19 February 1992 External T.I. 9131905 F - Private Health Services Plan

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.

24(1)

Attention:  19(1)

February 19, 1992

Dear Sirs:

Re:  Supplemental Health Care Account ("SHCA")

This is in reply to your letter dated November 13, 1991 wherein you requested that we confirm the income tax treatment of several types of SHCAs. We acknowledge the additional information obtained during our telephone conversations (Vanasse/19(1)) which we have incorporated into the following statement of facts. We apologize for the delay encountered in preparing our response.

FACTS

24(1)

24(1)

YOUR VIEWS

It is your understanding that the income tax treatment in respect to all three SHCAs are as follows:

A)     All amounts credited by the employer to the employees' SHCA are fully deductible to the employer.

B)     The amounts credited by the employer to the employees' SHCA do not constitute taxable income to the employees.

C)     Benefits paid pursuant to the coverage provided under the SHCA are not taxable income to the employees.

D)     Benefits paid pursuant to the coverage provided under the SHCA to terminated or retired employees are not taxable to these employees.

E)     Benefits paid pursuant to the coverage provided under the SHCA to the spouse and/or dependent children of deceased employees are not taxable to the spouse or dependent children.

OUR COMMENTS

The particular circumstances outlined in your letter on which you have asked for our views seem to be factual situations involving specific taxpayers. As explained in Information Circular 70-6R2, it is not the Department's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve specific taxpayers and completed transactions, you should submit all relevant facts and documentation to the appropriate district taxation office for their views. Furthermore, we are unable to comment specifically on each particular plan without having reviewed the plan documents and trust agreements. However, we are prepared to offer the following general comments which may be of some assistance to you.

Private Health Services Plan ("PHSP")

We are assuming that the question regarding the tax treatment of the SHCAs is whether each of the arrangements described above constitutes a PHSP. We are also assuming that the SHCAs are broad based plans available to employees by virtue of their office or employment.

General

A PHSP, as this term is defined in subsection 248(1) of the Act, means a contract of insurance in respect of hospital and/or medical expenses, or a medical and/or hospital care insurance plan. Furthermore, as discussed in paragraph 3 of Interpretation Bulletin IT-339R2, a PHSP must contain the following basic elements:

i)     an undertaking of 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.

In addition, it is important that a plan document exist which would outline the medical expenses covered by the SHCAs. Coverage provided under the plan must be restricted to those expenses which normally would qualify as medical expenses described in subsection 118.2(2) and Regulation 5700 of the Act.

Risk

In order to meet the necessary requirements of a PHSP, the plan or arrangement that purports to be a PHSP must be tested to ensure that the plan involves a reasonable degree of risk which is being transferred to the insurer. The basic elements contained in paragraph 3 of IT-339R2 are based on the decision of Mr.Justice Pennell in Re Bendix Automotive Ltd. and U.A.W.,Local 195 (1971), 20 D.L.R. (3d) 151 (Ont. H.C.). This case involved a question of whether or not a clause in a collective agreement was a "contract of insurance" and therefore void pursuant to a prohibition contained in section 25(1) in the then new Health Services Insurance Act in Ontario.

It is also useful to look at the decision of the Federal Court of Appeal in the case of Consolidated-Bathurst Limited v. Her Majesty The Queen, 87 DTC 5001, at 5006, where the court held that:

"... insurance involves risk shifting and risk distributing."

This view is shared by Brown and Menezes in Insurance Law in Canada, at p.1, wherein it is stated that:

"Indemnity insurance is a mechanism for the distribution of the financial burden of an actual loss among a wide group of persons who potentially run the risk of personally incurring similar loss. The members of this group (the insureds) pay premiums to an intermediary (an insurer) who provides indemnity for those relatively few clients who actually suffer injury or damage. Fundamental to this mechanism from a legal perspective is the insurance contract - the agreement whereby the insured transfers the burden of potential loss to the insurer."

It is therefore our view that plans that provides an indefinite carry forward of unused credits or amounts in the plan and/or the indefinite carry forward of unclaimed medical expenses would not be considered to have a reasonable degree of risk.

One example of what the Department views as the transfer of a reasonable degree of risk may be found in Advance Income Tax Ruling ATR-23, published on July 14, 1987. In this plan, employees were reimbursed for 80% of the cost of medical expenses up to a maximum of $500 per year. At the end of each benefit year, expenses that exceeded $500 in the year could be carried forward to the next benefit year. Unused amounts in the plan at the end of a year were forfeited.

Therefore, plans that do not have a reasonable degree of risk would not qualify as a PHSP and as such the employer's contributions to these plans would not be excluded from an employee's income pursuant to subparagraph 6(1)(a)(i) of the Act. The plan may be an employee benefit plan in which event the employer's contribution to the plan would only be included in the employee's income as amounts are paid out to the employees from the plan. The employer would only be able to claim a deduction for its contributions when amounts are paid out of the plan to the employee.

Self-Insurance

With respect to the funding options of the SHCAs, paragraph 7 of IT-339R2 makes the general statement that an arrangement where the employer reimburses its employees for the cost of medical or hospital care "may" come within the definition of a PHSP provided the employer has a contractual obligation to make such payments. This occurs where the employer is obligated under the employment contract to reimburse such expenses incurred by the employees or their dependants. Whether or not such an obligation exists would involve a finding of fact in each particular situation.

The Department has accepted that health and welfare trusts may provide coverage under a PHSP on a self-insurance basis.

Tax Implications To Employee

Provided that a SHCA is a PHSP, the value of the benefit received or enjoyed by the employee derived from his or her employer's contribution to the SHCA would not be taxable to the employee pursuant to the exception found in subparagraph 6(1)(a)(i) of the Act. In addition, benefit payments provided to an employee under a PHSP, whether the plan is (1) self-insured by the employer or, (2) available through a health and welfare trust (whether premiums are paid to an insurance carrier or self-insured by the trust) or, (3) available through an insurance carrier without the use of a health and welfare trust, are not subject to tax under the Act.

In situations where benefit payments are received by an employee or by the spouse and/or dependent children as a result of the subsequent use of unused credits remaining in his or her SHCA at the time of his or her termination of employment, retirement or death, it is the Department's position that, as the unused credits have an indefinite carry forward, these plans would not have a reasonable degree of risk and as such would not qualify as a PHSP. However, the Department is prepared to accept, as a PHSP, plans which permit the carry forward of unused credits for a period of one year after the date of termination of employment, retirement or death, after which time any remaining unused credits are forfeited. In this case, the use of these credits would continue to be received by the employee or by his or her spouse and/or dependent children on a tax-free basis.

Tax Implications to Employer

Paragraph 6 of IT-85R2 states that contributions made by an employer to a health and welfare trust must not exceed the amount required to provide the benefits under the trust. In order to meet this requirement, contributions to a health and welfare trust pertaining to self-insured coverage by the trust, such as the SHCA in Plans "B" and "C", must be actuarially determined. As the contributions for the SHCA coverage provided under both these plans are not actuarially determined, the trusts would not qualify as health and welfare trusts as described in IT-85R2. Therefore, both trusts would be considered ordinary trusts and, as a result, contributions to these trusts would not be deductible as they would represent disbursements made on account of capital. However, the employer would be entitled to a deduction when benefits are paid out to the employee(s) out of the SHCA.

Assuming that a trust otherwise qualifies as a health and welfare trust as described in IT-85R2, paragraph 8 of that bulletin mentions that contributions to a health and welfare trust by an employer using the accrual method of computing income are deductible in the taxation year in which the legal obligation to make the contributions arose to the extent that the contributions are reasonable in the circumstances and laid out to earn income from a business or property.

With respect to PHSP benefits provided directly by the employer, paragraph 7 of IT-339R2 states that where an employer has a self- insured PHSP, such as the SHCA in Plan "A", the employer will be able to deduct the benefits which are payable to the employees if the employer is obligated under the employment contract to reimburse such expenses incurred by the employees or their dependants. As a result, amounts that are simply credited by the employer to an employee's SHCA, such as in Plan "A", would not be deductible by the employer pursuant to paragraph 18(1)(e) of the Act as this would constitute a contingency reserve.

Taxation of Trust

Although not specifically referred to in your letter, we would mention that, as Plans "B" and "C" involve health and welfare programs administered through trust arrangements, paragraphs 11 to 14 of IT-85R2 should be consulted as to the deductibility of certain expenses incurred by the trust.

The above comments reflect an expression of opinion only, and as such, are not binding upon the Department.

We trust our comments will be of assistance to you.

Yours truly,

P.D. Fuocofor DirectorBusiness and General DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch