29 June 1995 External T.I. 9505455 - FLEX PLANS & CONVERSION OF SALARY TO CREDITS

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1. conversion of salary & other taxable amounts to flex credits
2. cash out of credits to a health spending account

Position TAKEN:

1. taxable at the time of conversion under 56(2) and 5(1)
2. cash out provision disqualifies a health spending account as a phsp

Reasons FOR POSITION TAKEN:

1. In a conversion situation, it is the employee, not the employer, who is paying for or providing the benefit so that the exemptions in 6(1)(a) are not applicable
2. Insurance only pays out in the event of an insured loss. A cash out without the occurance of an insured loss is not insurance

A. Humenuk
XXXXXXXXXX 950545

Attention: XXXXXXXXXX

June 29, 1995

Dear Sirs:

Re: Flexible Benefit Plans

We are replying to your letter of February 20, 1995 concerning the taxation of benefits under a flexible benefit plan.

You ask for confirmation of our position that an employee cannot use pretax income to purchase a non-taxable benefit. Specifically, you ask us to confirm that:

the conversion of salary or other taxable amounts to flexible credits under a flexible benefit plan will be taxable at the time they are credited to the plan notwithstanding that the credits so acquired may be used to obtain a benefit which is not required to be included in income and

the cash out of any unused credit by an employee from a flexible health spending account will compromise the plan's status as a plan of insurance and its qualification as a private health services plan.

In a typical flexible benefit plan, an employee is allocated a pre-determined amount of flexible credits before the beginning of the plan year representing the amount the employer is willing to contribute towards benefits for that particular employee. The plan will typically offer varying levels of benefits for various types of benefits or benefit plans, some of which may be taxable and some of which may not. Prior to the beginning of the plan year, the employee allocates the flexible credits to the various benefits offered under the flexible benefit plan and may, depending on the terms of the plan, use payroll deductions to obtain additional benefits.

However, taxable employee entitlements such as vacation, salary, the right to a salary increase may not be converted to non taxable benefits. If a plan permits an employee to convert an amount of salary, wages or other taxable employee entitlement to something of value (cash or other benefits) the employee will be taxed on that conversion up to the amount of the cash received or the market value of the benefit received pursuant to subsections 56(2) and 5(1) of the Act at the time of the conversion.

The rationale for this position is that while certain benefits provided by an employer are excluded from income by reason of paragraph 6(1)(a) of the Act, it cannot be said that the employer has provided a benefit or made a contribution to a plan where an employee converts something of value to that employee, such as an income entitlement, to flex credits which provide the basis for the contributions or benefits under the plan. It is the employee who made the contribution by converting what he or she otherwise had as an employee benefit to some other property of value (the flex credits). This is comparable to the situation where an employee makes his own premium payment to a private health services plan and the premiums are paid for by the employee with after-tax dollars whereas contributions to such a plan by an employer would not be taxable to the employee.

Before addressing your question relating to cashing out of credits under a flexible health spending account, it is important to distinguish between a flexible benefit plan and the employer-sponsored plans or accounts which form part of that flexible benefit plan. A health spending account is an example of one type of plan which may be available under a flexible benefit plan. Under a health spending account, an employee may be entitled to be reimbursed for eligible medical expenses to the extent that the employee has allocated flex credits to that plan.

In order for a health spending account to qualify as a private health services plan, the plan must involve a reasonable element of risk which is assumed by the employer. Plans which permit either the cash-out or rollover of unused credits to other plans offered under the umbrella of the flexible benefit plan would not qualify as a PHSP. However, a plan which permits the carryforward of either credits or eligible medical expenses (but not both) up to a maximum of 12 months will not be disqualified as a PHSP solely because of such a carryforward provision. A plan which permits the carryforward of credits or expenses for a period in excess of 12 months will not qualify as a PHSP.

We trust our comments will be of assistance to you.

Yours truly,

J.A. Szeszycki
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch