31 May 1999 External T.I. 9821335 - FLEXIBLE BENEFIT PLAN - GENERAL ISSUES

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: Whether a flexible benefit plan meets the conditions set by the Department so that the various benefit components under the plan are subject to specific provisions of the Act in the same manner as if they were offered on their own outside of the program. One of the benefits is a health care spending account (HCSA).

Position: Cannot rule as insufficient information provided. However, some general comments given.

Reasons: In order for benefits under a HCSA to qualify as tax-free, an employee should not have to forego any of his or her current salary or wages to buy coverage under the plan. In this regard, paragraph 9 of IT-529 states that the conversion of any portion of the employee’s salary to flex credits will result in an income inclusion of the amount of salary so converted. On the other hand, the bulletin states that when a contract of employment is renegotiated upon the expiration of a former employment contract to incorporate a flex plan which offers a choice between a decrease in the level of salary or wages over the term of the new contract in exchange for additional flex credits, the additional credits will not be required to be included in the employee’s income as part of salary and wages.

XXXXXXXXXX  	J. Gibbons
		5-982133
Attention: XXXXXXXXXX
May 31, 1999

Dear XXXXXXXXXX:

We are replying to your facsimile of August 17, 1998, in which you requested an advance ruling concerning a proposed flexible benefit plan for one of your clients. We apologize for the delay in responding.

Written confirmation of the tax implications inherent in particular transactions is 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 IC 70-6R3. Since a number of the requirements set forth in IC 70-6R3 (see paragraph 16 in particular) were missing from your submission, we were unable to proceed with your request. Also, because we identified some potential problems in your proposals, as outlined below, we did not pursue the matter further with you at this time. As a result of our review of your submission, we offer the following general comments.

Your client is a local hospital which is considering setting up a flexible benefit plan (herein referred to as the “flex plan”) as an incentive for its employees. As we understand it, the flex plan would contain the following elements:

• The employees would have the choice of: (i) participating in a health care spending account; (ii) receiving an amount as cash; or (iii) taking one week of vacation.
• The employees would be required to make an irrevocable election at the beginning of the plan year.
• The choice of a week of vacation would be on top of what employees now receive.
• The health care spending account would cover those expenses which qualify as medical expenses under subsection 118.2(2) of the Income Tax Act.
• If the health spending account is not fully used up in one year, it can be brought forward one year.
• Where an employee elects to receive an additional salary amount, this amount would be included in the employee’s salary and would be subject to payroll deductions for income tax, unemployment insurance premiums and contributions to the Canada Pension Plan.

For a general discussion of the Department’s position on flex plans, we refer you to Interpretation Bulletin IT-529, “Flexible Employee Benefit Pl an.” As a general rule, employees covered by a flex plan 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 (and, with some exceptions, the selection must be irrevocable). A flex plan can be segregated into multiple parts and the taxation of the benefits offered under the flex plan is not altered by the fact that it is provided under the umbrella of a flex plan.

Accordingly, for example, an employee choosing coverage under a health care spending account (“HCSA”) qualifying as a “private health services plan” (defined by subsection 248(1) of the Act) would not be taxed on employer-paid contributions to such a plan, by virtue of subparagraph 6(1)(a)(i) of the Act. For a discussion of “private health services plan,” we refer you to Interpretation Bulletins IT-529 (paragraphs 14 through 18) and IT-339, “Meaning of ‘Private Health Services Plan.’ ”

In your letter, you stated that the client’s flex plan does not represent the trading of vacation entitlement. We would also note that, in order for benefits under a HCSA to qualify as tax-free, an employee should not have to forego any of his or her current salary or wages to buy coverage under the plan. In this regard, in the documentation describing the health care spending account, which was prepared for your client’s staff, it indicates that an employee must elect to direct 1/52 of his or her salary to pay for coverage under HCSA. If that is the case, we refer you to paragraph 9 of IT-529, which states that the conversion of any portion of the employee’s salary to flex credits will result in an income inclusion of the amount of salary so converted. On the other hand, the bulletin states that when a contract of employment is renegotiated upon the expiration of a former employment contract to incorporate a flex plan which offers a choice between a decrease in the level of salary or wages over the term of the new contract in exchange for additional flex credits, the additional credits will not be required to be included in the employee’s income as part of salary and wages.

It was also not clear to us whether the flex plan would permit the carry-forward of the unused allocation in the HCSA for one or two additional years. In this regard, we refer you to paragraph 16 of IT-529, which states that a plan which permits the carry forward of either the unused allocation or eligible medical expenses (but not both) up to a maximum of 12 months will not be disqualified as a private health services plan by reason of the carry-forward provision.

We also refer you to paragraph 23 of IT-529, which discusses vacation buying. This paragraph states that when a flex plan permits purchased vacation leave to be carried forward to a subsequent plan year, the arrangement may be considered to be a salary deferral arrangement. While vacation pay trusts are excluded from the definition of a salary deferral arrangement, an arrangement to pay for the vacation leave so purchased out of a trust would not qualify as a vacation pay trust as defined in paragraph 149(1)(y). The criteria for establishing a vacation pay trust are explained in the current version of IT-389, “Vacation Pay Trusts Established under Collective Agreements.”

We trust that these comments will be of assistance.

Yours truly,

J.F. Oulton, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate