefit plans administered through the trust are restricted to the following types of plans or arrangements:

(a) a group sickness or accident insurance plan;

(b) a private health services plan ("PHSP");

(c) a group term life insurance policy; or

(d) any combination of (a) to (c).

To qualify for treatment as a health and welfare trust, the funds of the trust cannot revert to the employer or be used for any purpose other than providing health and welfare benefits for which the contributions are made. In addition, the employer's contributions to the fund must not exceed the amounts required to provide these benefits. Moreover, the employer contributions must be mandatory and enforceable by the trustees should the employer decide not to make the required contributions. The type of trust arrangement envisaged is one where the trustee or trustees act independently of the employer as opposed to the type of arrangement initiated unilaterally by an employer who has control over the use of the funds whether or not there are employee contributions.

In any situation where the underlying agreements relating to the setting up of a health and welfare trust do not include a provision that specifies that the funds of the trust can never revert back to the employer, and a provision that provides the trustees with the power to enforce the contributions required to be made by an employer to the trust, it is our view that such a trust arrangement would not be considered to be a health and welfare trust. Also, the inclusion of provisions in the underlying trust arrangements giving the trustees that are appointed by the employer ultimate control over any matters relating to the funding of, the administration of, the investments by, or the payment of any benefits under the trust, would result in the trust not being considered a health and welfare trust.

Further information with respect to health and welfare trusts can be found in Interpretation Bulletin, IT-85R2, Health and Welfare Trusts for Employees.

Private Health Services Plan

An employer may offer a benefit plan that is a PHSP without using a health and welfare trust. A PHSP is defined in subsection 248(1) of the Act as a contract of insurance in respect of hospital expenses, medical expenses or any combination of such expenses, or a medical care insurance plan or hospital care insurance plan or any combination of such plans. A plan in the nature of insurance, in this respect, must contain the following basic elements:

(a) an undertaking by one person,

(b) to indemnify another person,

(c) for an agreed consideration,

(d) from a loss or liability in respect of an event,

(e) the happening of which is uncertain.

In addition, in order to qualify as a PHSP, coverage under such a plan must be limited to medical expenses that would otherwise qualify for the medical expense tax credit pursuant to subsection 118.2(2) of the Act.

An employer may contract with a trusteed plan or insurance company for the provision of indemnification of employees' claims on defined risks under the plan, wherein the employer promises to reimburse the cost of such claims plus pay an administration fee to the plan or insurance company. Where such an arrangement is part of an employment contract, the plan may qualify as a PHSP.

Please refer to Interpretation Bulletin, IT-339R2, Meaning of" private health services plan" for more information about PHSPs.

In our view, a plan that consists of a contract between a sole proprietor with no full-time employees, and a trustee as an administrator, under which the administrator agrees to reimburse the proprietor, his spouse and members of his household for actual medical and hospital expenses, and receives as consideration an amount equal to the amount reimbursed plus an administrative fee, does not qualify as a PHSP, since it does not contain the necessary elements of insurance. In this situation, no person has undertaken to indemnify another person. Rather, the proprietor has assumed all of the risk for the personal hospital and medical bills. Even though a proprietor enters into a contract with a trustee as an administrator to pay medical and hospital expenses, it is our view that such an arrangement is not, in and of itself, sufficient to conclude that the plan is a PHSP.

Where a plan provides coverage for a proprietor and one or more full-time employees, it is our view that such a plan could qualify as a plan of insurance, whether or not the employee(s) deal at arm's length with the employer. The fact that a full-time employee does not deal at arm's length with the proprietor would not disqualify the plan, provided that such employee is receiving coverage as an employee and not because of the relationship with the proprietor / employer. Contributions made by a proprietor to a qualifying PHSP are deductible under subsection 20.01(1) subject to the limits provided in subsection 20.01(2) of the Act.

A plan or arrangement where a corporate employer reimburses its employees for the cost of medical expenses or hospital care may qualify as a PHSP. Where an individual, who is both a shareholder and an employee, receives a benefit under a PHSP and equivalent benefits are not available to all employees, the individual is generally considered to be in receipt of a taxable shareholder benefit under subsection 15(1) of the Act. Contributions made by the corporate employer to such a PHSP on behalf of the shareholder would not be deductible by the corporate employer.

On the other hand, when equivalent coverage under a PHSP is extended to all employees, including employees who are shareholders, the benefit provided to the employee/shareholders from such coverage is normally considered to be an employment benefit rather than a shareholder benefit. Similarly, when all employees of a corporation are shareholders and it is reasonable to conclude, based on the particular facts of the situation, that the PHSP coverage has been provided as part of a reasonable remuneration package, the benefit from such coverage is also considered to be an employment benefit rather than a shareholder benefit. In such cases, the benefit is not included in the employee/shareholders' income by reason of the exclusion in subparagraph 6(1)(a)(i) of the Act, and the corporate employer is entitled to a deduction in respect of the contributions made for such coverage, subject to any limitations imposed under the Act.

We trust our comments will be of some assistance.

Yours truly,

Wayne Antle, CGA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate