6 November 2012 External T.I. 2012-0455951E5 - Flexible Benefits

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 employee is required to include in income the value of flexible credits received as part of their annual incentive award?

Position: An employee is required to include the value of all performance related awards in employment income, and for years after 2012, even if the credits are converted to a contribution to a HCSA.

Reasons: Past positions and new administrative position regarding redirecting bonuses to a HCSA.

XXXXXXXXXX
2012-045595
C. Underhill

November 6, 2012

Dear XXXXXXXXXX:

Re: Flexible Benefits

We are writing in response to your letter of July 17, 2012, concerning the taxation of flexible credits that are assigned to employees as part of the employer's annual incentive award (variable credits).

In the situation you described, the employer provides a flexible benefit plan, whereby the employee can choose from various options including a health care spending account (HCSA). You have indicated that the plan meets the requirements as set out in Interpretation Bulletin IT-529, Flexible Benefit Plans, and the HCSA is a "private health services plan" as defined in subsection 248(1) of the Income Tax Act (Act). The employer's flexible benefit plan has a XXXXXXXXXX plan year and employees elect the allocation of their benefit credits in XXXXXXXXXX, prior to the start of the plan year. The benefit credits consist of two components: fixed benefit credits which are based on the employee's hours worked and the number of dependants he or she has enrolled in medical or dental coverage; and variable credits. The total benefit credits can be used to acquire certain optional levels of medical, emergency medical, dental, and short-term disability coverage, or accident insurance for employees and their eligible dependants. Any excess benefit credits may be directed to a HCSA or a wellness account. In addition, only variable credits may be redeemed for cash.

The maximum amount of variable credits that can be assigned to an employee is XXXXXXXXXX% of the employee's base salary. The portion of the annual incentive award exceeding XXXXXXXXXX% of an employee's base salary is paid in cash. Conversely, if the annual incentive award is less than XXXXXXXXXX% of the employee's base salary then only variable credits will be assigned. The annual incentive award is not guaranteed and is based on a combination of the employer and employee's performance.

The annual incentive award is in respect of the employer's fiscal period ending XXXXXXXXXX. The annual incentive award is determined in XXXXXXXXXX and the variable credits are assigned in XXXXXXXXXX of the next calendar year. Where an employee elects in XXXXXXXXXX to receive cash in lieu of allocating the variable credits to the available benefit options under the employer's flexible benefit plan for the new plan year beginning XXXXXXXXXX, the cash amount less withholding is paid in XXXXXXXXXX. It is your view that the employer's annual incentive award complies with the administrative position of the Canada Revenue Agency (CRA) on flexible benefit plans as outlined in IT-529 and that your award is distinguishable from arrangements that allow employees to redirect their bonuses to a HCSA.

Our Comments

Subsection 5(1) of the Act includes in an individual's income for a taxation year from an office or employment, the salary, wages, and other remuneration, including gratuities, received by the individual in the year. The terms salary, wages, and other remuneration are not defined for purposes of section 5 of the Act and therefore must be given their ordinary meaning. Generally, an amount paid to an employee as consideration for services rendered will be taxable as income from an office or employment. It is our understanding that although the variable credits are based, in part, on the employee's base salary; the employee's entitlement to the variable credits is not automatic. That is, the employee must achieve certain performance levels to be entitled to the annual incentive award and hence the variable credits. It is our view that the annual incentive award is considered to be remuneration as the amount arises under the contract of employment, in relation to services rendered by the employee. This is consistent with the CRA's long standing position that the value of performance-related awards is required to be included in the income of the employee as remuneration.

As you are aware, prior to the announcement at the 2011 Canadian Tax Foundation Annual Tax Conference, it was the CRA's administrative policy not to require all or part of a performance-related award (e.g. bonus, incentive) to be included in the employee's employment income if all or part of that award was redirected to a HCSA. Based on this administrative policy, the variable credits assigned to an employee as part of the employer's annual incentive award would not have been required to be included in income where the variable credits were allocated to a HCSA.

The administrative policy of allowing employees to redirect their bonuses to HCSAs on a tax free basis was re-examined and as a result, it is now the CRA's position that the allocation of a bonus to a HCSA should be taxed as employment income. Effective January 1, 2013, any bonus to which an employee is or will become entitled will be included in income in the year in which the amount is converted to flexible benefit credits.

Under the employer's plan, when the variable credits are assigned to an employee in XXXXXXXXXX, the employee has the choice to redeem the variable credits in cash or redirect them to a HCSA or other non-taxable benefit options. It is our view that the employer's annual incentive award is not distinguishable from arrangements that allow employees to redirect their bonuses to a HCSA. Under the employer's annual incentive award, the employee still has the choice, on an annual basis, to direct his or her incentive award to a HCSA or receive it in cash. Effectively, the employee chooses to forgo cash remuneration for a non-taxable benefit. Further it is our view that at the time the employee is assigned the variable credits, he or she will be considered to have received a performance-related award which, as stated above, is required to be included in his or her employment income.

That being said, the employee may be entitled to claim the medical expense tax credit for the amount of his or her annual incentive award that was directed to a HCSA, provided the HCSA is a "private health services plan" as defined in 248(1) of the Act. Under paragraph 118.2(3)(a) of the Act, any amount included in the employee's income from employment that would normally qualify as a medical expense under subsection 118.2(2) of the Act (such as an employee's premium or contribution to a private health services plan), will be deemed to be a medical expense paid by the employee.

In summary, it is our opinion that effective January 1, 2013; an employee would be required to include the value of the variable credits in employment income at the time the credits are assigned to him or her.

We trust these comments will be of assistance.

Yours truly,

Nerill Thomas-Wilkinson
Manager
For Director
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch