One of the most common and important benefits for employees working in any business is medical insurance and medical expense coverage. Unexpected ailments, injuries or health related services (dental, orthodontic, physiotherapy, massage therapy, etc.) can create significant financial burdens on individual employees if their employers do not offer sufficient medical and dental insurance plans. In addition, many employers struggle with the cost of providing extensive medical plans and they may pass the additional costs on to their employees indirectly through reduced wages or directly via employee optional coverage enhancements. Recognizing these issues, our tax laws permit certain tax-advantageous insurance arrangements and plans as a means of providing the benefit of extensive health coverage to employees, while at the same time, minimizing the costs to the employee and the business. These insurance arrangements and plans are commonly referred to as Private Health Services Plans (PHSPs).
What is a PHSP?
A PHSP is a vehicle by which a corporation can cover the medical expenses of its employees, and all blood-related members of their households, in a tax- efficient manner. If structured correctly, any expenses incurred by the corporation in relation to a PHSP are tax deductible, and the associated benefits received by the employees are tax-free.
How does a PHSP work?
A PHSP must contain the element of insurance – insurance through a third party or self-insurance. While there are different methods of administering PHSPs; the two most common are the “cost-plus” structure and the use of a Health and Welfare Trust.
“Cost-plus” plans are the most common and straightforward means of implementing a PHSP. Under the “cost-plus” structure, employees will initially pay for their medical bills, the employee will then make a claim with the insurance company contracted by the employer and be reimbursed. The employer promises to reimburse the insurer for the actual amount of all claims, plus an administration fee.
Health and Welfare Trust (HWT)
In contrast to the “cost-plus” plan structure, an HWT mandates that the employer makes fixed, regular (e.g., monthly, quarterly, etc.) contributions to a trust fund. Where the HWT is an insured plan, the employer contributions are used to pay for the necessary health insurance premiums. Where the HWT is a self-insured plan, the employer’s contributions create a pool of funds from which employees can seek reimbursements from specific, eligible claims.
What are the benefits and risks associated with a PHSP from a tax perspective?
The tax benefits associated with a PHSP can be significant. The corporation is allowed to deduct its contributions to the plan and/or expense reimbursements to its employees from its taxable income, thereby reducing its taxes. The employee, on the other hand, receives the monetary benefit of having his or her medical expenses reimbursed, and receives this benefit tax-free. Therefore, tax savings are created for both the employee and the employer.
However, if the plan does not meet the Canada Revenue Agency's ("CRA") qualifications for a PHSP, the corporation will be denied the deduction of the related expenses, and the employee will be deemed to have received a taxable benefit to the extent of any expense reimbursements received during the year.
It should be noted that payments and reimbursements to employees may be subject to Retail Sales Tax (8% in Ontario) and Insurance Premium Tax (2% in Ontario).
What are the restrictions on what qualifies as a PHSP?
When determining whether or not a corporation’s health benefit plan qualifies for tax treatment as a PHSP, the CRA will consider several factors such as:
- The corporation should be obligated to cover the employees’ eligible expenses under the plan, as dictated by their employment contract;
- There should be a pre-determined maximum benefit that employees or groups of employees are eligible to claim within a 12-month period;
- The HWT should not incur perpetual surpluses (temporary surpluses are permitted); and
- The HWT trustees (i.e. those who administer the HWT) should act independently of the employer.
While none are deemed essential qualifications of a PHSP on their own, if several of the considerations above are not met, the plan will unlikely qualify as a PHSP.
Can an individual who is both a shareholder and an employee of a professional corporation participate in a PHSP?
The underlying principal, as explained in "Technical Interpretation 2014-0521301E5" issued by the CRA, is that a PHSP qualifies for special tax treatment if it can be demonstrated that the plan is offered non-discriminatorily to all or a group of the corporation’s employees. If it can be shown that shareholders are entitled to the same benefit as employees who are not shareholders, but who have similar roles and responsibilities within the corporation, then the tax benefits stemming from the use of a PHSP would be available.
What about in the case of a sole shareholder who is the sole employee of the professional corporation?
In the Technical Interpretation mentioned above, the CRA does allow for the qualification of a PHSP for an incorporated individual if it can be demonstrated “that employees, who are not shareholders, with similar duties and responsibilities to another corporation of a similar size receive similar benefits under a similar plan.”
In practice, finding a sufficiently similar arrangement to use as a comparative becomes quite difficult. It is the CRA’s position, as well as Canadian tax jurisprudence, that if the individual professional is the sole employee of the professional corporation, the individual would be receiving the PHSP benefits by virtue of being a shareholder, not as an employee. In that situation, any benefits received from the PHSP would be considered a taxable benefit to the professional.
I think a PHSP is right for my professional corporation – what's next?
To ensure that a PHSP mitigates the risk of a successful challenge from the CRA, the corporation’s obligation to reimburse qualifying expenses to its employees, up to a predetermined maximum benefit, must be written into all of the corporation’s employment agreements. In addition, a resolution should be passed by the corporation’s board of directors outlining the details of the PHSP. Finally, if a HWT is to be used, a separate bank account should be opened in the name of the trust and a Trust Deed or Trust Agreement be drafted and put in place.
A PHSP is a tax effective means of funding the medical, dental and related health care expenses of your employees. It is also a great way to improve your professional corporation’s employee compensation plan, which will help to attract and keep the best available talent.
This article has been prepared for the general information of our clients. Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article. Please note that this publication should not be considered a substitute for personalized tax advice related to your particular situation.