7 December 1991 Income Tax Severed Letter - Determination of taxable income from health and welfare trusts

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.

Dear Sirs:

Re: Health and Welfare Trusts

This is in reply to your letter of September 17, 1991 concerning the determination of the taxable income of a trust which provides health and welfare benefits.

In the situation set out in your letter, each of a company's two divisions (Division A and B) utilizes the same trust which provides health and welfare benefits to employees of the company. The benefits provided to the employees of Division A are funded solely from employee contributions while the employees of Division B are provided with benefits solely from contributions made by the employer. The funds of each division are accounted for separately and there is no cross application of the funds of either division.

In the above circumstances, you have asked for our comments on the determination of the taxable income of the trust and have provided us with the following numerical example.

• • In year 1, Division A (employee contributions) pays out XXX in claims while earning XXX in interest and spending XXX on administrative expenses.
• • In the same year, Division B (employer contributions) pays out XXX in claims while earning XXX in interest and spending XXX in administrative expenses.

In the above situation, you have outlined two ways in which the income of the trust could be calculated.

The first is that if the trust income for each division is calculated separately, then Division A would not be able to deduct the XXX for paid claims, as the benefits are not taxable in the hands of these employees. As a result, the trust income for Division A would be XXX. Division B would be able to deduct the XXX for paid claims as the benefits are taxable in the hands of these employees. Therefore, the income of Division B would be $0.

On the other hand, if the income of the two divisions is calculated jointly, which you advise is normally done in the case of one health and welfare trust, the total income of the trust would be zero. The trust would have earned XXX in interest income. However, the trust would have paid out XXX in deductible paid claims and another XXX in administrative expenses (the other XXX paid for claims would not be deductible since it represents non-taxable benefits).

Our Comments

It appears to us that the above information may relate to an actual fact situation. On the basis that this is the case, the tax consequences thereof can only be determined following a review of all the relevant facts and related documentation. Should you wish such a determination, you should contact your local district taxation office. We are, however, providing you with the following general comments.

In a type of situation involving two self insured plans administered by a trust where the fund in respect of each plan earns significant investment income in relation to the benefits that are paid, the benefits paid in respect of one of the plans (the Taxable Plan) are taxable (employer funded), and the benefits paid in respect of the other plan (the Non-taxable Plan) are non-taxable (employee funded), we would consider a number of courses of action. Our comments in this regard are as follows:

• (a) Paragraph 12(c) of Interpretation Bulletin IT-85R2 entitled Health and Welfare Trusts indicates that such a trust "is allowed to deduct premiums and benefits payable out of trust income of the current year pursuant to paragraph 104(6)(b) of the Act ... Other benefits are normally regarded as having been paid out of trust income for the year. However, premiums and benefits that would not otherwise be taxable in the hands of the employee by virtue of paragraph 6(1)(a) may be treated at the trustee's discretion as having been paid out of prior year's funds or current year's employer's contributions, to the extent that they are available, to avoid the application of subsection 104(13)". In relation to these comments, the benefits from the Non-Taxable Plan could be considered to have been paid from prior year's funds accumulated in respect of this plan and the benefits from the Taxable Plan would be regarded as having been paid out of income earned by the fund established in respect of this plan. However, on the basis that each of the two funds is operated independently, it appears likely that the trust documentation would indicate that none of the benefits paid in respect of the Taxable Plan could be regarded as having been paid out of the income earned by the fund established in respect of the Non-Taxable Plan. Assuming this to be the case, the trust would not be permitted to claim a deduction in that regard with the result that the trust would be taxable on the income earned in respect of the Non-Taxable Plan. An additional consideration in respect of the separate operation of the two funds would be whether two separate trusts could be considered to exist. If the relevant facts and documentation indicated that this was the case, it would not, of course, be possible for the income from the Non-Taxable Plan to be reduced by taxable benefits paid from the Taxable Plan.
• (b) It is the Department's position that where an employer's contributions to a health and welfare trust exceed the amount required to provide the benefits, the excess contributions will be disallowed pursuant to section 67 of the Act. Since the employer has made all the contributions to the fund established in respect of the Taxable Plan and significant investment income has been earned by that fund, it appears that the employer has likely made excess contributions which are not deductible pursuant to that position.
(c) (i) The trust agreement and other relevant facts may indicate that benefits, other than those that may be paid out of a health and welfare trust pursuant to comments in paragraph 1 of Interpretation Bulletin IT-85R2, will be provided in respect of the Taxable Plan. We would, therefore, consider whether that plan might be an "employee benefit plan" or an "employee trust". For the Department's position on this type of situation where an employee benefit plan or an employee trust is considered to exist, we refer you to paragraphs 3 and 4 of Interpretation Bulletin IT-85R2. General comments on the tax consequences in respect of employee benefit plans and employee trusts are set out in Interpretation Bulletin IT-502 entitled "Employee Benefit Plans and Employee Trusts" which has been enclosed. In the event that the Taxable Plan were to be treated as an employee benefit plan or an employee trust, the income of the Non-Taxable Plan would be taxable in the hands of the trust assuming that paragraphs 104(6)(b) and subsection 104(13) of the Act were not applicable. On the other hand, if part of the Taxable Plan were to be regarded as an employee benefit plan or an employee trust, we refer you to our comments in (a) above concerning the deductions of benefits paid under the Taxable Plan (i.e., those benefits considered to have been paid out the health and welfare trust) against the income earned by the Non-Taxable Plan.
• (ii) In relation to the benefits paid out of the Taxable Plan, significant investment income has been earned by the fund established in respect of that plan. In our view, this could, in and by itself, result in the Taxable Plan being regarded as an employee benefit plan or an employee trust.

As a final comment, we are noting that in the general situation we have outlined, the Non-Taxable Plan and the Taxable Plan could be "wage loss replacement plans" described in paragraph 1 of Interpretation Bulletin IT-428 (A copy is enclosed) with the Non-Taxable Plan being an employee-pay-all plan referred to in paragraph 16 of IT-428 and the Taxable Plan being a plan referred to in paragraph 14 of IT-428 in respect of which the employer has made contributions. Assuming this to be the case, the benefits received from the Non-Taxable Plan would not be subject to tax while the benefits received out of the Taxable Plan would be taxable pursuant to paragraph 6(1)(f) of the Act. In order for the benefits from these two plans to be accorded that treatment, they must be considered to be separate and apart from each other.

If the two funds were to be combined with the trust agreement providing that benefits, which have always been taxable, were to be paid out of the income of the trust notwithstanding that a part of it was earned in respect of funds relating to employee contributions, it appears possible that only one wage loss replacement plan may be considered to exist and that plan would be one in respect of which the employer has made contributions. A further point is that since the income of the trust would be used to pay benefits which were always taxable, it appears possible to consider employer contributions to have been used in connection with benefits which were treated as being non-taxable prior to the formation of one fund. If only one plan were to exist, all benefits paid thereunder would be subject to tax to the extent provided under paragraph 6(1)(f) of the Act. For further information on the tax treatment of such a plan, you may refer to IT-428.

We emphasize that the foregoing comments, which are broad and general in nature, have been made in relation to the limited information you provided and that if an actual situation similar to that which we have set out above were to be encountered, there may be other considerations.

We hope that the foregoing comments are of assistance to you.