Is a Private Health Services Plan Right for Your Business?

Let’s set the scene – you are an entrepreneur who recently incorporated a rapidly growing business. You have a spouse who isn’t working and you are about to have your first child.  Currently you have no staff, but your business is expanding rapidly and you need to hire some employees.

As you start to write the job posting, you suddenly realize that any suitable candidate is going to want medical and dental coverage. You have been so busy dealing with the increase in customer demand that you haven’t had time to think about this for either yourself or your future employees.

So What Are Your Options?

One option is to look at traditional group insurance plans through an organization such as Blue Cross or other insurance companies. However, such plans may require a substantial premium to provide the level of coverage desired.

Unless you are an extremely large employer that allows employees to pick and choose, group insurance generally provides a set list of what is covered at a fixed cost. In such a situation there will always be employees who are not satisfied with either the coverage (i.e. not broad enough) or the cost (i.e. they are paying premiums for coverage they do not require).

Another option is to look at a Private Health Services Plan (“PHSP”).  A PHSP can alleviate some of the issues encountered by a traditional group insurance plan.

For example, a PSHP can allow employees to pick and choose the medical services they require while offering the business a certainty as to its costs. They are straightforward and easy to understand for both the employees and the employer.

What Is a PHSP?

A PHSP is a type of health and welfare trust that is governed by the Income Tax Act of Canada. Except for certain limited exceptions, benefits paid by an employer to an employee are generally taxable as income. One of the limited exceptions is an employer’s contributions to or under a PHSP.

In essence, a PHSP allows employees to have their medical expenses reimbursed on a tax-free basis while enabling the business – either a proprietorship or a corporation – to have a full deduction for the reimbursed expenses. Effectively you have transferred an out-of-pocket and after-tax expense into a business deduction.

As Revenue Canada states in Interpretation Bulletin IT-339R, to qualify the PHSP must be in the nature of insurance. This means it must be “an undertaking by one person, to indemnify another person for an agreed consideration from a loss or liability in respect of an event the happening of which is uncertain.”

Further, the coverage under a PHSP must be for medical care that would normally qualify for the medical expense tax credit under the Income Tax Act.

How Does It Work?

Generally a PHSP is set up through a third party service provider. The employer will contract with the PHSP provider to cover certain medical costs as defined in the employees’ employment contract (e.g. up to $1,000 for a certain level of employee, up to $5,000 for another level, etc.) on a “cost-plus” arrangement.

When the employee, or their family member, incurs a medical expense, they pay for it out of their own pocket and submit the medical receipt to the employer. The employer issues a cheque to the PSHP provider for the amount of the expense, plus an administration fee of a certain percentage of the costs (10% is normal). The PSHP provider in turn will reimburse the employee for their actual costs and keep the administration fee.

The above arrangement could be handled more economically if it was paid for directly by the employer rather than going through a third party service provider.

Revenue Canada states that such direct reimbursement plans may qualify as a PHSP. As noted in paragraph 7 of Interpretation Bulletin IT-339R:  “This occurs where the employer is obligated under the employment contract to reimburse such expenses incurred by the employees or their dependants. The consideration given by the employee is considered to be the employee’s covenants as found in the collective agreement or in the contract of service.”

As previously mentioned, the reimbursement received by the employee is on a tax-free basis.  The employer will get a full deduction for the amount they have paid.

Shareholders as Employees

It is common to have a situation where the shareholder of the company is an employee, and often the sole employee. Revenue Canada takes into consideration whether an individual receives a benefit under the PHSP in their capacity as a shareholder or as an employee.

If it is determined that the coverage is received by the individual by virtue of being a shareholder, a different section of the Income Tax Act would apply and the individual would now be in receipt of a taxable benefit. Further, in this situation payments to the shareholder would not be deductible to the corporation. This is a double-edged sword that needs to be avoided.

It is a question of fact whether benefits are received by an individual by virtue of being a shareholder or employee. When there are multiple employees and equivalent coverage is provided to all employees (shareholder and non-shareholder alike), Revenue Canada will normally consider the coverage to be an employment benefit rather than a shareholder benefit.

When you have a sole shareholder or all the employees are shareholders, if the coverage is provided as part of a reasonable employment remuneration package, again Revenue Canada will normally consider the coverage to be an employment benefit rather than a shareholder benefit.

Consider What’s Best for Your Business

A PHSP may not be the perfect solution in every situation. But depending on the types of benefits you want to provide and the number of employees you have, a PSHP can be an extremely useful component of a business owner’s toolbox and may be worth considering.

This article deals with complex matters which have not been addressed in full and may not apply to your particular facts and circumstances. As well, the matters presented and the references contained in the article reflect laws and practices that are subject to change. Please consult a tax advisor for advice about how the above information should be applied.