D.T. Dalphy Tel: (613) 957-2134
February 20, 1987
XXXX
This is in reply to your letter of December 8, 1986 regarding a flexible compensation program ('flex program') that will be implemented by one of your clients (the employer') effective July 1, 1987.
Our understanding of this flex program is as follows.
1. Each employee will automatically be provided with a "core" level of benefits. We assume that the employer, not the employees, will make contributions in respect of these "core" benefits.
2. In addition, the employer will allocate a number of flexible credits, based on each employee's salary, marital status and age, to each employee. Certain optional benefits may be selected by employees who choose to allocate their flexible credits in respect of such benefits. In addition, employees may purchase certain benefits through payroll deductions.
3. Any flexible credits not used by an employee to select optional benefits may be exchanged for cash. We assume that such cash payments would be received by an employee in the same plan year in respect of which the optional benefits would be available.
4. The selection of benefits by employees is to be once a year, on a prospective basis. Our understanding is that these elections will be made before the commencement of a plan year and that the elections will be irrevocable.
5. It appears that a number of separate benefit plans (e.g.. group term life insurance plan, medical and dental expense plans, etc.) will be established under this flex program:
I. Death Benefits/Group Term Life Insurance/Accidental Death and Dismemberment ("AD & D") Insurance - Core benefits
Under an agreement with an insurance company operating in Canada, a group term life insurance plan will provide each employee with $10,000 of life insurance. In the alternative, the employer may choose to provide $10,000 in death benefits in respect of each employee (no funds would be set aside in advance in respect of such death benefits).
Optional benefits
A group term life insurance plan will be established by the employer with a Canadian insurance company to provide employees with optional benefits. Each employee may choose to obtain additional $10,000 units of life insurance, up to an overall maximum of 4 X annual (we assume) earnings. In addition, an employee may choose to obtain life insurance in respect of his or her spouse ($10,000 in coverage) and children ($3,000 per child). Employees may also obtain AD & D coverage for themselves and their families, in units of $10,000, up to $250,000 (it appears that this maximum level of coverage is in respect of each employee). Although we have few details regarding AD & D coverage, it appears that these benefits will be provided pursuant to an insured plan that is separate from the group term life insurance plan. Both optional group term life insurance and AD & D coverage may be obtained by employees via the application of flexible credits, payroll deduction, or a combination of the two.
II. Disability Income - Core benefits
The employer will pay to a disabled employee a percentage of the latter's normal salary until he or she reaches age 65 or recovers from his or her disability, whichever is earlier. Short term disability income benefits will be paid directly by the employer (no funding is apparent); long term disability income benefits will be paid via a health and welfare trust.
Optional benefits
Although it is not clear, it appears that optional benefits are only available in respect of long term disability. Employees may obtain this coverage via the application of flexible credits or payroll deduction. The employer wishes to fund these benefits through a health and welfare trust. It appears that separate plans will be established in respect of (1) core benefits (2) optional benefits where flexible credits are applied and (3) optional benefits paid for by payroll deduction. The actuarial cost of the employee - paid plan will be funded solely through employee payroll deductions.
III. Medical and Dental benefits - Core benefits The employer will reimburse an employee for a portion of expenses incurred by the employee and his or her family while staying in hospital, for prescription drugs, for dental care and for certain other medical expenses not payable by the provincial insurance plan. These expenses will be funded through a health and welfare trust and administered through an administrative services only ("ASO") contract with an insurance company. The employer intends to establish a private health services plan in respect of these benefits.
Optional benefits
An employee may elect to obtain additional medical expense coverage providing for lower coinsurance and the elimination of deductibles. The employer intends to fund these optional benefits via a health and welfare trust and to provide for the administration of this plan through an ASO contract with an insurance company. A private health services plan is to be established and employees may pay for such optional benefits by payroll deduction or by allocating flexible credits to this plan.
IV. Extended Health Care
An employee may allocate flexible credits to this optional plan in order to obtain increased medical and dental coverage. The employer will reimburse participants in this plan for expenses that are not payable from either the provincial insurance plan or the core and optional medical and dental plans described above. Employees may purchase this coverage in units of $100 per year and units purchased are to be reduced dollar for dollar by any expenses that are reimbursed by the employer order the terms of this plan. You have advised that:
"The dollar value of these units are not redeemable in cash and must only be used to provide for the payment of eligible expenses. The balance of any purchased units at the end of a calendar year are carried forward to the subsequent year and may be claimed for reimbursement at any time up to the employee's date of termination of employment."
We are not certain if these units may be exchanged for cash upon an employee's termination. The employer intends to fund these benefits through a health and welfare trust and to provide for the administration of this plan through an ASO contract with an insurance company. The employer wishes to establish this plan as a private health services plan.
V. Dependant Care Plan
An employee may elect to purchase (via payroll deduction) units of $100 of expense coverage, up to a maximum of $2,000 per dependant child ($8,000 per family). The employer will reimburse an employee for expenses described in section 63 of the Income Tax Act (the "Act"). To the extent that the purchased coverage is not claimed by the end of a calendar year, the balance will be paid to the employees in cash. This does not appear to be an insured plan.
VI. Vacation - core benefits
Each employee will receive from 2 to 6 weeks of paid vacation each year, depending on his or her years of service. The cost will be paid directly by the employer. Vacation must be taken by April 30 of the following year (or traded under the optional plan) or it will be lost.
Optional benefits
An employee may elect to trade from 1 to 3 weeks of his or her annual vacation entitlement for additional flexible credits that may be used to purchase other benefits.
VII. Savings Plan ("Group RRSP")
An employee may elect to deposit payroll deductions of from 1% to 10% of his or her salary into a new Group RRSP. The employer will contribute 25% of the employee's deposits, up to a maximum of 1 1/2% of the employee's salary. The employer's contributions will be deposited directly to the PHSP when the deposits of the employees are remitted.
VIII. Pension - Core benefits
The employer sponsors a contributory defined benefit pension plan providing retirement income and supplementary benefits based on the employees' earnings, age and service. Both the employees and the employer will make contributions in accordance with a pension plan document and trust agreement. We are not aware of further details, such as whether this plan is a registered pension plan.
We prefer to answer specific questions on the tax consequences of proposed flex programs on the basis of specific terms of such plans and by way of an advance income tax ruling. Nevertheless, we offer the following comments on your understanding of the income tax treatment in respect of your client's proposed flex program in the order in which you have presented your comments:
I. "Death Benefits" Insured.
1. a) Contributions by an employer in respect of a group term life insurance plan (as defined in subsection 248(1) of the Act) or a group accident or sickness insurance plan in respect of its employees are deductible in computing the employer's income under section 9 of the Act, to the extent permitted by paragraph 18(l)(a) and section 67 of the Act.
b) Pursuant to subsection 6(4) of the Act, where an employee is insured at any time in a taxation year for an amount in excess of $25,000 under one or more group term life insurance policies, that part of any premium paid by his or her employer for such excess is included in the employee's income as income from an office or employment. Sample calculations are set out in paragraphs 16 to 18 of Interpretation Bulletin IT-227R . In our view, both amounts paid by the employer in respect of core benefits and flexible credits allocated to this plan would represent premiums paid by the employer.
c) Where a group term life insurance policy provides for a lump sum payment to an employee's estate or a named beneficiary the amount is not subject to taxation. We refer you to paragraphs 9(e) and (f) of Interpretation Bulletin IT-85R2 .
c-1) A plan that provides for coverage in respect of employees, their spouses and children (that is, a plan in respect of which dependant coverage is not optional and premiums in respect of employees' and dependants' coverage are not accounted for separately) would not be coverage under a plan which would otherwise be considered a group term life insurance plan.
c.2) As we do not have sufficient information with regard to AD & D benefits, we cannot comment on this plan at this time.
"Self-insured" (non-funded)
d) Payments by an employer to a beneficiary in the event of the death of an employee are deductible by that employer pursuant to section 9 of the Act, to the extent permitted by paragraph 16(1)(a) and section 67 of the Act.
e) Where the recipient of death benefits is the widow or widower of the employee, the exempt portion of the amount received by him or her is the first $10,000. Further, under the new definition of death benefits in subsection 248(1) of the Act, if a surviving spouse receives less than $10,000 in death benefits in respect of an employee and another taxpayer receives a death benefit in respect of that employee, the exempt portion for that other taxpayer will be the amount received by him or her to the difference between $10,000 and the amount received by the surviving spouse. Where more than one taxpayer other than a surviving spouse receives death benefits in respect of an employee, the exempt portion available to them will be shared among them on a proportionate basis having regard to the amounts received by each of them.
f) Amounts paid by the employer as death benefits that are provided otherwise than pursuant to a group term life insurance plan are not included in the $25,000 limit described in subsection 6(4) of the Act.
II. Disability Income Short term
a) Amounts paid by an employer to its employees in respect of the latter's short term disabilities are deductible by the employer pursuant to section 9 of the Act, to the extant permitted by paragraph 18(l)(a) and section 67 of the Act.
b) Payments received by employees from their employer in respect of short term disabilities are included in computing the employees' incomes from on office or employment.
Long term
a) Employer contributions to a "health and value trust" (we refer you to paragraph 5 of Interpretation Bulletin IT-85R2 ) in respect of a group sickness or accident insurance plan for its employees are deductible by the employer pursuant to section 9 of the Act, to the extent permitted by paragraph 18(1)(a) and section 67 of the Act. In our view, amounts paid by an employer to such a trust as a result of flexible credits having been allocated by employees would be considered employer contributions.
b) Contributions by an employee to a health and welfare trust in respect of wage loss replacement benefits are not deductible in computing an employee's income.
c) An employee does not receive or enjoy a benefit at the time his or her employer makes a contribution to a health and welfare trust in respect of a group sickness or accident insurance plan (we refer you to paragraph 9 of Interpretation Bulletin IT-85R2 and subparagraph 6(l)(a)(i) of the Act).
d) Benefits received by employees under an employee pay-all plan providing wage loss replacement benefits are not taxable (we refer you to paragraph 16 of Interpretation Bulletin IT-428 ). Benefits received by an employee under a wage loss replacement plan in respect of which the employer has made a contribution out of its own funds (e.g., core plan, optional plan where flexible credits are employed) are subject to tax in the employee's hands pursuant to paragraph 6(1)(f) of the Act (we refer you to Interpretation Bulletin IT-428 ).
III. Medical and Dental Expenses
a) Employer contributions to a health and welfare trust which provides employees with benefits under a private health services plan are deductible under section 9 of the Act, to the extent permitted by paragraph 18(1)(a) and section 67 of the Act.
b) Employer contributions to a health and welfare trust that provides employees with benefits under a private health services plan are not considered to be employee benefits (we refer you to subparagraph 6(1)(a)(1) of the Act and Interpretation Bulletin IT-339R ).
c) Benefits paid to employees pursuant to a private health services plan are not subject to taxation.
c.1) We refer you to paragraph 4 of Interpretation Bulletin IT-339R .
IV. Extended Health Care Plan
If this plan qualifier as a private health services plan, the income tax consequences would be the same as in III above; if, however, units may be exchanged for cash, this plan may be a "salary deferral arrangement".
V. Dependant Care Plan
a) We do not agree that amounts paid by employees to such a plan would be deductible by them at the time they make such contributions.
b) In our view, amounts provided under such a plan to employees would be included in computing their incomes from an office or employment.
VI. Vacation
Flexible credits generated through the trading of vacation weeks for cash or benefits under a flex program would, in our view, result in an income inclusion for employees when they are entitled to receive such cash or benefits.
VII. Savings Plan ("Group RRSP")
a) Employee contributions to a Group RRSP are deductible to the extent permitted by paragraph 60(i) and section 146 of the Act.
b) Although we have very little information about this plan, it appears that it may be a plan described in situation 2, paragraph 32, Interpretation Bulletin IT-502 .
The comments made herein represent our interpretation of the law as it applies generally, but this is not an advance income tax ruling and, accordingly, is not binding upon the Department. We hope this letter will be of some assistance.
for Director Small Business & General Division Rulings Directorate Legislative and Intergovernmental Affairs Branch
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