14 January 1988 Income Tax Severed Letter 5-4015 - Health and Welfare Trusts; Interpretation Bulletin IT-85R2

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.

N.R. Mitchell (613) 957-2134 Re: Health and Welfare Trusts; Interpretation Bulletin IT-85R2

This is in reply to your letter of September 21, 1987 - following up on our letter of July 25, 1987 - in which you ask a number of additional questions with respect to health and welfare trust arrangements. We shall deal with these questions in the order in which they are posed in your letter.

1. You refer to our earlier opinion that employer contributions to a health and welfare trust may include some allowance for reasonable administration costs. You also refer to the administration expenses permitted in computing such a trust's income which are described in paragraph 12 of Interpretation Bulletin IT-85R2

(the "Bulletin"). You ask us to confirm your assumption that it would be acceptable to "load up" employer contributions to a health and welfare trust to include investment management expenses.

We would agree with your conclusion, subject always to the condition that the investment management expenses in question are reasonable in the circumstances. It is also our view that the total "administrative load" paid by the employer in any particular year should not exceed an amount which corresponds to the administration costs anticipated for that year only.

2. We would confirm that employer contributions to a health and welfare trust, including those portions which relate to the reasonable administration costs of the trust, would be deductible to the employer outside the trust. As is stated in paragraph 8 of the bulletin, these contributions must be reasonable and must be laid out to earn income from business or property. It is also our view that in computing the income of the trust which would be subject to tax, the trust would be permitted to deduct amounts relating to administrative expenses as detailed in paragraph 12(b) of the Bulletin, notwithstanding that the employer's own deductible contributions to the health and welfare trust included amounts in respect of such administrative expenses.

3. You have asked us to clarify our earlier statement that "some allowance" for reasonable administration costs could be included in an employer's contributions to a health and welfare trust, without jeopardizing the status of the trust itself or the deductibility of these contributions to the employer. Our use of the words "some allowance" was not intended to mean that in all cases only some portion or percentage of the total administration costs would be permitted. Our intention was simply to limit the allowable load for administration expenses to an amount which is considered reasonable in the circumstances. Provided the administration expenses themselves are in fact reasonable, it would indeed appear possible for an employer to make allowable, deductible contributions to the health and welfare trust in an amount equivalent to the actual administration expenses to be incurred by or behalf of the trust.

4. You ask if we would consider an amount up to but not exceeding 12% of total contributions to a health and welfare trust to be a "reasonable" administration cost. (The figure of 12% is based upon the customary maximum "administrative services only" charges of insurance companies to administer self-insured/funded benefit plans for employers, under health and welfare trust arrangements.)

We cannot provide a categorical response to this question. The question of "reasonableness" would be a question of fact which could only be dealt with on a case-by-case basis. Furthermore, where the allocation for administration expenses is expressed as a percentage of the total contributions to the trust, the Department would need to be satisfied that this allocation was in keeping with the actual administration costs incurred.

5. (a) You ask if a taxable benefit to the employees would result in the case of a trust providing self-insured, non-taxable (i.e., employee-pay-all) wage loss replacement plan benefits if the employer contributes administration expenses necessary to provide the benefits.

In our view, as explained in paragraph 16 of Interpretation Bulletin IT-428 , an employee-pay-all plan is a plan the entire premium cost of which is paid by the employees. It is a question of fact whether or not an employee-pay-all plan exists and the onus is generally on the employer to prove the existence of such a plan. As we see it, the contributions by the employer of administrative expenses out of his own funds would take a plan out of the category of employee-pay-all plans. The result would be that benefits paid out of the plan would be taxable under paragraph 6(1)(f) of the Act to the extent that the benefits exceed the employee's own contributions to the plan (subject to the details and exceptions explained in IT- 428).

(b) You describe a situation in which a trust is established to provide insured group term life insurance coverage in excess of $25,000 for each employee. If the employer's contributions are "loaded up" to include administration expenses, you ask if the employees would be taxable on the net premium, excluding the administration load, or on the loaded up premium, including the administration portion.

Subsection 6(4) of the Act requires that an employee include in income for the year the "premium" in respect of any period in the year for any excess over $25,000 of the amount of life insurance in effect on the life of the taxpayer during that period under a group term life insurance policy. We understand the term "premium" to denote the total amount paid to an insurer in consideration for insurance coverage. To the extent that such premiums are applicable to life insurance coverage in excess of $25,000, a taxable benefit to the employee would result. However, the taxable benefit to the employee would be based on the premium actually paid to the insurer by the trustee and not on the loaded-up amount paid by the employer to the trustee in respect of the insurance coverage. In other words, no amount would be included in the employee's income as a result of the payment of reasonable administration costs by the employer to the trustee.

6. In your earlier letter you asked if the "meaning and purpose" of a health and welfare trust would be satisfied where the financial advantage of the arrangement is gained by other than the employer or its employees. In our reply we stated (among other things) that a third party, such as an insurer, may derive a profit from a health and welfare trust arrangement - i.e., by receiving more in premiums than is paid out in benefits and expenses - and that such a situation resulting from normal, reasonable business practices would not disqualify the health and welfare trust arrangement.

Following up on your earlier question, you remain concerned about possible cases in which the only advantage of a health and welfare trust arrangement is gained by persons other than the employer or its employees. You give as an example the hypothetical situation of a trustee of the arrangement who also acts as administrator, with the result (as you see it) that there is a complete lack of financial auditing and reporting control by the employer and by the Department of National Revenue. The administrator reports on the financial operation of the trust to the trustee and the trustee reports to the employer and to the Department. Where the trustee is also the administrator, the trustee has a direct monetary interest in the disclosure and reporting of the financial operation of the trust. It is your understanding that financial reports (e.g., T3 filings) of the trustee are generally not questioned, audited or regulated by either the employer or Revenue Canada. Therefore, where the trustee is also the administrator, you ask:

(a) does the Department consider this to be consistent with "normal, reasonable business practices";

(b) if so, would the Department also permit the loading up of employer contributions for administration in this situation; and

(c) if not, would the circumstances described above disqualify the arrangement from being treated as a health and welfare - trust?

We would advise you that we would not impose a hard and fast requirement that the positions of trustee and administrator of a health and welfare trust be occupied by different persons.

We would not consider this to be inconsistent with normal, reasonable business practices; indeed, it is our understanding that in many cases these two functions are fulfilled by one and the same individual. Where this is the case, it would still be permissible, in our view, for employer contributions to the trust to include an allocation for administration expenses. It should be stressed that the administration element must be reasonable in the circumstances and capable of substantiation through appropriate documentation and accounting. Once again, compliance with the standard of reasonableness would be a question of fact which could only be resolved on a case-by-case basis. The returns and the financial records of such health and welfare trusts are fully liable to the Department's regular compliance investigation procedures.

In the event that the administration expenses (or claims) of a health and welfare trust were dishonestly "padded" by the trustee/administrator or were otherwise in excess of a reasonable amount, the Department could take the position that the contributions to the fund were in excess of an amount reasonably necessary to provide health and welfare benefits and disqualify the arrangement on that basis - see paragraph 6 of IT-85R2 . Furthermore, as is explained in paragraph 8 of that Bulletin, the deductibility to the employer of contributions to the trust could be denied to the extent that these contributions exceed a reasonable amount or were not laid out to earn income from a business or property. Finally, the trustee's dealings with the trust funds for which he is responsible - including allocations for his own and other trust expenses - would presumably be subject to the usual fiduciary obligations imposed upon a trustee by the general law.

If you are aware of any particular cases of abuse in the administration of health and welfare trust arrangements, we would invite you to make such information known to the Department.

We trust this information will be of assistance. Yours truly,

ORIGINAL SIGNED BY XXXX for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch