15 September 2004 External T.I. 2004-0071731E5 - PHSP-General Information

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: General Statements re: set up and administration of a PHSP

Position: see letter

XXXXXXXXXX Lena Holloway, CA
2004-007173
September 15, 2004

Dear. XXXXXXXXXX:

Re: Private Health Services Plans ("PHSP's")

This is in response to your email of April 15, 2004 concerning the tax treatment of PHSP's. Your letter asked us to confirm the accuracy of several statements presented in your letter.

As noted in Information Circular IC 70-6R5, written confirmation of the tax consequences that apply to a particular fact situation is given by this directorate only in the context of an advance ruling request submitted in the manner set out in Information Circular 70-6R5. Where the particular transactions are completed, the inquiry should be addressed to the local Tax Services Office. However, we are prepared to provide the following general comments, which are not binding on the Canada Revenue Agency ("CRA"). The statements made in your letter are reproduced as follows:

1. Medical and dental plans are deemed to be PHSP's under the Income Tax Act (the "Act") as long as they meet the requirements of a PHSP under section 20.01.

2. In order to have a plan deemed a PHSP under the ITA, it must meet the definition under subsection 248(1). IT 339R2 indicates that the coverage of the plan must be in respect of items, which fit the requirements under 118.2 for the medical expense tax credit.

3. The only dependents that a PHSP can cover are dependants that, in the absence of a PHSP, would qualify as dependents for the medical tax credit, which would include the taxpayer, their spouse and any member of the household to which the taxpayer is related by blood, marriage or adoption. Therefore, if a dependant does not qualify for purposes of the medical expense tax credit, they would also not qualify as a dependent under a PHSP as they would not meet the requirements as laid out under section 20.01 and described in IT339R2.

4. If you have incorrectly included employees as dependants on your PHSP that don't meet the definition of dependents as defined under 118.2, you are, in effect, providing tax free remuneration to those employees.

5. If you are providing tax-free remuneration to non-eligible employees, you do not meet the definition of PHSP, but rather your plan could be deemed as an employee benefit plan as described in IT502.

6. If the CRA cannot decide whether a plan is a PHSP or an employee benefit plan, they can deem the entire plan an employee benefit plan and revoke the tax status of the PHSP, thereby altering the tax implications to both employee(s) and the employer. This is described in IT-502.

7. It is incumbent on the plan sponsor to ensure the plan meets the requirements of a PHSP by insuring that only eligible dependents as described under section 118.2 are receiving benefits out of the plan.

8. Failure to comply with the requirements of a PHSP renders the plan revocable and could result in the CRA reclassifying the plan as an employee benefit plan. Should this occur, every dollar paid out of the plan from the date the plan did not meet the requirements of a PHSP would become taxable in the recipients hands as income in the years they received the payments as described in IT 502.

Our Comments:

As several of your questions concern the requirements a plan must meet in order to qualify as a PHSP and the related income tax consequences to the employer and employee, we offer the following general discussion of the tax treatment of PHSP's, which should address all of your concerns.

Statements 1 and 2

In order for employer-paid health care insurance premiums to be excluded from employment income under subparagraph 6(1)(a)(i) of the Act, the particular plan must qualify as a PHSP as defined in subsection 248(1) of the Act. Subsection 248(1) of the Act defines a PHSP as:

a) a contract of insurance in respect of hospital expenses, medical expenses or any combination of such expenses, or

b) a medical care insurance plan or hospital care insurance plan or any combination of such plans.

Interpretation Bulletin IT-339R2, Meaning of Private Health Services Plan, dated August 8, 1989, sets out the requirements that must be met in order for a plan to be considered a PHSP. Generally, the employer would be entitled to a deduction for contributions made to a PHSP in determining its income provided these requirements are met, the contribution is reasonable in amount, and the amount is laid out to earn business or property income. Benefits received by employees in respect of employer contributions made to a PHSP are not subject to tax by virtue of subparagraph 6(1)(a)(i) of the Act.

Paragraph 3 of IT-339R2 specifies that a PHSP must be a plan in the nature of insurance. Therefore, where the plan represents (i) an undertaking by one person, (ii) to indemnify another person, (iii) for an agreed consideration, (iv) from a loss or liability in respect of an event, (v) the happening of which is uncertain, it will be considered to be in the nature of insurance. In addition, coverage must be in respect of hospital care or expenses, or medical care or expenses, which normally would otherwise have qualified as medical expenses under the provisions of subsection 118.2(2) of the Act in the determination of the medical expense tax credit. Please refer to IT-339R2 for further information on the various arrangements that may qualify as a PHSP.

Until 1998, amounts paid by self-employed individuals for their own health, medical and dental insurance coverage and for that of their families were not deductible in computing business income. Alternatively, businesses operated in the corporate form had been allowed deductions for insurance coverage for shareholders who were also employees. Section 20.01 was introduced in 1998 in order to give self-employed individuals (which includes individuals carrying on a business through a partnership) similar tax treatment to those corporate-run businesses. Section 20.01 of the Act allows, subject to certain conditions, individuals to deduct, in computing income from businesses carried on by them, premiums paid to a PHSP on behalf of themselves, their spouses and members of their households.

Therefore, with respect to your first statement, while section 20.01 sets out the maximum deduction permitted to an individual carrying on business through a proprietorship or partnership in respect of a premium, contribution or other consideration paid under a PHSP, the definition and requirements of a PHSP are actually found in the subsection 248(1) definition.

Statements 3 and 4

As stated in paragraph 4 of IT-339R2, the types of expenses, which may be provided under a PHSP, are limited to those that qualify as medical expenses for the purposes of the medical expense tax credit as defined in subsection 118.2(2) of the Act. Since a claim for the medical expense tax credit is limited to the expenses incurred in respect of an individual, the individual's spouse or a dependent of the individual within the meaning of subsection 118(6) of the Act, coverage within the same plan for anyone else would prevent the plan from qualifying as a PHSP as defined in subsection 248(1) of the Act and the related benefits would be subject to tax.

Where an employer wishes to extend to its employees non-qualifying health care benefits as well as those which do qualify for inclusion under a PHSP, the non-qualifying benefits can be offered through a separate plan, thereby preserving the tax-free status of the benefits that do qualify.

Statements 5 through 8

As noted above, if a particular plan provides coverage for expenses other than those described in subsection 118.2(2) of the Act, it is our view that the entire plan would not normally qualify as a PHSP, as defined in subsection 248(1) of the Act. In such cases, the rules for "employee benefit plans" ("EBP") could apply. Generally employees are taxable on amounts paid out of an EBP and an employer ordinarily may not deduct contributions for employees until the employee actually receives a corresponding benefit out of the plan.

As stated in IT-502, where an employer makes contributions to a custodian which are then used to fund several types of benefit plans, some of which are excluded from the definition of an employee benefit plan (such as a group sickness plan or a private health services plan), it is necessary for the employer to identify the portion of each contribution that relates to each separate plan. If the custodian of such an omnibus arrangement does not account separately for the income and disbursements of the component plans, it may be necessary to regard the total arrangement as an employee benefit plan and treat it accordingly in respect of the timing and amounts of both the employer's expense deductions and the EBP beneficiaries' receipt of benefits or income under the arrangement.

Should you wish a definitive determination on whether a particular plan is a PHSP such a review would only be undertaken in the context of a request for an advance income tax ruling submitted in the manner set out in IC 70-6R5. The Interpretation Bulletins mentioned above can be obtained from our website at www.cra-arc.gc.ca.

We trust our comments will be of assistance to you.

Yours truly,

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