Due to its nature involving employee and taxation issues, care should be taken to structuring the FlexSave™ program within any business. It is strongly recommended that your client review all plan setups and any questions with their tax advisor. The following information is guidelines only and should not be construed as advice.
Note: Applicable CRA bulletins can be found at the Canada Revenue Agency website
Setting Maximum Benefits/Classifications
Structure and classes should be clearly defined before the plan is put in place and should be available in writing for employee review. There must be justifiable rationale as to why each class of employees is receiving differing benefits than another (as would be the case with traditional benefits). Benefits must be equal amongst classes and fair between classes. For example, by setting up one class with a benefit maximum of $1,000, the next class should not exceed 2-4 times that benefit amount.
When attempting to determine a maximum for any employee, another rule of thumb to follow is to insure that the benefit amount does not exceed 10% - 15% of a persons annual income. In the benefits industry, it is rare to find individuals receiving more than that on a premium or reimbursement level.
Note: There are some unique restrictions on Unincorporated Business with Arms Length* Employee(s)
If the unincorporated business has eligible Arms Length employees, the CRA sets the owner maximum in a differing manner. The owner’s eligible amount in this case would be the lowest cost-equivalent coverage provided to their least-favored Arms Length employee. For example, if the owner provides only $500 to an employee, then their personal deduction ability will also be limited to $500 per annum.
*Arms Length employee is one that is unrelated to the sole proprietor.
Maintaining an Employee Benefit and Not a Shareholder Benefit
Programs like FlexSave™ are designed to provide benefits for employees (see reference: IT bulletins IT85R2 and IT339R2). Thus, the plan should be extended beyond the ownership group to the employees. Failure to do so could result in CRA ruling the contributions as a shareholder benefit not an employee benefit. This could lead to the contributions not being deductible to the business and the benefit being taxable to the shareholder, certainly not a favorable outcome.
The appeal courts in Canada followed the above logic in the case of Docket 2003-2910 (IT) between Spicy Sports Inc. and Her Majesty the Queen. CALU commented on this case by stating: “this case highlights the risks associated with establishing private health services plans only for shareholders and their families. Where there are other employees, the failure to include them in the plan will be an indication that the benefit is being provided by virtue of the shareholdings.”
A corporation controlled by a sole shareholder/employee may create a PHSP and receive benefits tax-free, provided they receive those benefits as an employee. While a sole shareholder with no employees could have trouble proving that the PHSP benefits were tax-free employee benefits, and not taxable shareholder benefits, the option still exists. Generally, where a sole shareholder is also the sole employee, CRA would consider the sole shareholder-employee to receive the benefits in his or her capacity as a shareholder unless he or she can demonstrate 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.
The CRA has stated that there must be an element of risk to the employee. In order to satisfy this requirement a one year carry-forward period of the unused credits is maintained. If an employee does not use their allotment after the one year period, they will lose that portion. The employer is not required to offer carry-forward to their employees but should they choose to, the one year period will apply.
Annual maximum for employee is $1,000
2009: employee spent $500 in expenses
2010: employee eligible for $1,500 for the year based on last year’s unused credits
2010 year end: employee did not spend any amount. The $500 carried forward from 2009 and still unused is forfeited
2011: employee eligible for $2,000 ($1,000 from 2010 and $1,000 from 2011)
No Revision to the Employer
Paragraph 6 of IT-85R2 states that trust funds cannot revert to the employer or be used for any purpose other than providing health and welfare benefits for which contributions are made. CRA Tech Interpretation 1995 - 9433745 states that “acceptable uses of trust funds upon windup included distribution to a registered charity as defined in section 149.1 of the Act and the provision of additional qualifying benefits as described in paragraph 1 of IT 85R2 to the employees covered by the plan.”
Primary Income Source
Self-employment/earned income must be the primary source of income in the year (over 50%). This is designed to prevent someone from setting up a business for the sole purpose of obtaining more tax-efficient paying of medical expenses. This also eliminates the use of investment/holding companies as they do not have “earned income” by definition of the CRA.