19 May 1998 External T.I. 9809225 - FLEX PLANS - CREDITS BASED ON SALARY

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) The tax consequences of changes to the amount of flex credits awarded to an employee where the flex credits are awarded on the basis of an employee’s salary, which changes during the year.

(2) Interpretation of paragraph 8 of IT-529. In particular, the value of allocated credits constructively received by an employee and whether all employees of the plan or only the particular employee is affected.

(3) The tax consequences of a change in a flex plan from credit carry-forward to medical expense carry-forward and vice versa.

(4) The interpretation of paragraph 7 of IT-529. In particular, whether the requirement (that nothing of value be forfeited by the employee to obtain flex credits if flex credits are considered to have no value) will apply where an employee benefit plan is cancelled in favour of a flexible benefit plan.

Position:

(1) In some cases the increased flex credits will have no effect on the plan. In other cases, the particular employee will be considered to have constructively received employment income equal to the value of the allocated credits, or, alternatively, the entire plan may be considered an employee benefit plan.

(2) The value of the allocated credits is just that, the value of the credits, not the value of the benefits paid to the employee. Constructive receipt applies to all employees.

(3) A one-time change may be acceptable. A plan that allows changes from year to year will likely not qualify as a PHSP.

(4) No comments given.

Reasons:

(1) A change in employment status entitles the employee to make prospective changes to the allocation of flex credits to take into account the change. Other salary-related changes in flex credits are not covered by this exception.

(2) This is the position in IT-529.

(3) A plan that allows a change in carry-forward mode from year to year would not have the necessary element of risk.

(4) This is a question of fact.

XXXXXXXXXX 	5-980922
		. Gibbons

Attention: XXXXXXXXXX

May 19, 1998

Dear XXXXXXXXXX:

We are replying to your letter of April 7, 1998, in which you raise several questions with respect to flexible employee benefit plans (“flex plans”).

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.

Part A of your letter relates to flex plans which award credits on the basis of salary. You enquire as to the tax consequences of changes to the amount of flex credits awarded to an employee that are entailed by changes in salary and/or employment status after the beginning of the plan year. According to paragraph 5 of Interpretation Bulletin IT-529 (“Flexible Employee Benefit Programs”), in order for an employer to be entitled to segregate the taxable and non-taxable benefits offered by its flex plan, employees are required to choose which benefits will be provided under the flex plan and how the benefits will be funded prior to the beginning of the plan year. In addition, the selection must be irrevocable. However, as indicated in paragraph 6 of IT-529, where the amount of flex credits allocated to the employee is altered as a result of a change in employment status, adjustments to the original selection of benefits to accommodate an increase or decrease in the amount of credits available is permitted on a prospective basis.

On the other hand, the exception in paragraph 6 of IT-529 does not apply where the amount of flex credits awarded to an employee changes because of a salary adjustment not entailed by a change in employment status. Accordingly, the tax consequences described in paragraph 8 would apply, that is, the employee will be considered to have constructively received employment income equal to the value of the allocated credits unless the entire Flex Plan can be considered an employee benefit plan. Where the entire Plan is an employee benefit plan, employee contributions are not deductible. This brings us to Part B of your letter. First, the phrase, “the value of all benefits received” in paragraph 8 is meant to refer to “the value of the allocated credits.” Second, constructive receipt in this instance applies to all employees in the plan.

Question 3 of Part A of your letter asks whether applying additional credits to reduce employee contributions or increasing employee contributions to reflect decreased credits will affect the tax status of all of the flex credits under the plan. Where the fluctuation in flex credits ensues from a change in employment status, changes to employee contributions may be made without affecting the entire plan. Of course, any amounts contributed by the employee will be included in his or her income.

In Part C, you enquire whether the Department would permit an employee to change from credit carry-forward mode in plan year 1 to expense carryforward in plan year 2 with respect to a health spending account. You state the change would only be applied to unreimbursed expenses incurred in plan year 2 and plan year 1 would still be administered as a credit carry-forward year. Our position with respect to carry-forwards, which is described in paragraph 16 of IT-529, is that a plan which permits the carry-forward of either unused credits or eligible medical expenses, but not both, will not be disqualified as a private health services plan solely by reason of the carry-forward provision. It is also our view that a one-time change in a plan from credit carry-forward to medical expense carry-forward or vice versa will not generally disqualify a plan. On the other hand, a plan that permits such changes on an annual basis would likely be disqualified as a private health services plan because it would not have the necessary element of risk to be considered a plan of insurance.

The last part of your letter, Part D, deals with paragraph 7 of IT-529, which states that flex credits are considered to be notional amounts with no intrinsic value only if the credits have no redemptive value and nothing of value has been forfeited by the employee to acquire the credits. Specifically, you enquire whether changes to existing benefit plans and coverage will be considered as something of value that has been forfeited by the employee to acquire the credits. The tax consequences, if any, of replacing existing benefit plans with notional credits depends on the rights employees have under the existing plans. Therefere, we are unable to provide any comments in this regard since it is essentially a question of fact which can only be answered after a review of the plan documents and relevant terms of employment.

We trust that these comments will be of assistance.

Yours truly,

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