14 July 2006 Ministerial Correspondence 2006-0188061M4 - Private Health Services Plans

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: The application of section 20.01 to sole proprietors. Is a particular arrangement a private health services plan (PHSP)?

Position: General comments re: relevant considerations when a "cost-plus" health services arrangement is implemented by a sole proprietor.

Reasons: N/A

Signed on July 14, 2006

XXXXXXXXXX

Dear XXXXXXXXXX:

Mr. Michel Dorais, Commissioner of the Canada Revenue Agency (CRA), has asked me to reply to your letter received on May 4, 2006, in which you advise that the administrator of the health services arrangement that is currently being used by your sole proprietorship has told you that the CRA is conducting a review of its status as a private health services plan (PHSP). You are concerned that any review conducted by the CRA with respect to PHSPs should consider the interests of sole proprietors.

For purposes of the Income Tax Act, a PHSP is defined as a contract of insurance in respect of hospital expenses, medical expenses, or any combination of such expenses, or a medical care insurance plan or hospital care insurance plan, or any combination of such plans. The CRA's Interpretation Bulletin IT-339R2, Meaning of Private Health Services Plan, which is available on the CRA Web site at www.cra.gc.ca/E/pub/tp/it339r2/README.html, sets out the requirements that must be met in order for a plan to be considered a PHSP. Generally, an employer is entitled to a deduction for contributions made to a PHSP in determining its income provided these requirements are met, the contribution is reasonable in amount, and the amount is laid out to earn business or property income. The benefits received by employees in respect of the employer contributions to the PHSP are not subject to tax by virtue of subparagraph 6(1)(a)(i) of the Act.

Until 1998, amounts paid by self-employed individuals for their own health, medical, and dental insurance coverage and for that of their families were not deductible in computing business income, as the Act does not permit the deduction of personal expenses in computing income from a business. On the other hand, businesses operated in corporate form were permitted to deduct the cost of insurance coverage for those shareholders that were also employees. Section 20.01 of the Act was introduced in 1998 to give self-employed individuals, which includes individuals carrying on a business through a partnership, similar tax treatment to those corporate-run businesses.

Section 20.01 of the Act allows, subject to certain conditions, individuals to deduct in computing income from businesses carried on by them premiums paid to a PHSP on behalf of themselves, their spouses, and members of their household.

A key requirement of a PHSP is that the plan must be in the nature of insurance. Paragraph 3 of IT-339R2 explains what is required for a health services arrangement to satisfy this requirement. When the plan represents (i) an undertaking by one person, (ii) to indemnify another person, (iii) for an agreed consideration, (iv) from a loss or liability in respect of an event, (v) the happening of which is uncertain, it will be considered to be in the nature of insurance. Plans involving contracts of insurance in an arm's length situation normally contain these basic elements.

Paragraph 6 of IT-339R2 discusses "cost plus" health services arrangements. In cost plus plans, the employer contracts with a trusteed plan or insurance company, otherwise known as an administrator, for the provision of indemnification of employees' claims on defined risks under the plan. The employer promises to reimburse the cost of the claims plus an administration fee to the administrator. If the employee's contract of employment requires the employer to reimburse the administrator for these claims, the basic elements of insurance discussed above may be satisfied.

What needs to be kept in mind in cost plus arrangements is that it is the employer, and not the administrator, that would be insuring the employees. As such, when a sole proprietor implements a cost plus plan, it may be difficult to satisfy the requirement that the plan be in the nature of insurance. In general, this requirement cannot be satisfied unless the plan provides coverage for at least one employee other than the sole proprietor. Otherwise, the proprietor is not undertaking to indemnify another person. Obviously, this will not be possible in circumstances where the sole proprietorship has no employees. In such a case, the sole proprietor is simply paying his or her own medical or hospital expenses, and thus the plan would not qualify as a PHSP.

To the extent that an employee's qualifying medical expenses are reimbursed from a PHSP, the employee may not include the medical expenses in computing his or her medical expense tax credit. When, however, a sole proprietor has an arrangement in place to pay his or her own qualifying medical expenses, and the arrangement is not a PHSP because it is not a plan of insurance, the qualifying medical expenses (but not the fee paid

to the administrator of the arrangement) may be included in computing the proprietor's medical expense tax credit. For further information about the medical expense tax credit, please see the CRA's Interpretation Bulletin IT-519R2, Medical Expense and Disability
Tax Credits and Attendant Care Expense Deduction, which is available on the CRA's Web site at www.cra.gc.ca/E/pub/tp/it519r2-consolid/README.html.

If you have any other questions about sole proprietors and PHSPs, I invite you to call, collect, the CRA's Income Tax Rulings Directorate at 0-613-957-8953.

I appreciate the opportunity to respond to your concerns.

							Sincerely,

							Brian McCauley
							Assistant Commissioner
							Legislative Policy and
						 	  Regulatory Affairs Branch

Robin Maley
613-957-2141
July 6, 2006