N.R. Mitchell (613) 957-2139
Attention: XXXX
May 7, 1986
Dear Sirs:
Re: Tax Status of Prepaid Legal Services Plans
This is in reply to your letter of January 27, 1966 in which you seek confirmation of the income tax consequences for a number of hypothetical group legal services plans offered by an employer to its employees. In all cases, the costs of these plans would be borne entirely by the employer. The tax issues with which you are chiefly concerned are the amount and timing of the employer's deduction of the costs of the plan and the taxation of employees with respect to the plan. We regret the unavoidable delay in responding.
The first type of plan described in your letter is that of an "insured plan" provided by means of an insurance contract. Under this arrangement the employer would pay a premium to an insurer and in return the insurance company would be responsible for legal expenses incurred by employees whether by paying lawyers directly or by reimbursing the employee's legal expenses. In your view the following tax consequences would result from such an arrangement:
(a) the employer may claim a deduction in the year the premium is paid to the insurer by virtue of subsection 9(1) and paragraph 18(1)(a) of the Income Tax Act (the "Act"). The amount of the deduction would be equal to the total amount of premium paid in the year.
(b) Each employee would receive a taxable benefit in the year the employer pays the premium to the insurer by virtue of paragraph 6(1)(a) of the Act. The amount of the taxable benefit would be equal to the premium attributable to the respective employee.
(c) The payment or reimbursement of legal expenses incurred by an employee would not give rise to any tax consequences to either the benefiting employee or the employer.
On the understanding that the arrangement in question would qualify neither as an "employee benefit plan" nor as an "employee trust", as those terms are defined in subsection 248(1) of the Act, we would agree with the interpretation set out above. We would add, however, that the deductibility of the premiums by the employer would also be subject to the limitation imposed under subsection 18(9) of the Act.
We will next consider the arrangements described in your letter under the heading of "self-insured plans", that is to say, arrangements under which benefits are paid for from a fund made up of employer contributions. The benefits (legal services) may be provided in either of two ways:
(i) by hiring of staff lawyers who provide direct legal services to members (method #1); or
(ii) by using the fund to pay independent lawyers directly or to reimburse employees for the costs of legal services performed by independent lawyers (method #2).
If the self-insured plan is structured as an Employee Trust (and, we assume, qualifies as such according to the definition in subsection 248(1) of the Income tax Act) you believe the tax consequences would be as follows:
(a) The employer may claim a deduction in the year he contributes to the plan by virtue of subsection 9(1) and paragraph 18(1)(a) of the Act. The amount of the deduction would be equal to the total amount of employer contributions made in the year.
(b) The employee receives a taxable benefit in the year the employer pays the contributions to the plan by virtue of paragraph 6(1)(h) of the Act. The amount of the taxable benefit would be equal to the employer contributions made in the year allocated or attributable to the respective employee.
(c) The payment of benefits out of the plan whether by method #1 or method #2 as described above would not give rise to any tax consequences to either the employer or the employee receiving the benefit.
We are in general agreement with your views as outlined above. However, with respect to (b), we would simply point out that the benefit to the employee should also take account of the net income and net capital gains of the trust in the year. (Please refer to paragraph 37 of Interpretation Bulletin IT-502 (the "Bulletin"), a copy of which is enclosed for your convenience.
Finally, you have asked us to consider the tax consequences if the self-insured plan was structured as an Employee Benefit plan, as defined in subsection 248(1) of the Act. You believe the following consequences would result:
(a) The payment of employer contributions to the plan would not give rise to any tax consequences to either the employer or the participating employees.
(b) The employer may claim a deduction in the year legal benefits are received by employees pursuant to section 32.1 of the Act.
(c) The employee who receives benefits under the plan would be in receipt of a taxable benefit in the same year by virtue of paragraph 6(1)(g) of the Act. The calculation of the amount of the employer's deduction and the amount of the taxable benefit received by the employee would be relatively simple if the legal services are provided by method #2 (independent lawyers) since the value of the services received are readily identifiable. However, if the legal services are provided by method #1 (staff lawyers) then the determination of the cash value of each employee's benefit would involve a relatively complicated process of allocating the plan's expenses (lawyers, paralegals, secretaries, office supplies and office accommodation etc.) to individual employee inquiries, probably through some internal hourly rate mechanism.
We are again in general agreement with the views outlined above with respect to a plan structured as an "employee benefit plan".
The comments made herein represent our interpretation of the law as it applies generally, but this is not a ruling and, accordingly, is not binding upon the Department.
Further to your telephone inquiry of March 4, 1986, we have considered the foregoing response in light of the proposals in the February 26, 1986 Budget Speech concerning salary deferral arrangements. We regret that we cannot express an opinion with respect to the potential impact of any Budget resolutions until we have had the opportunity to study the actual wording of the amendments to the Act. As the amendments in question have not been drafted, we suggest that you direct your inquiries in this respect to the Department of Finance.
We hope this letter will be of some assistance.
Yours truly,
for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch