IT85R2 Health and Welfare trusts for employees - Update 2002
For a number of years, the CCR has been allowing employers
to operate their health and welfare programs through a "trust"
arrangement. The CCRA's (CRA) position on the income tax implications
for such arrangements, known as health and welfare trusts,
is set out in interpretation bulletin IT-85R2, dated July
31, 1986, Health and Welfare Trusts for Employees.
The types of benefits administered by an employer through
health and welfare trust arrangements are restricted to:
a) group sickness or accident insurance plans
b) private health services plans
c) group term life insurance policies, or
d) any combination of a) to c).
Essentially, the CCRA allows these trusts to be treated as
conduits: an employee does not receive or enjoy a benefit
at the time the employer makes a contribution to a health
and welfare trust. Further, any income tax advantage that
an employee would otherwise get is not affected because of
the health and welfare trust. For example, payment by the
trustees of health and welfare trusts of all or part of an
employer's contribution to a private health services plan,
does not rise to a taxable employment benefit. The legislative
exemption in subparagraph 6(1)(a)(i) flows through to the
employees.
Employers can deduct contributions to health and welfare
trusts in the year the legal obligation to make the payment
to the trust arises, to the extent they are responsible and
laid out to earn business or property income.
The bulletin describes the tax implications for the trust.
In general terms, non of the receipts from an employer are
taxable, nor are the payments deductible in the trust. However,
the trust is taxed as an inter vivos trust on any investment
income generated because of investments made in the course
of managing the employee benefit programs. The minimum tax
rules must be considered as they could also have application.
In recent months, there has been a significant issue related
to the funding of health and welfare trusts and the quantum
of the deductions that an employer can claim when money is
invested in the trust to fund the employees' benefits.
Question 1
What is the legal basis for a health and welfare trust under
the Income Tax Act.
Response 1
Health and Welfare trusts are not specifically defined or
described in the Act. They became recognized administratively
by the CCRA in the manner set out in IT-85R2, after extensive
consultations with the tax community and employee benefits
consultants in the 70s.
Question 2
Since the last version of the bulletin was issued in 1986,
have there been any significant changes to the CCRA's position
on health and welfare trusts?
Response 2
No, there have been no major changes to the CCRA's overall
administrative positions set out in the bulleting. There have,
however, been changes to the law that make some of the explanations
of the income tax rules in the bulletin outdated. For example,
the bulletin still has the discussion on the former $25,000
exemption for coverage under the group term life insurance
policy. We will update the bulletin to reflect current law.
Question 3
Have any important issues arisen recently that would be of
interest to administrators/trustees of health and welfare
trusts?
Response 3
Yes, a significant issue has been considered over the last
few months in connection with the funding of the cost of long-term
disability benefits under "group sickness and accident
plans" that are administered by employers through a health
and welfare trust.
Question 4
Before getting into the issue on funding, could you briefly
comment on the CCRA's general position in regard to the funding
of a health and welfare trust.
Response 4
Yes, the CCRA's general position on funding is described
in paragraph 6 of IT-85R2, which states that an employer's
contributions must not exceed the amount required to provide
the health and welfare benefits and that the payments cannot
be made on a voluntary or gratuitous basis. In this regard,
I would like to emphasize that this means the "current"
cost of paying out the benefits for a particular year. This
is usually based on an actuarial determination where the employer
has engaged a carrier to provide the health and welfare benefits.
Question 5
Could you now explain recent development in regard to the
cost of funding benefits in a health and welfare trust?
Response 5
The main issue has been with what we have referred to as
the over-funding of benefits through lump sum payments by
employers to a health and welfare trust. By this we mean that
employers were proposing to fund 100% of the estimated value
of all future benefits payable with respect to insured claims
under the long-term disability benefits provided under a health
and welfare trust. That is, the employer would contribute
a lump sum amount to a health and welfare trust that would
finance not only the current benefits payable under the plan,
but the estimated cost of the benefits that would be payable
over a number of years.
Question 6
Could you describe the CCRA's position relating to the so-called
over-funding of the benefits by the payment of a lump sum
amount, including the effect on the deductions that may be
claimed by the employer as well as any consequences for health
and welfare trusts that otherwise meet the criteria outlined
in IT-85R2?
Response 6
The CCRA's position is that, in those situations where an
employer's contributions to a health and welfare trust are
for future benefits, subparagraph 18(9xa)(iii) of the Act
applies to the deductibility of such contributions by employers.
That is, the lump sum amount will be regarded as having been
made or incurred as consideration for insurance for a period
after the end of a taxation year. We have also concluded that
contributions of lump sum amounts to fund future benefits
would not, in and by itself, disqualify a trust as a health
and welfare trust. However, the contributions must be based
on actuarial determinations of amounts needed to fund the
future health and welfare obligations.
Question 7
In the course of considering the over-funding issue, there
has been some discussion on the impact of the Canadian Pacific
Limited decision and whether it would support the full deduction
in a taxation year, of the lump sum amounts paid to fund future
benefit obligations in health and welfare trust. This is based
on the reasoning that, since the Court supported the position
that the lump sum in question in that decision was held to
be a legitimate business deduction and not prohibited by paragraph
18(1)(e) because it was contingent, the full amount should
be a legitimate business deduction in a taxation year.
Response 7
The CCRA has accepted the outcome in Canadian Pacific that
the amounts set aside for the future payment of benefits were
not "contingent" in nature. For health and welfare
trusts, this means that contributions for actuarially required
contributions by an employer to a health and welfare trust
will not be denied as a deduction under paragraph 18(1)(e)
as noted above. However, as also noted, subparagraph 18(9)(a)(iii)
applies. In this regard, audit officials in the tax services
office have already issued reassessments applying this rule.
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