The Canada revenue agency has decided to take a harder line on employee bonuses that are redirected toward health-care spending accounts.
Beginning Jan. 1, 2013, any such reallocation of bonuses or other cash remuneration to an HCSA will now have to be included in employment income and thus will be fully taxable in the hands of the employee.
The CRA announced this change to its administrative policy regarding bonuses and HCSAs at the annual conference of the Canadian Tax Foundation, held in Montreal in November 2011. In the past, the CRA had allowed employees to direct all or part of a bonus toward an HCSA without having to include that amount in employment income, thus escaping taxation on that portion of the bonus.
Although the CRA has given no specific reason for this change in policy, CRA representatives have said that the agency recently had re-examined its administrative position and arrived at a different conclusion regarding this matter.
HCSAS SUBJECT TO TAXES
“The allocation of a bonus to obtain additional flex credits in an HCSA is an allocation of forgone cash remuneration,” says Philippe Brideau, senior media relations advisor with the CRA, “and should be subject to taxes.”
Jamie Golombek, managing director, tax and estate planning, with Canadian Imperial Bank of Commerce’s private wealth-management division in Toronto, suggests that the policy considerations that might have led the CRA to make this change are understandable: the previous policy had allowed employees of a company who knew they would have eligible medical expenses to use the reallocation of a bonus to avoid taxation on what would otherwise have to be included in employment income.
“For those who benefited from the [CRA’s] previous policy,” says Golombek, “it was a good run while it lasted.”
Employers will offer HCSAs as a means of helping employees with medical or dental expenses that aren’t covered or are not covered fully by the company’s regular group medical and dental insurance plan. The credits in an HCSA can be used only for eligible medical or dental expenses; credits cannot be converted into cash and taken out of the plan by the employee.
“An HCSA could be considered a type of secondary health-care plan,” says Murray Pituley, director of tax and estate planning with Winnipeg-based Investors Group Inc. in Regina. “Employers offer HCSAs as a way of differentiating themselves, so that they can attract and retain good employees.”
HCSAs offer tax advantages for both employers and employees. Contributions made by employers to an HCSA account are tax-deductible business expenses for the employer. However, neither the contribution nor any benefit that an employee derives from the plan has to be included in his or her income. The HCSA must qualify as a private health services plan under the Income Tax Act in order to receive this tax-favourable treatment.
CHANGE IS CONSISTENT
The change in the CRA’s administrative policy announced in November affects only the voluntary reallocation of an anticipated cash bonus into an HCSA, Golombek says, not the essential benefits or the tax treatment of HCSAs.
“Companies can still offer HCSAs, and the benefits employees receive from them remain non-taxable,” Golombek says. “However, if the employee has a choice of contributing voluntarily a portion of their bonus into an HCSA, then that contribution would now be taxable.”
In recent years, the CRA has received several requests from taxpayers for advance tax rulings regarding HCSAs, with the agency suggesting that the redirection of a cash bonus into an HCSA would not result in taxable employment income for the employee. The recent change in policy negates those rulings. The CRA says it has contacted the recipients of the previous advance rulings to inform them of the policy change.
The agency also has set the effective date of its policy change to Jan. 1, 2013, to give companies enough time to make any changes necessary to the administration of their HCSAs.
Golombek suggests that the CRA’s change in administrative policy regarding HCSAs is consistent with the moves the agency has made in recent years to eliminate what it perceives to be unfairness in the tax system — and to look for extra revenue.
“We know that taxation revenue is down, expenses are up and the budget is in a deficit position,” Golombek says. “So, the government has a general mandate to look at all things that may be grey areas or loopholes.” IE