(From the July 2021 Edition of eFORUM)
By Kevin Wark
Health and Welfare Trusts (HWTs) have been an important vehicle for businesses, large and small, in sourcing and administering group benefits for employees. While the tax rules for providing employee benefits through HWTs are not specifically set out in the Income Tax Act, the Canada Revenue Agency (CRA) has developed administrative rules that effectively treat an HWT as a proxy for the employer for tax purposes. This permits the employer to deduct contributions to an HWT to fund group sickness and accident insurance, group term life insurance, and private health services plans (PHSPs). Similarly, health and welfare benefits received by employees under an HWT are taxed as if they were received from an insured plan maintained by the employer.
As part of budget 2018, the CRA announced that it would no longer accept the creation of new HWTs, and that existing HWTs would need to be wound up or converted to an Employee Life and Health Trust (ELHT) by the end of 2021. Finance also indicated that it would establish transition rules for HWTs that wanted to convert to ELHTs. Let’s discuss the rationale for these changes, the issues arising for small businesses under the existing ELHT rules, and how the ELHT rules have subsequently evolved to accommodate health and welfare plans for small businesses.
The Budget 2018 Proposals
ELHTs were introduced in 2010 to respond to the potential failure of larger, mostly unionized corporations arising from the 2008 financial crisis. In effect, employers were permitted to establish ELHTs to protect the health and welfare benefits of their employees in the event of corporate restructuring or bankruptcy. While ELHTs resembled HWTs in many respects, HWTs continued to be used by a wide variety of employers. However, the CRA wanted to rationalize the types of employee benefit plans they had to administer, and Finance agreed to assist this process by modifying the ELHT rules to accommodate existing HWTs.
As a result, budget 2018 announced that the CRA would no longer apply their administrative guidelines to new HWTs and the guidelines would be withdrawn for existing HWTs by the end of 2021. Finance Canada also announced that the ELHT rules would be modified to support the transition of existing HWTs to ELHTs. This meant that existing HWTs would need to be either converted to an ELHT or wound up by 2022 to avoid adverse tax consequences.
However, there were several restrictions in the ELHT rules that meant they were not suitable for many small businesses. One legislative requirement was that an ELHT could not be established primarily for “key employees,” which includes business owners and highly paid employees. Another requirement restricts the ability of an ELHT to provide rights and benefits to key employees that are “more advantageous” than the rights and benefits of other “non-key” employees participating in the plan. While these restrictions apply to all employers, they could have a more significant impact on smaller businesses whose employees are mainly owner/managers and highly specialized/highly paid employees.
In response to these concerns, the Conference for Advanced Life Underwriting (CALU) and the Third Party Administrators Association of Canada (TPAAC) made a number of submissions to Finance Canada. These submissions reviewed the benefits of trusteed third-party arrangements, which included removing the employer from having to adjudicate claims, protecting the privacy of employee health information, and the ability to have multi-employer groups to obtain better rates and benefits for employees. The submissions also explored how the existing ELHT restrictions would prevent small employers from using ELHTs in place of an existing HWT. This would result in smaller employers becoming less competitive in attracting and retaining employees as they would not be able to provide a comparable suite of employee benefits in comparison to larger employers.
Finance Canada responded to these various concerns outlined in these submissions by proposing to make certain modifications to the rules governing ELHTs. In addition, the CRA agreed to extend its administration rules relating to existing HWTs to the end of 2022 to provide more transitional time for employers.
Finance Canada’s Response to These Concerns
As part of the 2021 Budget Implementation Bill released in April 2021, Finance Canada released the final legislation relating to ELHTs, which included the following positive changes:
- The concern with the existing restriction in the ELHT rules regarding the participation of key employees was partially addressed by modifying the key employee test to apply at the plan level rather than at the employer level. Thus, it might be possible for a “multi-employer” ELHT to be created that would satisfy the existing key employee test, even though one or more employers participating in the plan would not otherwise have qualified had they established a separate ELHT. However, such plans still need to meet the second test, which requires the rights and benefits of key employees under the ELHT cannot be “more advantageous” than the rights and benefits of other classes of employees.
- Even where the key employee test cannot be not satisfied, a plan will qualify as an ELHT where the total cost of PHSP benefits for each key employee (and family members) does not exceed $2,500 per member. For example, where a key employee, spouse, and two children are members of the plan, the plan may still qualify as an ELHT, provided the total cost of PHSP benefits for the family does not exceed $10,000 in the year.
The 2021 Budget Implementation Bill (Bill C-30) received Royal Assent on June 29, and the revised ELHT legislation is now in effect. Employers with an existing HWT have until the end of the year to determine whether to convert their plan into an ELHT or make other provisions to provide employee benefits. It is therefore very important for all businesses in this situation, big and small, to consult with their professional advisors and plan administrators, and where appropriate, take the necessary steps to modify their plans to comply with the ELHT rules as soon as possible. Failure to do so within the required timeframes can result in adverse tax consequences for both the business and their employees.
Kevin Wark, LLB, CLU, TEP, is the author of The Essential Canadian Guide to Estate Planning, 2nd Edition.