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It is generally well-known that an employer may offer a tax-free benefit to an employee in the form of a Private Health Services Plan (PHSP) for hospital and medical expenses. The PHSP must meet the nature of insurance and is commonly provided by an insurance company in exchange for premiums paid in whole or in part by the employer.
However, a Private Health Services Plan can be expensive to provide and private employers have sought out ways to offer coverage that is flexible and cost-effective. This has led to plans that may be offered either directly or indirectly by the employer without the need to involve an insurance company offering traditional PHSP coverage.
Premiums paid under a Private Health Services Plan are deductible to the corporation and are not a taxable benefit to the employee where it is received in his/her capacity as an employee, rather than a shareholder. CRA PHSP rules stipulate that the expenses covered must qualify for the medical expense tax credit (“METC”).
In a 2004 Tax Court of Canada case, the court stated that whether the taxpayer received the benefit as a shareholder or employee is dependent on whether the corporation would have entered into such a contract with an arm’s length key employee as an employee and not a shareholder.
In the case, the company reimbursed the majority shareholder over $35,000 in relation to US medical services, and there was no evidence that the PHSP was made available to other employees. The court agreed with CRA’s position that the taxpayer received the reimbursement by virtue of being a shareholder and not by virtue of employment.
The CRA has commented that if a shareholder is actively engaged as an employee of the company and it is reasonable to conclude that the benefit has been provided as part of a reasonable employee remuneration package, the benefit would be derived by virtue of employment.
Where the plan does not qualify as a PHSP, the reimbursement is fully taxable as an employment benefit or shareholder benefit to the recipient. The corporate deduction is only available following actual payment to a person in his/her capacity as an employee and not as a shareholder.
The different types of Private Health Services Plans available include:
- Traditional extended health care plans, drug plans, and dental plans – These are provided by third parties (generally, insurance companies) under contract with the employer.
- Cost-plus PHSP contract - The administrator agrees to indemnify the policyholder for costs related to events covered by the policy, and the policyholder agrees to reimburse for the amounts paid under claims on the policy, plus an administration fee. To qualify under CRA PHSP rules, the employee’s contract must stipulate that the employer must reimburse the administrator for claims made under the policy.
- Health care spending account (HCSA) - The HCSA is a plan where individual employees are awarded notional spending account credits each year for the reimbursement of eligible medical and dental expenses. The nature of insurance is not met where it is likely that the employee will use up the credits allocated or is allowed to withdraw or transfer an amount from the HCSA. The features of an HCSA generally include the carryforward of unused allocation to a maximum of 12 months, a dollar limit on the benefits, and no requirement for a deductible.
To self-administer the HCSA, the employer must be obligated under the employment contract to reimburse its employees or their dependents for qualifying expenses and should not be able to terminate the arrangement without notice, or at its sole discretion.
Self-employed individuals do not qualify for Private Health Services Plan treatment unless purchased from a third party normally in the business of selling insurance. Special CRA PHSP rules exist with regard to the amount that self-employed individuals can deduct. These rules will be reviewed in greater detail in a future article.
Which PHSP Plan Is Right for You?
Choosing the right plan will depend on the specific facts and circumstances of the employer and employee.
- The cost-plus PHSP and HCSA are popular because they can cost less than traditional plans and employers can set reimbursement limits, offering certainty on business cost. There are typically fewer restrictions for employees, without being subject to deductibles or a percentage limit reimbursement.
- The self-administered HCSA may provide further cost savings as the administration fee charged by a third party may be eliminated. However, this should only be considered if the employer has sufficient capacity to handle the administration. We strongly recommend that employers considering a self-administered plan first consult with their tax advisors to ensure that they have the appropriate knowledge and capacity to meet the necessary conditions.
- An externally administered plan, on the other hand, may offer more privacy for employees.
- It may be possible to qualify as a PHSP where a shareholder is the sole employee, if the shareholder is actively engaged as an employee and the plan’s terms form part of a reasonable remuneration package. The facts of each situation must be considered and in particular, care must be taken with respect to a shareholder vs employee role. Where a benefit is considered to be received in one’s role as a shareholder, there is effectively a double tax penalty as the benefit becomes taxable to the recipient but is not deductible to the corporation.
Finally, a Private Health Services Plan must be documented with sufficiently certain terms and be properly communicated to employees. The terms must include:
- Who is eligible to participate,
- Which CRA medical expenses and/or dental expenses will qualify,
- What limits apply,
- The legal entity that has the legal obligation to pay or reimburse a claim.
Please contact Wendy Seet of the Manning Elliott Tax Team with any questions by submitting a contact form inquiry.
This content is believed to be accurate as of the date of posting. Tax laws are complex and are subject to frequent change. Professional advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.