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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 (HWT) for employees1 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 (ELHT).3 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 or produce income from a business.4 The second is that employees prefer that these costs not be included in their taxable income (as benefits received or enjoyed from employment).5 For employees, the health care plan benefits are also more attractive when amounts claimed under the plan are not included in their taxable income.6 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.

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:

  • a specified employee9: 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.10

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.

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:
Group sickness or accident insurance plan.
Group term life insurance.
Private Health Services Plans (PHSP).
Any combination of the above.

Benefits provided:
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:
Employer contribution must not exceed the amounts required to provide the benefits, although some pre-funding is permitted.
Employee contributions are possible.

Funding:
Employer contribution must not exceed the amounts required to provide the benefits although some pre-funding is permitted.
Employee contributions are possible.

Trustee(s):
One or more acting independently of the employer.

Trustee(s):
One or more - employer representatives must not constitute a majority of trustees or otherwise control the trust.

Participating employer(s):
Single or multi-employer trust arrangement.

Participating employer(s):
Single.
Multi-employer trust arrangement subject to special rules under subsection 144.1(6) ITA.

TAX IMPLICATIONS

Trust residency:
No trust residency requirement but the CRA has recently challenged some non-resident HWTs.

Trust residency:
Trust must be resident in Canada.for tax purposes

Employer contribution:
Deduction of reasonable contributions to earn income from business or property paid in the year the legal obligation to make the contribution 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.

Employer contributions deductible when:
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.

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.
No trust funds may revert to employer.
No loans to employer or related person.11
Contributions made in one year that are not deductible may be deducted in future years to which benefit payments relate.

Employees (beneficiaries):
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) ITA12

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.

Amount paid as an employee benefit must be included in the recipient's income unless otherwise excluded by other provisions of the ITA.

Employees (beneficiaries):
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.

Employee contributions to the trust are not deductible except where expressly provided.

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:
Inter vivos trust.
Taxation year at December 31st
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.

Taxation of trust:
Inter vivos trust.
Taxation year at December 31st
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:
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.

Trust distributions:
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:
Alternative minimum tax.

Not subject to:
Alternative minimum tax.

If trust no longer resident in Canada:
Trust property subject to deemed disposition rules in s. 128.1 ITA at fair market value.

If trust no longer resident in Canada:
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.

  1. CANADA REVENUE AGENCY, Interpretation Bulletin IT-85R2, "Health and Welfare Trusts for Employees," July 31, 1986.
  2. 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.
  7. An inter vivos trust is one established during life, as opposed to a testamentary trust, which is established at death
  8. 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.
  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.
  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)

Sun Life Financial© Sun Life Assurance Company of Canada, 2012.

Published: 13/03/2012