2 November 1992 Income Tax Severed Letter 9223635 - Status of Payments - Wage Loss Replacement Plans

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.

922363
24(1) M. Eisner
(613) 957-2138

Attention: 19(1)

November 2, 1992

Dear Sirs:

Re: Group Long Term Disability Plan

This is in reply to your letter of August 5, 1992 in which you asked for our comments on certain transitional issues relating to a group long term disability plan that is to be changed so that the employer rather than the employees will make all the contributions thereto. We apologize for the delay in our response.

24(1)

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

It is apparent that your situation relates to a specific proposed transaction. Confirmation of the tax consequences of such a transaction will only be provided in response to a request for an advance income tax ruling. The procedures for requesting an advance income tax ruling are set out in Information Circular 70-6R2. We are, however, providing you with the following general comments which should not be construed as relating to a particular fact situation.

Our Comments

The Department's general position on periodic amounts received by an employee or a former employee as compensation for loss of income from an office or employment that were payable under a sickness, accident, disability or income maintenance insurance plan (wage loss replacement plan) is set out in Interpretation Bulletin IT-428.

In our comments below, we have referred to a group long term disability plan under which the employees made all the contributions as an "Initial Plan" and a plan of that type under which the employer made contributions as a "Second Plan". We also wish to note that our comments set out below are based on the premise that on the conversion of an Initial Plan to a Second Plan, the terms of the Initial Plan concerning benefits will be continued in the Second Plan.

Where an Initial Plan which provides for the payment of long term disability benefits is converted to a Second Plan, one of the concerns is whether an employee would be entitled to deduct the premiums paid by that employee prior to the conversion against periodic amounts received pursuant to the Second Plan. In this regard, the wording preceding subparagraph 6(1)(f)(iv) of the Income Tax Act (the Act) refers to a plan in respect of which an individual's employer has made a contribution while subparagraph 6(1)(f)(v) of the Act refers to the contributions made by the individual under the plan. As a consequence, it is our view that the Second Plan must be regarded as being the same plan as that which existed prior to the conversion if the individual is to be entitled to deduct the premiums he/she paid prior to the conversion. Where an Initial Plan is converted to a Second Plan, it is our view that a significant factor to be considered is that periodic payments made under the former plan are non-taxable whereas periodic payments made under the latter plan are subject to tax. By virtue of this factor, it is our view that the conversion would result in a different plan with the result that the members thereof could not apply contributions made under the Initial Plan against taxable benefits received pursuant to the Second Plan.

While this point may be apparent, it is our view that the conversion is not an "internal alteration" of the type referred to in paragraph 13 of IT-428 because the change results in a new plan.

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

In relation to the situation where an Initial Plan that provides for long term disability benefits is converted to a Second Plan, we have considered the following situations:

• (a) A disabled individual was receiving benefits under the Initial Plan at the time of the conversion; (b) An employee was receiving short term disability benefits at the time of the conversion. When these benefits cease, the individual would qualify for long term disability benefits if the individual was still considered to be disabled at that time;
• (c) An individual had a degenerative disease at the time of conversion although the individual continued to carry out his/her normal employment duties. It is anticipated that the individual will become disabled and begin to receive long term disability benefits a short time following the conversion;
• (d) An individual had been receiving long term disability benefits under the Initial Plan immediately prior to the conversion. However, a short time following the conversion, the individual commences to carry out his/her normal employment duties. If the individual becomes disabled a second time within a certain time frame, the individual would immediately be entitled to receive long term disability benefits if the second period of disability can be regarded as being related to the cause of the initial period of disability;
• (e) A disabled individual was receiving reduced long term disability benefits under the Initial Plan at the time of the conversion because the individual was in the process being rehabilitated (i.e., the individual was earning some employment income in attempting to adjust to an employment related environment). However, if the rehabilitation turns out to be unsuccessful and the individual continued to be disabled, normal long term disability benefits would again be paid to him/her;

Our comments below on (b) and (c) are based on the assumption that the individual in each of these two situations will receive long term disability benefits under the Second Plan subsequent to the conversion. Similarly, our comments on (d) are based on the assumption that the individual will receive long term disability payments under the Second Plan after the conversion as a result of a second period of disability and our comments on (e) are based on the assumption that the individual will receive normal long term disability benefits under the Second Plan following the conversion.

However, before commenting on the situations set out in (a) to (e) above, we wish to provide some clarification on paragraph 21 of IT-428

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

which is relevant. In addition, we are also making comments concerning the conversion of an Initial Plan to a Second Plan where the former plan is in a deficit position. Our comments are as follows:

(I) Part of paragraph 21 of IT-428 is set out below:

"Whether or not the benefits an employee receives under a plan are required to be included in his income is governed by both the type of plan in effect at the time of the event that gave rise to them and any changes in the plan subsequent to that time. When a pre- June 19, 1971 plan, or an employee-pay-all plan, is changed and becomes a new taxable plan, an employee who was receiving benefits at the time of the change may continue to receive them tax-free thereafter but only in the amount and for the period specified in the plan as it was before the change. Where the new taxable plan provides any increase in benefits, whether by increases in amounts or through extension of the benefit period, the additional benefits must be included in income since they flow from the new taxable plan."

With respect to the above excerpt, our first observation is that the opening sentence of paragraph 21 addresses the type of situation where an employee is receiving benefits under one plan and that plan might be converted to a different plan (e.g., a non- taxable employee-pay-all plan is converted to a new taxable plan). Accordingly, the sentence should not be construed as setting out interpretative comments on circumstances where an individual has a degenerative disease but is not in a disabled condition while one plan is in effect and who subsequently becomes disabled following a conversion. It also follows that the event referred to in the first sentence of paragraph 21 can generally be regarded as being the physical or mental condition of an individual in respect of which benefits may be paid. Furthermore, the comments in the second sentence of the excerpt have been made with respect to the quantum of certain benefits that would be regarded as continuing to flow from the old plan following a conversion on the assumption that where insurance premiums were charged by an insurer prior to the conversion, those premiums would normally have been charged on the basis that benefits being paid at the time of the conversion would continue subsequent to the conversion even though the old plan ceases to exist. As a consequence of these two points, where an individual was receiving benefits at the time of the conversion of a non-taxable plan to a taxable plan, the benefits paid subsequent to the conversion would be non-taxable in the amount and for the period specified in the non-taxable plan on the basis that those benefits, (to the extent that they are non-taxable), would be considered to have flowed from the non-taxable plan rather than having been paid "pursuant to" a plan "to or under which his employer has made a contribution" for the purposes of paragraph 6(1)(f) of the Act.

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

• The above clarifying comments are consistent with the overall context of paragraph 21 of IT-428.
• (II) It has come to our attention that a reason for converting an Initial Plan to a Second Plan may be that the former plan is in a deficit position (i.e., sufficient funds are not available for the subsequent payment of benefits that will be required to be made under the Initial Plan) which will be remedied by employer contributions made subsequent to the conversion. While we are not in a position to provide informative comments on this type of situation without a review of all the relevant facts and documentation, the problem is that benefits, which would otherwise be considered to have flowed from a non-taxable plan, would be provided as a consequence of contributions from the employer. In other words, those benefits could no longer be regarded as having been received solely in respect of contributions made by employees. Accordingly, we believe that an important consideration, inter alia, would be whether the old plan could be regarded as one under which an employer has made a contribution for the purposes of paragraph 6(1)(f) of the Act. In the event that this were to be the case, all periodic payments made subsequent to the conversion, which would otherwise be considered to have flowed from a non-taxable plan, would be described in paragraph 6(1)(f) of the Act.
• While the above comments may be germane to a particular fact situation, our general comments set out below have been made on the assumption that this is not the case.

Our comments on the situations set out in (a) to (e) are set out below:

(A) Since the individual in (a) became disabled and was receiving benefits prior to the conversion, it is our general view, pursuant to the comments set out in paragraph 21 of IT-428 and our related clarifying comments (See (I) above), that the long term disability benefits paid subsequent to the conversion would continue to be non-taxable in the amount and for the period specified in the plan as it was before becoming a Second Plan.

(B) In the case of (b), it appears that the Initial Plan would not have included terms which would have defined the benefits that would be paid in the circumstances set out in (b) immediately prior to the conversion. In addition, it appears that premiums may not have been charged under the Initial Plan in respect of this situation because long term disability benefits did not commence until some time following the conversion. Accordingly, it seems that the periodic long term disability benefits would be taxable to the individual (subject to a reduction as set out in paragraph 6(1)(f) of the Act for any contributions made by the individual in respect of the Second Plan) on the basis that they

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

• are being received "pursuant to" a plan "to or under which his employer has made a contribution" for the purposes of paragraph 6(1)(f) of the Act. However, we do not preclude the possibility that the terms of the relevant documentation in respect of an actual fact situation might indicate otherwise.

(C) In the case of (c), it seems unlikely that the Initial Plan would have included terms which would have defined the benefits that would be paid in the circumstances set out in (c) immediately prior to the conversion. Consistent with this comment, it also appears likely that premiums may not have been paid under the Initial Plan in respect of this situation because the period of disability did not commence until some time following the conversion. Accordingly, it seems that the periodic long term disability benefits provided subsequent to the conversion would be taxable to the individual (subject to a reduction as set out in paragraph 6(1)(f) of the Act for any contributions made by the individual in respect of the Second Plan) on the basis that they are being received "pursuant to" a plan "to or under which his employer has made a contribution" for the purposes of paragraph 6(1)(f) of the Act. However, we are also adding that the terms of the relevant documentation in respect of an actual fact situation might indicate otherwise.

• Pursuant to comments in your letter, we have also considered certain comments made in the tax service entitled "Access to Canadian Income Tax" which, in connection with a letter dated May 16, 1986 issued by this Department, stated "that where benefits were being received or there was an entitlement to benefits from a claim made in respect of an event that took place prior to the date of conversion to an employee-pay-all plan, there would be no change in the tax status of these benefits." With respect to these comments (and those appearing in the letter of May 16, 1986), the word "event" was used in a context where an individual was entitled to benefits as a consequence of a claim that arose prior to a conversion or was receiving benefits prior to the conversion. In our view, it follows that benefits (in the amount and for the period specified in the plan as it was before conversion) being received by an individual in either of these two sets of circumstances subsequent to the conversion should be considered to have flowed from the old plan. As a consequence of our comments in the first paragraph set out above under (C), this would not appear to be the case with respect to the individual referred to in (c). Accordingly, the above quote from "Access to Canadian Income Tax" cannot, in our view, be used as a basis for considering the benefits that the individual referred to in (c) receives subsequent to the conversion to have flowed from the Initial Plan.

As requested in your letter, we have also referred to comments in
paragraph 3 of IT-428 which concerns section 19 of Income Tax

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

• Application Rules (ITAR). In this regard, subsection 19(1) of the ITAR excludes certain amounts from a taxpayer's income which would otherwise be subject to the provisions of paragraph 6(1)(f) of the Act. In part, subsection 19(1) of the ITAR refers to "amounts received by a taxpayer ... in consequence of an event occurring before 1974 ... pursuant to a plan ... that was established before June 19, 1971" (emphasis added). With respect to the word "event", paragraph 3 of IT-428 includes the following comments:
• "It is to be noted that, for 1974 and subsequent taxation years, the exemption in section 19 of the ITAR is applicable only if amounts received by a taxpayer are attributable to an event occurring before 1974. In this context, the word "event" has reference to the thing that caused the disability. ... Similarly, in the case of a degenerative disease such as muscular dystrophy, the "event" is the onset of the disease however much later the incapacity occurs."
• As a consequence of our clarifying comments concerning paragraph 21 of IT-428 (See I above) and since the word "event" is not used in paragraph 6(1)(f) of the Act, it is our view that the comments in paragraph 3 of IT-428 cannot serve as a basis for considering any part of the long term disability benefits paid subsequent to the conversion to be regarded as having flowed from the Initial Plan. It is also our understanding that section 19 of the ITAR is not applicable to this situation as it has not been indicated that the onset of the disease commenced prior to 1974. As a further comment, we wish to note that the Department is not prepared on an administrative basis to view those benefits as being non-taxable in the amount and for the period specified in the Initial Plan on the assumption that benefits could be considered to have flowed from the Initial Plan.

(D) With respect to (d), it is our general view, consistent with comments in (I) above, that since the initial disability occurred prior to the conversion of the Initial Plan to the Second Plan, the second period of disability is considered to be an extension of the initial disability, and insurance premiums while the Initial Plan was in effect, would have normally been charged in respect of the possibility of a second period of disability following the conversion, the benefits paid subsequent to the conversion would be non-taxable to the extent set out in (A) above.

(E) In the case of (e), it is our general view, consistent with (I) above, that since the disability occurred while the Initial Plan was in effect, and insurance premiums, while that plan was in effect, would have normally been charged in respect of the

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

• possibility of such an individual being entitled to normal long term disability benefits following the conversion, the benefits paid subsequent to the conversion would be non-taxable to the extent set out in (A) above.

As a final comment, we wish to emphasize that the foregoing comments are broad and general in nature. Accordingly, you may wish to consider the submission of an advance income tax ruling request.

We trust our comments will be of assistance to you.

Yours truly,

P.D. Fuoco
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information