15 May 1998 External T.I. 9806245 - HEALTH SPENDING ACCT & FLEX BENEFIT 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.

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) Whether an option which allows an employee to choose between coverage in a health spending account and vacation is a flexible benefit plan.

(2) Whether the establishment of such a plan in return for a reduction in vacation will be taxable to the employee.

Position:

(1) The plan is likely a flexible benefit plan.

(2) Whether the forfeiture of vacation is taxable to the employee depends of whether it results from a valid renegotiated employment contract.

Reasons:

(1) A flexible benefit plan is not defined in the Act. According to the summary in IT-529, a flex plan can generally be described as a program of delivering company benefits where the employees are able to select the type and level of coverage from a menu of available benefits. A menu of 2 benefits qualifies.

(2) If the forfeiture of vacation results from the renegotiation of a valid employment contract, it is not a willing forfeiture by the employee and would not be taxable as employment income to the employee.

XXXXXXXXXX 			980624
J. Gibbons

Attention:  XXXXXXXXXX 

May 15, 1998

Dear XXXXXXXXXX:

We are replying to your letter of March 11, 1998, in which you raise several questions concerning the establishment of a “health spending account” and/or a “flexible benefit plan” for one of your clients.

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. The following comments are, therefore, of a general nature only.

Your client is a local municipality which has both staff that are governed by collective agreements and those that are not (the “exempt staff”). For the exempt staff, you are considering the establishment of a health spending account. The account would be funded by cutting the exempt staff’s vacation entitlement by two weeks and depositing the equivalent dollar amount in the health spending account. The employees would have the option of purchasing back some or all of the vacation days prior to the start of the new plan year. A similar arrangement would be made with the union employees, except that overtime compensation, as well as vacation entitlements, might be used as the funding vehicle.

The tax consequences arising from a change in an employee’s employment package as part of an amended employee compensation arrangement depend on the employee’s legal entitlements under the contract of employment. When a contract of employment is renegotiated upon the expiry of a former employment contract to incorporate a reduction in vacation entitlement and a corresponding increase in the amount of premiums paid by the employer in respect of a benefit plan described in subparagraph 6(1)(a)(i) of the Act, the premium paid by the employer will not be treated as a taxable benefit to the employee.

On the other hand, if an employee has a legal entitlement, pursuant to the terms of an existing employment contract, to a certain number of vacation days, the diversion of a portion of those vacation days in return for entitlement for health related coverage, which would have been non-taxable to the employee by virtue of subparagraph 6(1)(a)(i) of the Act if his or her employer had made the contribution, results in additional employment income for the employee. In this situation, the employee is considered to have paid for the additional benefits by way of additional services rendered. If the previous contract of employment is only verbal, the onus will be on the employer to satisfy the Department that a valid renegotiated employment agreement is in place and that the increased benefits are funded by the employer.

If the health spending account is funded using overtime compensation, it is our view that the employee will be considered to have paid for the benefits using the overtime compensation.

The criteria for determining whether a health plan qualifies as a “private health services plan” is set out in Interpretation Bulletin IT-339, (“Meaning of ‘Private Health Services Plan’”). For this purpose, whether a health spending account is set up as an adjunct to a flexible employee benefit plan or as a “stand-alone” plan is irrelevant. However, as indicated in the “Summary” in Interpretation Bulletin IT-529 (“Flexible Employee Benefit Programs”), a flexible benefit plan can generally be described as a program of delivering company benefits where the employees are able to select the type and level of coverage from among a menu of available benefits. In addition, the Summary indicates that a particular flexible employee benefit program will not necessarily contain all the features described in IT-529. Accordingly, it is our view that an arrangement which provides taxpayers with the option of choosing between a health spending account and vacation entitlement can be considered a flex plan, and the comments in IT-529 will apply to such a plan.

Paragraph 7 of IT-529 indicates that a flex program will not be considered an employee benefit plan if the credits are notional, i.e.,if the flex credits have no redemptive value and nothing of value is forfeited by the employee to acquire the credits, and the employee is required to make an irrevocable selection of benefits before the beginning of the year, except in the case of an occurrence of a “life event” or a change in employment status. It is our view that the requirements in paragraph 7 will likely be met in a situation where, as a result of a valid renegotiated contract, a flex plan is established which allows employees to select between additional vacation entitlement and coverage under a health spending account at the start of each plan year. However, this assumes that any unused coverage under the flex plan cannot be redeemed by the employee.

Your question concerning the extent to which a person must be dependent on an individual at some time in the year to qualify as a “dependant” is a question of fact. Accordingly, the question should be directed to the responsible local tax services office, along will all of the facts of the particular situation.

We trust that these comments will be of assistance.

P. Spice
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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