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In general terms, the proposed amendments would allow amounts paid to employees and retirees from an "employee life and health trust" to be deducted in computing the trust's income. At the same time, the benefits would receive the same tax treatment (generally tax-free) in the hands of employees as if they had been paid directly by the employer. If the trust's costs (including payments to employees) exceed its revenue for a particular year, the excess will be treated as a business loss for the trust, subject to a special three-year carryback and carryforward mechanism.
More details are provided below. Other aspects of the proposed tax treatment are in most respects similar to the existing income tax law and policy that currently applies in the area of health and welfare trusts for employees.
Under the proposals, an "employee life and health trust" is generally defined in the Income Tax Act (the "Act") as a trust, established by one or more employers, that meets a number of conditions. "Designated employee benefits" are defined to mean any combination of group sickness or accident benefits, private health services plan benefits or group term life insurance benefits for employees or former employees of an employer provided through a plan of insurance (including a self-funded plan of insurance). In general terms, the trust would have to meet the following conditions throughout any taxation year that it wished to benefit from employee life and health trust status:
- Its objects must be limited to the provision of designated employee benefits, and paying out any remaining surplus on wind-up;
- It must be a Canadian resident trust;
- All beneficiaries must be employees or former employees of an employer, dependants of those employees, or another employee life and health trust;
- The trust must be maintained primarily for the benefit of ordinary employees (and not "key employees" – a new defined term under the rules);
- Key employees must generally be treated the same as other employees under the trust;
- Employers generally may not have any rights to distributions from the trust; and
- Employer representatives may not constitute a majority of the trustees of the trust.
Under the proposals, no deduction would be permitted in a taxation year for the portion of an employer contribution to the trust made in the taxation year which related to anything other than designated employee benefits being provided in that year. Instead, the portion of the pre-funding, if any, that relates to designated employee benefit payments in a given future taxation year could be deducted in that future year. As a result of these rules, employer contributions to the trust in excess of the amount that is actuarially determined to be necessary to fund the contemplated benefits being provided over the life of the trust would not be deductible in any year.
To the extent that an obligation to the trust is satisfied with the issuance and contribution to the trust of a promissory note (or similar evidence of indebtedness) of the employer or a related party, payments in respect of any portion of the principal amount evidenced by the promissory note, or interest thereon, shall be deemed to be payments in satisfaction of the employer's liability to the trust, and not payments of principal or interest. From the employer's perspective these payments will, provided they are made in order to fund the payment of designated employee benefits and subject to normal tax rules, generally be deductible in the later of the year to which the portion relates and the year in which the payment to the trust is made.
Employee contributions would be permitted but not required, and would not be deductible by employees, but could qualify for the medical expense tax credit, to the extent that they are contributions to a private health services plan. Similarly, employee contributions to a wage loss replacement plan that is administered by the employee life and health trust would reduce the taxable portion of any wage loss replacement received from the trust.
Unevenness of trust revenues and expenses
Trust distributions to beneficiaries in a year that exceed the trust's income for that year normally are treated as distributions of trust capital with no other income tax impact. However, an employee life and health trust would be permitted to treat employee benefit payments as expenses. If the trust's expenses exceed its revenue for a particular year, the excess would be treated as a type of loss of the trust, with special rules allowing it to be deductible against income in any of the three preceding or three following taxation years, provided that the trust retained its status as an employee life and health trust for the year.
Treatment of benefits in the hands of employees
Of the "designated employee benefits" described above, some are currently taxable in the hands of employees on receipt (i.e., benefits under a wage loss replacement plan or coverage under a group term life insurance policy), while others are generally tax-exempt when received by employees. Either taxable or tax-exempt benefits, or a combination of the two, could be provided through an employee life and health trust, but their tax treatment in the hands of employees would not change due to the existence of the trust.
For example, private health services benefits would generally be tax-exempt in the hands of the employees, while disability insurance payments would generally be taxable. No benefit would be considered to be received or enjoyed by an employee because of an employer contribution to the trust, 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 when similar benefits are provided through the trust.
Payments made on the wind-up of the trust, otherwise than for the provision of designated employee benefits, would be taxable to the recipient.
To the extent that a particular benefit is taxable to the employee, the benefit paid from the trust would be required to be reported as an employment benefit and not as a trust distribution.
Part XIII Tax
Part XIII of the Income Tax Act imposes certain taxes on the income of a non-resident from Canadian sources. Distributions that are payments of designated employee benefits from an employee life and health trust to non-resident employees or former employees will generally not be subject to tax under Part XIII.
These proposals will apply to trusts established after 2009.