Principal Issues: [TaxInterpretations translation] 1) What are the tax consequences to an employee with respect to contributions made by an employer out of its own funds when setting up a Health Care Spending Account?
2. What are the tax consequences for an employee when carving-out a salary increase to improve the employee's Health Care Spending Account?
Position: 1. A question of fact. If a Health Care Spending Account is designed to satisfy all of the relevant conditions of a Private Health Services Plan set out in Interpretation Bulletins IT-339R2 and IT-529, paragraph 6(1)(a) of the Act provides that an employer's contribution to such a plan is not to be included in the income of employees. That contribution is either a lump sum or is calculated as a percentage of each employee's salary. Using a reasonable estimate of salary levels to determine flex credits to a Health Care Spending Account may not affect the qualification of a Health Care Spending Account. In all cases, this determination must be made before the beginning of the plan year.
2. A question of fact. The tax consequences resulting from a reduction or forgoing of a salary increase, converted into equivalent additional flex credits in a Health Care Spending Account, depends on the employee's entitlement to such a salary increase under the employee’s employment contract. If the reduction or increase in salary is made in the context of the establishment of a new employment contract, the additional contributions may not be taxable. However, if the reduction of the salary increase is made during the term of an existing employment contract, the additional contributions will be included in the employee's income as salary.
Raisons: 1. General information contained in Interpretation Bulletins IT-470, IT-529 and IT-339R2.
2. General information contained in Interpretation Bulletins IT-529 and IT-339R2.
Lucie Allaire, Advocate,
XXXXXXXXXX CGA, D. Fisc.
2008-027224
August 21, 2008Dear Sir,
Subject: Design of a Supplementaryhy Health Care Plan (the "Health Care Spending Account").
This is in response to your letter of March 19, 2008 in which you requested our opinion regarding the implementation of a health care spending account and its qualification as a private health services plan ("PHSP").
First, you referred to a situation where an amount determined at the beginning of the year for a Health Care Spending Account would be used to reimburse an employee for medical expenses described in paragraph 4 of Interpretation Bulletin IT-339R2 Meaning of Private Health Services Plan, which refers to Interpretation Bulletin IT-519R2 Medical Expense and Disability Tax Credits and Attendant Care Expense Deduction. The only other particulars provided are that that amount would be entirely paid by the employer, that it would represent only a notional amount and that the unused balance would not be refundable. In that regard, you wish to know whether the health care spending account that your employer intends to set up constitutes a PHSP for the purposes of the Income Tax Act (the "Act").
Secondly, and in order to improve the health care spending account, you wish to know the tax consequences for employees who relinquish, once at the beginning of the year for the health care spending account, part of their salary increase in order to add additional credits.
Unless otherwise indicated, all legislative references herein are to the provisions of the Act.
Our Comments
The situation described in your letter is an actual situation involving taxpayers. As stated in paragraph 22 of Information Circular 70-6R5 of May 17, 2002, it is our practice not to issue written opinions regarding proposed transactions otherwise than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
Paragraph 6(1)(a) includes in a taxpayer's income the value of board, lodging and other benefits of any kind received and enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of, an office or employment. Subparagraph 6(1)(a)(i) excludes benefits derived from employer contributions to a PHSP. The latter is defined in subsection 248(1) and is described in detail in Interpretation Bulletin IT-339R2.
A PHSP is a contract of insurance in respect of hospital expenses, medical expenses or any combination of such expenses, or a medical care insurance plan or hospital care insurance plan or any combination of such plans. The program must include the following elements:
(a) an undertaking by one person,
(b) to indemnify another person,
(c) for an agreed consideration,
(d) from a loss or liability in respect of an event,
(e) the happening of which is uncertain.
Coverage under a PHSP must be in respect of hospital care or expense or medical care or expense which normally would otherwise have qualified as a medical expense under the provisions of subsection 118.2(2) in the determination of the medical expense tax credit.
In order for a PHSP to be recognized, it must first be a true insurance plan. In order for a health care spending account to qualify as a plan of insurance, there must be a reasonable element of risk. For example, if the plan or arrangement is such that there is little risk that the employee will not eventually be reimbursed for the full amount allocated to that employee annually, then the arrangement is not a plan of insurance. If the account is not recognized as a PHSP, the employee must pay tax on the value of the benefits received under the plan.
Whether a particular program designed by your employer is a PHSP, an employee benefit plan, a pension plan, a retirement compensation arrangement, a salary deferral arrangement or an employee trust is a question of fact and depends on the final design and structure of each program. The qualification of a plan can only be made after reviewing all of the terms and conditions of a program, the existing current employment contracts, the method by which salary, wages or other employment benefits and conditions of employment are determined, the period of time over which salaries and other employment benefits are determined, and all relevant documentation. In that regard, we can only make a final determination in the context of an advance ruling request. A contribution to a plan is made as a lump sum or is calculated on the basis of a percentage of salary. Adopting a method using a reasonable estimate of salary levels to determine variable credits may not affect the qualification of a plan.
Generally, allocations of variable credits paid by an employer, before the beginning of a plan year, under a health care spending account that qualifies as a PHSP, will not generally be taxable if, inter alia, the variable credits have no cash surrender value and the employee has not disposed of anything of value in order to acquire these credits.
With respect to your second question, an employee's contribution may be made through payroll deductions or by giving up certain rights to salary or wages in exchange for equivalent variable credits. Paragraph 9 of Interpretation Bulletin IT-529, Employee Benefit Programs Tailored to the Needs of Employees, states that if an employee forgoes an amount to which the employee is or will become entitled, such as a negotiated salary increase, vacation or bonus, the amount of remuneration forgone is included in income in the year in which the amount is converted to flex credits. On the other hand, when a contract of employment is renegotiated upon the expiry of a former employment contract to incorporate a decrease in the level of salary or wages to be paid to an employee over the term of the new contract and the new contract also provides 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. However, if an employment contract is renegotiated during the term of an employment contract to decrease salary and increase the allocation of flex credits, the additional credits so allocated will be included in the employee's income as salary. Also, the benefits acquired by means of the additional credits will be considered to have been provided through employee contributions.
These comments are not advance income tax rulings and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, are not binding on us.
Best regards,
François Bordeleau, LL.B.
Manager
Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate.