At issue
Claiming annual payments for medical expenses does not often lead to significant tax relief. In addition to being a non-refundable tax credit at the lowest bracket rate, there is a cap on the amount used as the base for calculating the claim.
For business owners, a strategy that may offer a better tax result is to establish a private health services plan (PHSP) for employees. Carefully structured, this entitles the employer to a business deduction for the plan premium, while the employee will have no income inclusion when premiums are deposited nor when qualifying medical payments are eventually paid out of the PHSP.
In November 2015, the Canada Revenue agency (CRA) announced a welcome change in its position on deductibility of PHSP premium payments.
CRA Income Tax Folio S1-F1-C1, Medical Expense Tax Credit (METC)
This is the CRA’s administrative guide to claiming medical expenses. Qualifying expenses are enumerated in the folio, and may be claimed for any 12-month period that ends in the taxation year for which a return is being filed.
As with most tax credits, the credit rate is at the lowest bracket rate (federally 15%) multiplied by the qualifying amount. But unlike most credits, the actual amount expended is not what is used directly for the calculation. Rather, the medical expense total is reduced by the lesser of two figures:
- the fixed amount (indexed annually), which is $2,208 for the 2015 tax year, and
- 3% of the taxpayer’s net income
A similar calculation applies for the corresponding provincial/territorial credit.
Income Tax Act (ITA) Canada
A “private health services plan” is defined in ITA s.248(1). Practical guidance is given in IT339R2 ARCHIVED – Meaning of private health services plan. Though archived, this bulletin continues to be referenced in CRA’s own communications. It confirms that a payment made into a PHSP is a business expense for the employer under ITA s.18(1)(a), but not a benefit to the employee under ITA s.6(1)(a)(i).
Key to being a PHSP is that it is based on an employment relationship. A plan could be at risk of losing PHSP treatment if benefits favour shareholders over employees. On the other hand, it may be acceptable if the benefits of a shareholder-employee are comparable to other employees. Further insight on this issue can be gleaned from Income Tax Folio S2-F1-C1, Health and Welfare Trusts.
CRA roundtable, Canadian Tax Foundation conference – November 24, 2015
CRA’s position has to-date been that in order to qualify as a PHSP, all medical expenses covered under a plan had to be eligible for the METC. The question was posed to the CRA panel whether the agency had an update regarding its position.
The CRA now considers that a plan is a PHSP as long as all or substantially all of the premiums paid relate to medical expenses eligible for the METC. Generally that means 90% or more of covered expenses must be METC-qualified. The reason for the change is to alleviate concerns that nominal or incidental charges (eg., non-prescription vitamins) may put a plan offside, thus allowing for certainty and flexibility in plan design and administration.
The revised position is retroactive to January 1, 2015.
Practice points
- A personal tax credit is available to offset qualifying medical expenses. However, due to the structure of the credit calculation, the amount of relief is often limited.
- Bearing in mind what costs there may be in establishing a PHSP, a plan of this type will likely lead to a better tax result for supporting medical expenses incurred by employees.
- A PHSP is based on an employment relationship. Where shareholders are also employees, expert advice should be sought in order to assure that the proposed plan remains within the PHSP rules.