PHSP is defined in subsection 248(1) of the Income Tax Act. It means
(a) a contract of insurance in respect of hospital expenses, medical expenses or any combination of such expenses, or
(b) a medical care insurance plan or hospital care insurance plan or any combination of such plans,
except provincial and federal government health care insurance plans.
Essentially, an employer provides an insurance to reimburse eligible medical expenses of employees.
A business may deduct amounts paid under a PHSP on behalf of employees and their dependents. Payments made under a PHSP should not include reimbursement of non-medical expenses. The CRA defines eligible medical expenses. This includes reimbursement for medical insurance premiums paid to insurance companies.
There must be a document which outlines the coverage for employees under the PHSP. If there are no limitations to the coverage, the plan will be unlikely to qualify as a PHSP. In this document, the employer can set different annual limits for PHSP benefits provided to different employee groups in the company.
An arrangement where an employer reimburses the medical expenses of an employee or dependents to a third party is called a cost plus. In this set-up, the employer contracts with a PHSP administrator for the provision of indemnification of employees’ claims. The employer promises to reimburse the cost of such claims plus an administration fee to the administrator. The employee’s contract of employment requires the employer to reimburse the administrator for proper claims, and a contract exists between the employee and the administrator in which the latter agrees to indemnify the employee for claims on the defined medical expenses so long as the employment contract is in good standing.
An arrangement where an employer directly reimburses its employees for the cost of medical or hospital care may come within the definition of private health services plan. This occurs where the employer is obligated under the employment contract to reimburse such expenses incurred by the employees or their dependents.
Both incorporated and unincorporated businesses (self-employed proprietors, partnerships) can have PHSPs, but there are different restrictions on each. The treatment for corporations is more favorable than that for unincorporated businesses.
PHSP for Corporations
Although the Income Tax Act does not place a limit on the amount of deduction allowed for PHSP premiums, the employment contract will limit the PHSP reimbursement.
The Income Tax Act does not restrict entitlement for PHSP coverage to arm’s length employees, but the CRA has issued some technical interpretations and limited the coverage for the shareholders. In 2004, the CRA issued the technical interpretation 2003-0050541E5 PHSP for shareholder. As per this interpretation if a shareholder is actively engaged as an employee of the company, and the benefits received by the shareholder under the PHSP (including the applicable limits) are reasonable having regard to all of the circumstances, it is the CRA’s general view that the benefits would be derived by virtue of the individual’s employment and exempt under subparagraph 6(1)(a)(i).
In 2014, the CRA issued the technical interpretation 2014-0521301E5 PHSP sole shareholder sole employee. Here, the CRA made it clear that a plan for a sole employee-shareholder would not likely qualify as a PHSP since it does not contain the necessary elements of insurance.
PHSP for unincorporated businesses
Section 20.01 sets up the criteria and limitation for deductibility of reimbursements under a PHSP. In order to qualify for PHSP:
- An individual should be actively engaged in the business on a regular and continuous basis; and
- In the current or preceding taxation year, excluding deductions for PHSP expenses,
- more than 50% of the individual’s total income for the year is from the business, or
- the individual’s income in the year from sources other than the business does not exceed $10,000.
Reimbursement under PHSP should be made through a third party. This is called a cost plus plan and defined earlier in this article. Therefore, an unincorporated business cannot simply reimburse an employee under a PHSP plan.
If there are no employees covered by the PHSP besides the business owner, the CRA’s view is that a cost plus plan will not constitute insurance, so will not qualify as a PHSP.
If the number of full-time arm’s length employees covered under the PHSP is more than 50% of total number of employees, the maximum allowable deduction for the the business owner will be equal to the cost of equivalent coverage under the plan in respect of the arm’s-length employees.
When less than 50% of employees are arm’s length, the maximum allowable deduction for the business owner will be an annual amount equal to the total of $1,500 for each of the sole proprietor, spouse, and dependents age 18 or more, plus $750 for each dependent under 18.