January 2012
Employee Life and Health Trusts
Effective 2010, employers can access a new tax tool to implement employee benefits. Employee Life
and Health Trusts (ELHT) are based in large part on the rules applying to Health and Welfare Trusts
(HWT) but have significant differences. In this bulletin, we will examine the key similarities and
differences between the two types of trust.
Employee benefit plans can take a number of different forms. The most common are private
health services plans (PHSP) and health plans funded by a master group sickness or accident insurance
policy held by the employer with an insurance company. For many decades Health and Welfare Trusts
1
(HWT) for employees have also been among the tools available for creating employee benefit plans.
2
The federal government added a new tool to the mix in 2010. This is the Employee Life and Health Trust
3
(ELHT). Instead of relying on a Canada Revenue Agency (CRA) administrative tolerance as the way that
an HWT does, the ELHT relies on rules contained in a new section of the Income Tax Act (ITA), section
144.1.
Two major tax objectives must be reconciled when a health care plan is established within a
business. The first is that employers want to deduct the costs of the plan as an expense incurred to gain
4
or produce income from a business. The second is that employees prefer that these costs not be
5
included in their taxable income (as benefits received or enjoyed from employment). For employees, the
health care plan benefits are also more attractive when amounts claimed under the plan are not included
6
in their taxable income. To achieve these objectives, the tax authorities must agree that both the tool
used to provide the benefits and the funding method fall within the exceptions to the general principle
established by legislation that employee benefits are included in income.
1
CANADA REVENUE AGENCY, Interpretation Bulletin IT-85R2, “Health and Welfare Trusts for Employees,” July 31, 1986.
In Quebec, the creation of such trusts is also possible under an administrative tolerance outlined in Revenu Québec interpretation letter 96-010030, dated July 9,
1996, which states: [TRANSLATION] “We confirm that subject to the particular specifications of the tax system in Quebec, the position of the Ministère du Revenu
is identical to that expressed by the Canadian revenue Agency (CRA) in Interpretation Bulletin IT-85R2 as regards income tax payable under Part I of the Québec
Taxation Act.”
3
The Quebec Minister of Finance has not indicated whether Quebec will harmonize its rules with the federal rules to allow the creation of ELHTs in Quebec.
4
Paragraph 18(1)(a) ITA
5
Paragraph 6(1)(a) ITA
6
In Quebec, as in the rest of Canada, an employer may deduct reasonable expenses incurred to fund a plan, if the criteria set out in section 128 TA are satisfied.
But employees must include all or part of the contributions or premiums paid by the employer to the plan when computing their taxable income (articles 32 and 37
of the Taxation Act, R.S.Q., c. 1-3). HWT and ELHT benefits are paid tax-free in Quebec, as in the rest of Canada.
2
© Sun Life Assurance Company of Canada, 2012.
1
ELHTs and HWTs – similar characteristics
Both ELHTs and HWTs are inter vivos trusts funded by employers to provide employee benefits.
7
Benefits are restricted to group term life insurance, group sickness or accident insurance, or to private
health services plans. The trustees must act independently of the employer and must have the authority
to enforce the employer’s obligations to make contributions to the trust to pay insurance policy premiums
and benefits. The employer’s contributions can never revert back to the employer and cannot be used for
any purpose other than to provide the benefits for which the contributions were made. Lastly, an
employer’s contributions are deductible from its taxable income as long as they meet certain limits. At the
same time, those contributions are not included in the employees’ taxable income, except for the
premiums paid for a group term life insurance policy.
8
ELHTs and HWTs – key differences
While HWTs result from an administrative tolerance contained in CRA Interpretation Bulletin IT-85R2,
ELHTs are defined in the ITA. To qualify as an ELHT, the trust must be resident in Canada for tax purposes. This
mandatory requirement does not exist for a HWT. Further, an ELHT’s only object must be to provide “designated
employee benefits” for employees, former employees or members of their families who belong to at least one
“class of beneficiaries” of one or more participating employers, and for whom contributions are made to the trust.
Class of beneficiaries defined
The terms “designated employee benefit” and “class of beneficiaries” are defined in the ITA, and
are the cornerstones of an ELHT. Although the definition of designated employee benefit results
ultimately in the same benefits paid for both ELHTs and HWTs, the definition of a class of beneficiaries
clarifies who is entitled to designated benefits from an ELHT. The group of beneficiaries that form a class
must contain “members of the class [who] represent at least 25% of all of the beneficiaries of the trust
who are employees of the participating employer”. Also, “at least 75% of the members of the class
[cannot be] key employees of the participating employer.” The expression “key employee” is specifically
defined in the Act and means:
•
9
a specified employee : in broad terms this means an employee who owns not less than 10% of
the issued shares of any class of the capital stock of the employer or any corporation that is
related to the employer, or a person (including a corporation) that is related to the employee, or
•
an employee whose employment income from the employer in any two of the five preceding
taxation years, exceeded five times the Year’s Maximum Pensionable Earnings (YMPE) for the
calendar year in which the employment income was earned.
7
8
10
An inter vivos trust is one established during life, as opposed to a testamentary trust, which is established at death
Subparagraph 6(1)(a)(i) and Sect 6(4) ITA.
9
The expression “specified employee” is defined in subsection 248(1) ITA. This definition makes reference to the definition of “specified shareholder” found in the
same subsection.
2
Consequently, senior managerial staff, officers and shareholders can participate in an ELHT as long as
the benefits they receive are also available to a large number of non-key employees.
An ELHT can take advantage of a number of specific tax features regarding the taxation of a trust
that make it very attractive. An employer’s contributions to an ELHT are tax-deductible to the extent
permitted by the ITA. The deductions allowed as income expenses for a participating employer in an
ELHT are as follows:
•
premiums paid to a Canadian licensed insurance company, and
•
a reasonable amount paid to provide benefits in the year.
An amount based on an actuarial report and determined prior to the payment of the contribution is also
presumed to reflect the employer’s obligations for the year.
Premiums are deductible only in the year during which they are actually used. An employer participating
in an HWT is also entitled to deduct trust contributions from its taxable income. The deductions are limited
to those paid during the taxation year. Extra money cannot be deducted in the future even if based on an
actuarial provision. Please refer to the attached chart on page 4 for further information.
Funding ELHTs and HWTs with individual insurance products
According to several CRA technical interpretations, individual disability (ID), critical illness (CI) and long
term care (LTC) insurance policies may be used in employee benefits plans as long as they qualify as
“group accident and sickness insurance”. Grouped life insurance policies can also qualify if these are
group term insurance policies. Consequently when a plan is funded with these products, an employer can
deduct the premiums paid. No taxable benefit occurs for the participating employees as long as the plan
meets all the conditions. It seems that both HWTs and EHLTs may use these types of insurance plans.
Advising clients – employee benefits (key and non-key)
The rules for ELHTs are better suited to large and medium sized businesses since it may be
difficult for trusts established by smaller organizations or family businesses to meet and maintain all the
legal conditions needed to qualify as ELHTs at all times during the taxation year. Smaller employers, or
employers who wish to set up retention programs for their key employees that provide more
advantageous benefits than those allowed under an ELHT, may be able to do so with an HWT. It is clear
that in such situations the lawyers who draft the trust, and the trustees who administer the plan, will have
to be very careful to ensure that the plan is not disqualified if the only participants are company
shareholders. An HWT is often used to enhance employee benefits offered to managerial staff, key
employees and senior officers, and thus contribute to an organization’s retention of talent. When an HWT
is considered, obtaining a CRA advanced tax ruling is strongly recommended. For more details about
HWTs and ELHTs, please refer to the reference paper Employee Life and Health Trusts.
10
For 2010 and 2011, the YMPE is $47,200 and $48,300 respectively. An employee with earnings of at least $236,000 in 2010 and $241,500
in 2011 would be considered a key employee and automatically included in that group.
3
TRUSTEED EMPLOYEE LIFE AND HEALTH BENEFIT PLANS
HEALTH & WELFARE TRUST
(HWT) IT-85R2
EMPLOYEE LIFE & HEALTH TRUST
(ELHT) Section 144.1 ITA
Formal trust arrangement (in Québec: private trust
constituted by onerous title, generally speaking a trust
established for commercial, not personal, purposes).
No requirement to submit the trust agreement to the CRA
for approval but must meet guidelines in IT-85R2.
Advanced tax ruling (ATR) recommended where doubt as
to acceptability as an HWT.
Formal trust arrangement.
Employer/employee labour contract.
No requirement to submit trust agreement to the CRA for
approval but must meet requirements of ITA s. 144.1
throughout the taxation year.
Benefits provided:
Benefits provided:
Group sickness or accident insurance plan.
Group term life insurance.
Private Health Services Plans (PHSP).
Any combination of the above.
Trust must provide “designated employee benefits”
defined as benefits under a:
Group sickness or accident insurance plan.
Group term life insurance.
Private Health Services Plans (PHSP).
Any combination of the above.
Funding:
Funding:
Employer contribution must not exceed the amounts
required to provide the benefits, although some prefunding is permitted.
Employee contributions are possible.
Employer contribution must not exceed the amounts
required to provide the benefits although some pre-funding
is permitted.
Employee contributions are possible.
Trustee(s):
Trustee(s):
One or more acting independently of the employer.
One or more – employer representatives must not
constitute a majority of trustees or otherwise control the
trust.
Participating employer(s):
Participating employer(s):
Single or multi-employer trust arrangement.
Single.
Multi-employer trust arrangement subject to special rules
under subsection 144.1(6) ITA.
TAX IMPLICATIONS
Trust residency:
Trust residency:
No trust residency requirement but the CRA has recently
challenged some non-resident HWTs.
Trust must be resident in Canada.for tax purposes
Employer contribution:
Employer contributions deductible when:
Deduction of reasonable contributions to earn income from
business or property paid in the year the legal obligation to
make the contribution arose.
Used to pay premiums to licensed insurance company to
provide benefits in the year and prior year.
Reasonable expense to earn income from business or
property deductible in the year or prior year the legal
obligation to pay the benefits arose.
No trust funds can revert to employer.
Note – The CRA has indicated it will not allow employers
to deduct contributions that relate to benefits payable in a
subsequent taxation year.
Contribution based on an independent actuarial report
provides rebuttable presumption that contribution made to
enable the trust to make benefit payments required during
the year.
No right to trust distributions.
4
No trust funds may revert to employer.
11
No loans to employer or related person.
Contributions made in one year that are not deductible may
be deducted in future years to which benefit payments relate.
Employees (beneficiaries):
Employees (beneficiaries):
No taxable benefit when employer’s contributions are for:
• a group sickness or accident insurance plan
• a PHSP
12
• a combination of the two under s. 6(1)(a)(i) ITA
No taxable benefit when employer’s contributions are for:
• a group sickness or accident insurance plan
• a PHSP
• a combination of the two under s. 6(1)(a)(i) ITA
Premiums paid under a group term life insurance policy
are a taxable benefit to the employee under s. 6(4) ITA.
Premiums paid under a group term life insurance policy are a
taxable benefit to the employee under s. 6(4) ITA.
Employee contributions to the trust are not deductible
except where expressly provided.
Employee contributions to the trust are not deductible except
where expressly provided.
Amount paid as an employee benefit must be included in
the recipient’s income unless otherwise excluded by other
provisions of the ITA.
Amount paid as a designated employee benefit must be
included in the recipient’s income unless otherwise excluded
by other provisions of the ITA.
No taxable disposition of the employee’s participation rights
in the ELHT when a participating employee ceases to be a
Canadian resident.
Taxation of trust:
Taxation of trust:
Inter vivos trust.
st
Taxation year at December 31
Taxed at the higher individual tax rate on its investment
income and incidental income other than
employer/employee contributions minus deductible
expenses incurred in earning investment income, normal
operation of trust, premiums and benefits payable out of
the trust income.
Inter vivos trust.
st
Taxation year at December 31
Employer/employee contributions are trust capital
Taxed at the higher individual tax rate on its investment
income and incidental income other than employer/employee
contributions minus deductible expenses incurred in earning
investment income, normal operation of trust, premiums and
benefits payable out of the trust income.
Non-capital losses limited to a three year carry-forward and
carry-back, as long as the trust qualifies as an ELHT for the
year the deduction is claimed and was operated in
accordance with its terms.
Trust distributions:
Trust distributions:
No limitation to the usual “flow-through” rules applicable to
the Trust, e.g.:
• transfer at cost for the trust
• transferee acquires at cost
Trust assets cannot revert to an employer.
Distribution to a charity is permitted.
Employer has no right to trust distributions.
On wind-up or reorganization, the property of the trust may
only be distributed to employees and certain family members
(other than key employees and related persons), another
ELHT, or in certain circumstances to her Majesty in right of
Canada or a province.
Distribution to a charity is not permitted (but under
consideration by Finance).
Distribution from the ELHT occurs at fair market value (FMV)
except if recipient is another ELHT.
Subject to:
Not subject to:
Alternative minimum tax.
Alternative minimum tax.
11
An ELHT could hold a promissory note issued by an employer as evidence of the employer’s indebtedness for unpaid employer contributions. As well,
an ELHT could accept shares of the employer as contributions in some circumstances.
12
In Québec, at the provincial level only, the value of the premiums or a portion of the premiums paid to provide coverage under a personal insurance
plan are taxable benefits to the employee according to articles 37.0.1.1 and 37.0.1.2 TA.(Taxation Act, R.S.Q., c.I-3)
5
If trust no longer resident in Canada:
If trust no longer resident in Canada:
Trust property subject to deemed disposition rules in s.
128.1 ITA at fair market value.
Trust property deemed to be inventory with a “nil cost base”
and disposed of at its FMV.
Plan no longer qualifies as an ELHT whether or not benefits
are still paid to Canadian beneficiaries.
This article is intended to provide general information only. Sun Life Assurance Company of Canada does
not provide legal, accounting or taxation advice to advisors or clients. Before your client acts on any of
the information contained in this article, or before you recommend any course of action, make sure that
your client seeks advice from a qualified professional, including a thorough examination of his or her
specific legal, accounting and tax situation. Any examples or illustrations used in this article have been
included only to help clarify the information presented in this article, and should not be relied on by you
or your client in any transaction.
6