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A New Tax Vehicle for Employee Life and Health Benefits

Author(s): Dov Begun

Mar 16, 2010

On February 26, 2010, the Honourable Jim Flaherty, Minister of Finance, announced his intention to introduce a new type of taxable trust into the Income Tax Act (Canada) (the Act) to fund employee life and health benefits.

“These proposed amendments will ensure that a fair and neutral tax regime applies to employee life and health trusts,” said Minister Flaherty.  “The Government of Canada remains committed to a fair and competitive tax system.”

The proposed amendments would apply to trusts established after 2009.  The Government will accept comments on the proposal until April 30, 2010.  The following is a summary of the key elements of the proposal.

What is an “Employee Life and Health Trust”?

Under the proposed amendments, an “employee life and health trust” (ELHT) is defined as a trust, established by one or more employers, to provide “designated employee benefits”, being any combination of group sickness or accident benefits, private health services plan benefits or group term life insurance benefits for employees or former employees.  To qualify as an ELHT in a taxation year, the trust must meet the following conditions throughout the year:

  • its only objects must be to provide designated employee benefits and to pay out any remaining surplus on wind-up;
  • it must be a Canadian resident trust;
  • beneficiaries must be employees or former employees of an employer, persons related to such employees or another ELHT;
  • the trust must be maintained primarily for the benefit of ordinary employees and not “key employees”, (key employees are generally non-arm’s length or high income employees);
  • key employees must generally be treated the same as ordinary employees under the trust;
  • employers may not have any rights to distributions from the trust; and
  • employer representatives may not constitute a majority of the trustees of the trust.

Employer Contributions

While an employer would be permitted to pre-fund the trust in respect of designated employee benefits payable over a number of taxation years, the amount of the deduction that may be claimed for a year would be limited to the amount reasonably regarded as having been contributed to fund designated employee benefits payable in the year.

If an employer satisfies its obligation to the ELHT by the issuance to the trust of a promissory note (or similar evidence of indebtedness), the issuance of the note itself is not considered a contribution to the trust.  Rather, payments of principal or interest under the note are deemed to be employer contributions to the trust at the time of payment and subject to the deduction provisions under the new rules.

Employee Contributions

Employee contributions to the ELHT would be permitted but would not be deductible by the employee.  However, if identified as contributions in respect of a particular designated employee benefit, such contributions would be deemed to be payments by the employee in respect of the particular benefit.  Thus, for example, an employee contribution identified as a private health services plan contribution could qualify for the medical expense tax credit.

Taxation of “Designated Employee Benefits”

The current tax treatment of the benefits encompassed within “designated employee benefits” will continue under the new ELHT structure.  Thus, for example, private health services plan benefits would continue to be tax-exempt when received by employees.  No benefit would be considered to be received or enjoyed by an employee because of an employer contribution to the ELHT, except to the extent that the trust provides group term life insurance coverage.  The value of group term life insurance coverage is currently a taxable employment benefit during each year of coverage, while life insurance proceeds received on death are generally tax-exempt.  This tax treatment would be preserved under the ELHT structure.

Payments of designated employee benefits made to non-resident employees or former employees would not be subject to non-resident withholding tax under Part XIII of the Act.

Payments made on the wind-up of the trust, otherwise than for the provision of designated employee benefits, would be taxable to the recipient.

Taxation of the ELHT

The ELHT will be a taxable trust, but special rules will generally permit the trust to minimize or eliminate its income tax payable for the year.  In addition to a deduction in computing income for the year in respect of designated employee benefits payable in the year, an ELHT would be permitted to treat such designated employee benefits as expenses.  If the trust’s expenses exceed its revenue for a particular year, the excess would be treated as a non-capital loss of the trust, which may be carried back three years and forward three years by the trust to offset income in those years.

A trust that qualifies as an ELHT throughout a taxation year will be excluded from the rules governing employee benefit plans, retirement compensation arrangements and salary deferral arrangements.  An ELHT will also be exempt from the 21-year deemed disposition rule applicable to most trusts as well as from the alternative minimum tax.

Conclusion

The ELHT rules will facilitate the provision by employers of designated employee benefits on a basis that will provide both certainty of tax treatment of employer contributions as well as a measure of security for employees and former employees of an employer in respect of important benefits, without adversely affecting the current tax treatment of such benefits.

However, as with any new tax regime, careful consideration of the consequences to all parties should be undertaken prior to implementing an ELHT.