A private corporation and its shareholder–employee (business owner) may wish to consider using a “private health services plan” (PHSP), as defined in the Canadian Income Tax Act, as part of a tax-effective remuneration strategy for the corporation’s employees, including the business owner.
For purposes of the Income Tax Act, a PHSP is, among other things, a contract of insurance in respect of hospital expenses, medical expenses or any combination of such expenses. In general, the contract of insurance requirement will be satisfied by an undertaking by a corporate employer to indemnify its employees from the cost of the employees’ qualifying medical expenses under the act.
A business owner who utilizes a PHSP to pay for his or her (and his or family’s) medical expenses must ensure that benefits provided under it are commensurate to those that would be provided to a similarly situated arm’s-length employee who is not a shareholder as part of a reasonable compensation package. (For example, if the business owner is the president of the employer corporation, then the PHSP benefits should not exceed those that would be provided to an employee president that is not a shareholder of the corporation, but is doing the same job in similar circumstances as the business owner.)
If this principle is not adhered to and the PHSP benefits are in excess as a result of the business owner’s shareholdings, Canada Revenue Agency could make an adverse assessment of the benefits received under the PHSP by the business owner.
As long as the receipt of benefits by an employee of the corporation under the PHSP is considered to be received in his or her capacity as an employee of the corporation, the corporation should be able to deduct benefits provided to its employees under the PHSP. Further, if such benefits are received in an employee capacity, the benefits should not be taxable to the employee.
As a result, there is preferential tax treatment availed to the use of a PHSP for employee compensation, as in almost all other cases, benefits provided by an employer to an employee are taxable to the employee. (The tax policy for this preferential treatment appears to be to motivate employers to pay for employees’ medical expenses, perhaps as a means to reduce the state’s obligations to assist with these expenses.)
By way of illustration, suppose a corporation that qualifies for the small business deduction rate of tax (i.e., 14 per cent) pays $10,000 in respect of the medical expenses of Alberta resident employees who are subject to tax at the highest marginal rate (i.e., 39 per cent).
The use of the PHSP in this scenario results in a approximate net cost of $8,600 for the medical expenses vis-à-vis a net cost of between $9,900 and $12,500 if no PHSP is used; in other words, PHSP savings of between $1,300 and $3,900. (The savings range in the foregoing example occurs as all, some or none of the medical expense tax credit may be available for employees paying for their own medical expenses.)
The savings from the use of a PHSP result because the PHSP utilizes pre-tax corporate dollars to pay for medical expenses instead of after-tax personal dollars, and because most employees are unable to fully utilize the medical expense tax credit as a means to reduce the cost of their medical expenditures.
In appropriate circumstances, a corporation may be able to avoid the use of a third-party service provider to administer its PHSP by administering it internally, thus avoiding the five to 10 per cent administration fees chargeable by the provider. In any event, PHSP and related documents should be carefully prepared to adhere to the statutory requirements, as well as the administrative policy of the CRA to avoid disagreements.
In view of the inherent flexibility of a PHSP and potential business and tax benefits from the use thereof, a business owner should consider utilizing a PHSP as part of the corporation’s employees’ remuneration packages.
Tax Talk appears on the first and third Tuesday of every month in the Business section of the Advocate. It is written by Jason Stephan, a chartered accountant and a tax lawyer who is tax counsel with Red Deer law firm Warren Sinclair LLP. Readers with specific tax issues are encouraged to consult a qualified tax professional for advice appropriate for their circumstances. Stephan can be contacted by email at firstname.lastname@example.org and by telephone at 403-343-3320.