2008 Ruling 2007-0254811R3 - Health Care Spending Account

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 the creation and allocation of health care spending credits under the Company's flexible health care benefit plan, which is linked to a bonus the employee may receive, would result in employment income to an employee?

Position: No.

Reasons: The allocation of the credits takes place under a private health services plan as defined in subsection 248(1) of the Act and meets the administrative guidelines as described in IT-339R2 and IT-529.

XXXXXXXXXX 							2007-025481

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling Request
XXXXXXXXXX - Health Care Spending Account

This is in reply to your letter of XXXXXXXXXX , and your supplemental correspondence, including your letter dated XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the above-noted taxpayer. You have advised that to the best of your knowledge, and that of the taxpayer, none of the issues involved in this Ruling is:

(i) in an earlier return of the taxpayer or a related person;

(ii) being considered by a tax services office (TSO) or taxation centre (TC) in connection with a previously filed tax return of the taxpayer or a related person;

(iii) under objection by the taxpayer or a related person;

(iv) before the courts or if a judgment has been issued the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

You have also advised that to the best of your knowledge, and that of the taxpayer, that the proposed transactions will not result in the taxpayer or any related person described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

(a) "Act" means the Income Tax Act R.S.C. 1985 (5th Supp.) c.1 as amended from time to time and consolidated to the date of this letter and unless otherwise expressly stated every reference herein to a part, section or subsection, paragraph or subparagraph, and clause or subclause is a reference to the relevant provision of the Act, and the Income Tax Regulations thereunder are referred to as the Regulations;

(b) "arm's length" has the meaning assigned by subsection 251(1);

(c) "CRA" means the Canada Revenue Agency;

(d) "Company" means XXXXXXXXXX (CRA business number XXXXXXXXXX );

(e) "Dependants" has the meaning assigned by subsection 118(6);

(f) "Eligible Employees" are individuals who are currently employed by the Company at the end of the particular IPP Year as salaried employees. Any one of the Eligible Employees is referred to as an "Eligible Employee";

(g) "Eligible Medical Expenses" have the meaning assigned by subsection 118.2(2) and are expenses of an Eligible Employee or of the Eligible Employee's Dependants and which are not already covered under any other existing medical insurance plan;

(h) "HCSA" refers to the Company's proposed health care spending account plan described in the Proposed Transactions;

(i) "HCSA Administrator" means XXXXXXXXXX ;

(j) "IPP" means the Company's incentive pay plan for its salaried employees as described in Paragraphs 3 and 4;

(k) "IPP Year" is the calendar year;

(l) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;

(m) "private health services plan" has the meaning assigned by subsection 248(1);

(n) "Proposed Transactions" means the transactions described in Paragraphs 6 to 13; and

(o) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

FACTS

1. The Company was formed under the laws of the Province of XXXXXXXXXX and is a taxable Canadian corporation. The Company is in the XXXXXXXXXX business, XXXXXXXXXX . The Company's fiscal year and taxation year ends on XXXXXXXXXX . The Company files its tax returns at the XXXXXXXXXX TC and otherwise deals with the XXXXXXXXXX TSO.

2. The Company provides its employees with medical and dental insurance, disability insurance, group life insurance and group sickness and accident insurance through a group benefits plan.

3. The Company also has an incentive pay plan (the "IPP") for all its salaried employees ("Eligible Employees"). The IPP is one component of the total compensation package offered by the Company and the amount of any incentive pay (the "Incentive Pay") earned by an Eligible Employee is determined and paid as described in Paragraph 4. For greater certainty, the Company's unionized employees who are paid on an hourly basis are not Eligible Employees under the IPP.

4. The amount of Incentive Pay under the IPP is generally based on both the Company's success in attaining certain corporate objectives and the success of the particular Eligible Employee in attaining certain levels of performance for the particular IPP Year. The IPP is fully discretionary and may be changed or discontinued by the Company at any time and there is no minimum or guaranteed amount of Incentive Pay. Where the specific performance objectives are not met in a particular IPP Year an Eligible Employee may not be awarded any Incentive Pay for that year. The amount and timing of the payment of Incentive Pay is determined as follows:

(a) For all salaried employees other than salaried sales employees, a review of each Eligible Employee's success in completing his or her specific individual personal objectives and the Company's financial performance objectives for the particular IPP Year is conducted by the compensation committee of the Company's Board of Directors (the "Board") in XXXXXXXXXX following the end of the particular IPP Year. The compensation committee then meets with the Board in XXXXXXXXXX to recommend the amount of Incentive Pay and the Board will normally formally approve such Incentive Pay. The Eligible Employees are only advised of their respective Incentive Pay amount, if any, following Board approval and the Company normally pays the Incentive Pay XXXXXXXXXX following the particular IPP Year.

(b) For salaried sales employees, a review each Eligible Employee's success in meeting his or her specific sales performance objectives and the Company's territorial profit and volume are conducted by the Company's President and V.P. of Commercial Operations three times during a particular IPP Year. The three measurement periods are based on the Company's normal business/sales cycles. The first measurement period begins on XXXXXXXXXX and ends on XXXXXXXXXX ("Period 1"). The second measurement period begins on XXXXXXXXXX and ends on XXXXXXXXXX ("Period 2"), while the third measurement period begins on XXXXXXXXXX and ends on XXXXXXXXXX ("Period 3"). The Incentive Pay for Period 1 and Period 2 is normally determined and paid in XXXXXXXXXX , respectively. However, since the Period 3 Incentive Pay takes into account the Company's annual territorial profit and volume targets as well as the individual's annual specific performance targets and objectives, the amount of Incentive Pay for Period 3 is assessed in XXXXXXXXXX following the end of the IPP Year. Eligible Employees are only advised of their respective Period 3 Incentive Pay once the Company's President and V.P. of Commercial Operations determine these amounts. The Company pays the Period 3 Incentive Pay in XXXXXXXXXX when the Incentive Pay is paid for the other salaried employees as described in (a).

For Eligible Employees described in (a), such employees have no legal entitlement to any Incentive Pay, or knowledge of such amount, until the compensation committee has had the opportunity to assess the measurement criteria following the end of the particular IPP Year and the Board approves the amount of Incentive Pay. This typically takes place in XXXXXXXXXX following the particular IPP Year. For Eligible Employees described in (b), such employees will have no legal entitlement to any Incentive Pay for Period 3, or knowledge of such amount, until the measurement criteria is assessed by the Company's President and V.P. of Commercial Operations following the end of the particular IPP Year. As noted above, this typically takes place in XXXXXXXXXX following the particular IPP Year.

5. Where a salaried employee of the Company, who would otherwise have been an Eligible Employee but for the fact that his or her employment with the Company was terminated prior to the end of the particular IPP Year due to death, disability, or retirement, such employee will still be entitled to an amount of Incentive Pay, if any, for the particular IPP Year. However, the amount of Incentive Pay, determined as described in Paragraph 4, in such case will be pro-rated based on the particular employee's date of termination. In any other circumstances where an employee has ceased to be employed by the Company before the end of the IPP Year, or prior to the end of Period 1 or Period 2, as the case may be, such employee will not be entitled to any Incentive Pay for that particular Period or for that IPP Year, as the case may be.

PROPOSED TRANSACTIONS

6. Upon receipt of a favourable advance income tax ruling, the Company proposes to amend the terms of the IPP to provide for a health care spending account ("HCSA") for its Eligible Employees effective XXXXXXXXXX .

7. Generally speaking, the HCSA will allow a salaried employee who is also an Eligible Employee to elect before the end of the IPP Year and the determination of the amount of Incentive Pay for that IPP Year, to allocate some or all of his or her Incentive Pay as credits under the HCSA. The actual allocation of credits under the HCSA will follow the IPP Year and will occur on the date the amount of Incentive Pay would otherwise become payable. Eligible Employees wanting to participate in the HCSA are expected to enrol in XXXXXXXXXX prior to the commencement of the particular IPP Year. For the XXXXXXXXXX IPP Year, such enrolment will take place in XXXXXXXXXX .

8. The HCSA Administrator deals at arm's length with the Company. Only Eligible Medical Expenses will be covered under the HCSA. Where an Eligible Employee participates in the HCSA, any Eligible Medical Expenses of an Eligible Employee or a Dependent of such person, will be reimbursed by the HCSA Administrator, subject to the amount of such Eligible Employee's available credits in the HCSA. The Company will reimburse the HCSA Administrator for the cost of such eligible claims plus a reasonable administration fee.

9. More specifically, under the HCSA each Eligible Employee may, subject to the limits described in Paragraph 10, elect to allocate all or a portion of his or her Incentive Pay for the particular IPP Year as credits to his or her HCSA as follows:

(a) where the Eligible Employee is an employee described in Paragraph 4(a), such employee will be required to irrevocably elect in writing, before the end of the particular IPP Year and before the determination of his or her Incentive Pay amount for that IPP Year, to transfer all or a portion of the Incentive Pay into credits under the HCSA; and

(b) where the Eligible Employee is an employee described in Paragraph 4(b), such employee will be required to irrevocably elect in writing, before the end of the particular IPP Year and before the determination of his or her Period 3 Incentive Pay amount for that IPP Year, all or a portion of the Incentive Pay into credits under the HCSA.

For greater certainty, Eligible Employees who occupy salaried sales positions described in Paragraph 4(b) will not be permitted to elect to allocate any amount of Incentive Pay for Period 1 or Period 2.

10. The maximum amount of the Incentive Pay that can be allocated as HCSA credits under the Eligible Employee's irrevocable election described in Paragraph 9 is limited to the lesser of: XXXXXXXXXX % of the particular Eligible Employee's Incentive Pay that will otherwise be determined and become payable for the particular IPP Year as described in Paragraph 9 following the time the irrevocable election is made; or XXXXXXXXXX % of the particular Eligible Employee's base salary as at the end of the particular IPP Year. In addition, in no case will any allocation of HCSA credits be able to exceed $XXXXXXXXXX in a particular IPP year.

11. Where an Eligible Employee irrevocably elects to allocate all or a portion of his or her unpaid Incentive Pay as credits under the HCSA the amount of that Eligible Employee's unpaid Incentive Pay, as otherwise determined for the particular IPP Year as described in Paragraph 4, will also be reduced by the amount of the particular Eligible Employee's credit allocation.

12. The credit allocation will only be effective once the amount of Incentive Pay has been determined and would otherwise become payable to the particular Eligible Employee following the particular IPP Year as described in Paragraph 4. Moreover, the allocation of the credits under the HCSA would be done only in respect of Eligible Employees who are still employed by the Company on the date that the Eligible Employees' unpaid Incentive Pay would otherwise become payable as described in Paragraph 4. For example, where an otherwise Eligible Employee elected to allocate credits to the HCSA for the particular IPP Year but his or her employment with the Company ended after the election was made and prior to the time the Incentive Pay for that particular IPP Year is determined and becomes payable following the IPP Year, no credits would be allocated to such person's HCSA and the particular person's Incentive Pay would be paid out in cash.

13. Unused HCSA credits in an Eligible Employee's HCSA at the end of the IPP Year that were earned in the particular IPP Year that just ended may only be carried forward to the next immediately following IPP Year after which such unused HCSA credits will be forfeited. In no case can HCSA credits be exchanged for cash. Eligible Medical Expenses of an Eligible Employee for a year that exceed that amount of available HCSA credits for that particular year will not be permitted to be carried forward to a subsequent year.

PURPOSE OF THE PROPOSED TRANSACTIONS

14. The Company desires to enhance its employee benefit program by allowing its salaried employees the option to allocate all or a portion of their Incentive Pay, within specified limits, to credits in the HCSA. This will provide greater flexibility in the benefit coverage for employees and also will help the Company attract and retain employees.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are set forth below.

A. The Company's HCSA described in the Proposed Transactions will be a private health services plan.

B. Provided the irrevocable election that will be made by an Eligible Employee to allocate all or a portion of that Eligible Employee's Incentive Pay amount to credits under the HCSA for a particular year is made as described in Paragraph 9, the election will not, in and of itself, result in an income inclusion pursuant to either subsection 5(1) or paragraph 6(1)(a).

C. Payments by the Company or the HCSA Administrator to reimburse an Eligible Employee's Eligible Medical Expenses under the terms of the HCSA will not be included in the employment income of the Eligible Employee pursuant to either subsection 5(1) or paragraph 6(1)(a), by virtue of the exclusion in subparagraph 6(1)(a)(i).

D. Where an Eligible Employee has allocated all or portion of Incentive Pay as credits under the HCSA for the particular year, as described in the Proposed Transactions, no amount may be deducted by the Company under the Act in respect of such allocation until the Company becomes legally obligated to reimburse the HCSA Administrator or an Eligible Employee for an amount of Eligible Medical Expenses under the terms of the HCSA. Any such deduction will be subject to section 67.

E. Pursuant to subsection 118.2(3), there shall not be included as a medical expense of an Eligible Employee under subsection 118.2(1) any Eligible Medical Expense for which the Eligible Employee is entitled to be reimbursed by the Company or the HCSA Administrator under the terms of the HCSA.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and is binding on CRA provided that the Proposed Transaction is completed by XXXXXXXXXX . The above rulings are based on the law as it presently reads and does not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

Unless otherwise confirmed in the above ruling, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of any goods and services tax consequences, provincial income tax consequences or any other tax consequences relating to the facts or proposed transactions other than those specifically described in the ruling given above.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch