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: Whether an employer's contribution to a claim stabilization fund (a separate bank account), as required by a contract with a third-party plan administrator of a PHSP, is deductible.
Reasons: Paragraph 18(1)(e). Also, the fund is maintained for the ultimate benefit of the employer; no expense is incurred until an amount is paid or payable from the fund pursuant to the terms of the PHSP.
XXXXXXXXXX Eliza Erskine
April 20, 2006
Re: Private Health Services Plan ("PHSP") and Claim Stabilization Fund
We are writing in reply to your facsimile of October 25, 2005, regarding the above-noted subject matter. You requested our comments about the deductibility and reasonableness of a "claim stabilization fund" set aside by an employer pursuant to an agreement with the plan administrator of an employee health and dental plan. We also acknowledge our telephone conversations with you of February 22 and March 24, 2006 (XXXXXXXXXX/Erskine).
Written confirmation of the tax consequences inherent in a particular transaction or series of transactions are 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. Notwithstanding the foregoing, we are prepared to provide the following general comments.
A PHSP is defined in subsection 248(1) of the Income Tax Act (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.
An arrangement where an employer reimburses its employees for medical or hospital expenses may come within the definition of a PHSP where the employer is required by the employment contract to pay such expenses. For more information in this regard, please refer to Interpretation Bulletin IT-339R2, Meaning of "Private Health Services Plan". The benefit enjoyed by an employee as a result of contributions made by the employer to or under a PHSP is excluded from the employee's income by virtue of subparagraph 6(1)(a)(i) of the Act. Such contributions by the employer to or under a PHSP generally constitute business outlays or expenses of the employer for purposes of paragraph 18(1)(a) of the Act.
The situation described in your facsimile involves an employer (or "plan sponsor") contracting with an arm's length plan administrator to administer a PHSP. You advise that the arrangement is similar to what insurance companies refer to as an "Administrative Services Only" (an "ASO") contract. An ASO contract is not a contract of insurance, as the insurance company is not actually bearing any risk. Similarly, the plan administrator in your situation is not providing insurance. Rather, the employer is assuming the risk with respect to the employees' health and dental costs, within the limits set out in the plan, and the plan administrator is providing administration services for a fee.
Generally, under these types of arrangements, the employer regularly deposits pre-determined amounts into a bank account (the "PHSP account") that the plan administrator can draw upon to pay out claims. You advise that it is also common for the contract between the employer and the plan administrator to require the employer to maintain a separate account, referred to as a "claim stabilization fund", to act as a reserve that the plan administrator can draw upon whenever there are insufficient funds in the PHSP account to meet current claims. This situation might arise because of unforeseen or unusually high claims during a particular year, or where the employer fails to meet its obligation to maintain the PHSP account. Generally, the reserve account exists solely for the convenience of the plan administrator; the employer is liable to meet all valid claims arising under the terms of the plan regardless of the amount in either the PHSP account or the reserve account.
Where a PHSP is set up as described above, the employer can deduct in computing its income:
(i) reasonable fees paid to the plan administrator; and
(ii) amounts that are determined by the plan administrator to be payable under the plan in respect of a valid claim.
The employer cannot deduct its regular deposits to the PHSP account, even though these are sometimes referred to as "contributions", because these amounts either remain wholly within the control of the employer or are maintained solely for the benefit of the employer to be used to meet the employer's obligations under the PHSP. Until an amount is paid or payable, the employer has not actually incurred an expense. Moreover, paragraph 18(1)(e) of the Act prohibits the deduction of any amount "as, or on account of, a reserve, a contingent liability or amount or a sinking fund except as expressly permitted in [Part I of the Act]". Amounts deposited into the PHSP account are amounts on account of a contingent liability. For the same reasons, amounts paid into a "claim stabilization fund" cannot be deducted from income until they are paid or payable to meet valid claims under the PHSP.
The Act does specifically allow certain deductions in respect of reserves maintained by insurance companies. However, we have assumed that the employers involved in the PHSP arrangements you have described are not insurance companies as that term is used in the Act.
We note that the tax consequences are somewhat different where a PHSP is set up as a "health and welfare trust" (a "HWT"). Generally, contributions to a HWT are deductible by the employer when they are made, regardless of whether amounts are paid or payable from the trust during the year with respect to actual claims. However, an employer cannot retain any interest in amounts contributed to a HWT. Further, contributions by an employer to a HWT for a particular year that exceed the amount that the HWT can reasonably be considered to require to meet claims for that year cannot be deducted by the employer. For more information on HWTs, please refer to Interpretation Bulletin IT-85R2, Health and Welfare Trusts.
The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, these comments do not constitute an income tax ruling and accordingly are not binding on the Canada Revenue Agency.
We trust that our comments are of assistance to you.
Partnerships and Health Section
Business and Partnerships Division
Income Tax Rulings Directorate
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