15 November 1999 External T.I. 9925405 - HEALTH CARE SPENDING ACCOUNT

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 health care spending account which is part of a flexible benefit plan that allows employees to choose their benefit package after the end of the year qualifies as a private health services plan.

Position: No.

Reasons: Based on position in paragraph 6 of IT-529.

XXXXXXXXXX 	J. Gibbons
		5-992540
Attention:XXXXXXXXXX 

November 15, 1999

Dear XXXXXXXXXX:

We are replying to your letter of September 21, 1999, in which you requested our views regarding proposed changes to a health care spending account (HCSA) by one of your clients (the "taxpayer").

As requested, we have considered your situation and have provided some general comments. However, we cannot confirm the tax implications of particular transactions unless 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. If you need assistance on completed transactions, you should contact the local tax services office.

Facts

The taxpayer established the HCSA for its employees on XXXXXXXXXX. It was designed to qualify as a "private health services plan" ("PHSP"). However, the employees mistakenly understood that any unused balance in their account at the end of the year could be paid to them as cash or as an RRSP contribution. This misunderstanding has been rectified for the plan year commencing XXXXXXXXXX. Thus, the employees now understand that any unused balance in their HCSA will be forfeited if not used up in the time permitted, as set out in paragraph 16 of Interpretation Bulletin IT-529, "Flexible Employee Benefit Programs".

The taxpayer proposes to make payments to the employees because of their misunderstanding that unused balances could be paid to them. Under the proposal, each employee would receive a payment equal to the balance in his or her HCSA. In making these payments, the taxpayer would like to maintain the tax-free status of the benefits that were received by employees in respect of eligible medical expenses. In this regard, the taxpayer proposes that it be treated as having sponsored three separate plans:

Plan #1 would be for those employees who did not make any medical claims. This plan would allow the payment of a participating employee's HCSA in cash. Accordingly this plan would not qualify as a PHSP, and the amount received by the employee would be treated as employment income.

Plan #2, as well as Plan #3, would be for employees who had been reimbursed for medical expenses from their HSCA. Plan #2 would allow a participating employee to receive his or her remaining HCSA as cash. Accordingly, this plan would not qualify as a PHSP, and the employee would be taxed on the total of the cash received and the amount of reimbursements for medical expenses.

Plan #3 would allow employees to carry forward unused account balances for up to one year after the end of the plan year, and employees would receive no cash payment. In this case, the plan would qualify as a PHSP, and employees would not receive a taxable benefit by virtue of paragraph 6(1)(a) of the Act.

Your views

You believe that the taxpayer's proposal would be acceptable since we allow employers to offer employees both a PHSP and another plan which reimburses ineligible medical expenses. Further, you state that we accept that two separate plans exist if: i) the plan administrator accounts for the contributions, income and disbursements of the part of the plan which provides PHSP-eligible expenses separately from that which provides non-PHSP eligible expenses; ii) there is no cross-subsidization between the plans, and (iii) the level of benefits, the premium rates, the qualifications for membership and other terms and conditions of each of the plans is not dependent upon the existence of the other plan. In regard to these views, you refer to Technical Interpretations 9532815, 9331845, and 9827665. In conclusion, you state that your proposed solution maintains the HCSA as a plan of insurance for those employees who opt for Plan #3.

Our views

Our position concerning arrangements whereby employees are able to select the type and level of coverage from a menu of available benefits (sometimes referred to as "cafeteria plans" or "flexible benefit programs") is discussed in IT-529, "Flexible Employee Benefit Programs." Paragraph 5 discusses the situation where a taxpayer attempts to segregate benefits offered under the umbrella of such a "flex program" into multiple parts, which may include non-taxable benefits under a private health services plan. In these situations, the statutory rules applicable to salary deferral arrangements, retirement compensation arrangements, employee benefit plans or employee trusts, as the case may be, will apply to the entire flex program unless the employees covered by the flex program are required to choose which benefits will be provided under the flex program and how the benefit will be funded "prior" to the beginning of the plan year (and, subject to paragraph 6 of IT-529, the selection is irrevocable). Typically, each employee will get a booklet from the employer explaining the details of the particular flex program and a worksheet to assist the employee in making choices. Based on this requirement, it is our view that the taxpayer's proposed arrangement will not succeed because employees would choose their benefits after the end of the plan year. Thus, benefits received by employees from any of the three plans will be taxable.

We trust that these comments will be of assistance.

Yours truly,

John Oulton
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate

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