Health and Welfare Trust

A health and welfare trust (HWT) is not defined in the Income Tax Act (the Act). In general terms, a health and welfare trust is described as a trust arrangement established by an employer for the purpose of providing health and welfare benefits to its employees. Under this type of trust arrangement, trustees receive contributions from the employer and in some cases from employees, to provide certain health and welfare benefits agreed to between the employer and the employees. Multiple employers can participate in the same health and welfare trust.

In the past, the Canada Revenue Agency (CRA) has published administrative positions regarding the requirements for HWTs along with detailed guidance on computing taxable income of such trusts. Employer’s contributions to a HWT are tax deductible in the year made if they are reasonable. In preparing trust income tax returns, a HWT may deduct taxable benefits it pays out.

Employee Life and Health Trust

In 2010, the Act was amended to introduce the employee life and health trust (ELHT) rules which are virtually identical to the CRA’s administrative guidance on HWTs. An ELHT, like a HWT, is an arrangement that allows an employer to make contributions to a trust that will provide benefits under a group sickness or accident insurance plan, a private health services plan or group term life insurance. Employer’s contributions to an ELHT are tax deductible. An ELHT may deduct all expenditures related to providing eligible benefits, including insurance premiums, claims and administrative expenses plus any benefits it pays out.

An EHLT has restrictions on what employees can participate. The ELHT’s objects are limited to paying “designated employee benefits” for employees, former employees or members of their families who belong to at least one “class of beneficiaries” of one or more participating employers. At least one class of beneficiaries of an ELHT must contain more than 25% of all employees and at least 75% of the members of that class cannot be key employees. A key employee is defined as an employee who owns 10% or more of the employer’s shares or a “high-income” employee. This rule discourages plans that benefit business owners and key employees only.

Key differences between HWTs and ELHTs

  • While HWTs rely on administrative positions contained in CRA’s Income Tax Folio S2-F1-C1, ELHTs are defined in section 144.1 of the Act.
  • An ELHT must be resident in Canada while a HWT may be established in a foreign country.
  • An ELHT cannot be created primarily for the benefit of key employees. There are no restrictions for a HWT on the participation of key employees.
  • An ELHT can be more tax efficient than a HWT as an ELHT is able to deduct all expenditures related to providing eligible benefits, including insurance premiums, claims and administrative expenses plus any benefits it pays out. A HWT is taxable on its net investment income and is only able to deduct taxable benefits paid.

2018 Federal Budget proposals

The 2018 Federal Budget proposes to discontinue the application of the CRA’s administrative positions with respect to existing HWTs after the end of 2020 in order to encourage conversion of such trusts to ELHTs. Starting in 2021, only ELHTs will be subject to the tax rules for trusts according to the Act. In addition, the CRA will no longer adhere to its administrative positions for HWTs established after February 27, 2018.

The Department of Finance has requested comments on the transitional rules by June 29, 2018. The issues for consideration in the consultation include:

  • Whether a HWT can continue as an ELHT without creating a new arrangement;
  • Whether and under what conditions a rollover of assets of a HWT to an ELHT will be permissible; and
  • The tax implications for a HWT that does not satisfy the conditions to become an ELHT or where the trustees choose not to convert.

The Department of Finance will release draft legislative proposals and guidance to facilitate the conversion of existing HWTs to ELHTs following the consultation.


Please send your comments by June 29, 2018 to the Department of Finance at: 
HWT-consultation-FSBE@canada.ca 

This week, the Department of Finance issued two news releases, being their initial responses to the vast number of submissions received during the consultation period related to the July 18, 2017 tax proposals. Further information is expected to be forthcoming.

Small Business Tax Rate

The Government announced its intention to lower the federal small business tax rate from 10.5% to 10% effective January 1, 2018, and to 9% effective January 1, 2019. This tax rate applies to the initial $500,000 of qualifying active business income of a Canadian-controlled private corporation.

Income Sprinkling Measures

The Government announced its intention to move forward with a simplified form of measures proposed to limit income sprinkling using private corporations. As originally announced, the tax on split income rules will introduce a reasonableness test for family members aged 18-24, as well those 25 and older. The intention of these tests will be to demonstrate an adult family member’s contribution to the business through a combination of the following four principles:

  • Labour contributions;
  • Capital or equity contributions to the business;
  • Financial risk taken on, such as co-signing a loan or other debt; and/or
  • Past contributions in respect to previous labour, capital or risks.

The Government promises to simplify the proposed measures in the draft legislation released on July 18, 2017 in order to reduce the compliance burden, better target the proposed rules and address double taxation concerns. How the rules will be simplified is yet to be seen; however, the tax on split income rules will be effective for the 2018 and subsequent taxation years.

Lifetime Capital Gains Exemption

The Government will not be moving forward with the proposed measures that prevent the multiplication of the lifetime capital gains exemption (LCGE). The originally proposed rules sought to disallow the LCGE for capital gains that accrue before the year an individual turns 18 years of age and those that accrue during the time the property was held by certain non-qualifying trusts. However, it appears capital gains may still be subject to the tax on split income rules, which may limit the LCGE claim.

Anti-surplus Stripping

The Government has also abandoned the proposed measures relating to the conversion of dividend income into capital gains. The proposed rules would have created increased taxes for intergenerational business transfers, increased taxes on private company shares held upon death, and uncertainty around capital dividend account balances.

Passive Investments

The Government announced its intention to move forward with measures to limit the deferral benefits of passive investments in private corporations while:

  • Ensuring passive investments already made by private companies, including the future income earned from such investments, are protected;
  • Protecting the ability of businesses to save the funds they need for contingencies or future investments;
  • Including a passive income threshold of $50,000 per year, below which would not be subject to an increase in tax, for future go-forward investments; and
  • Working with venture capital and angel investment sectors to ensure continued investment in the next generation of Canadian innovation.

Currently, it is unclear as to what measures will apply to track income from grandfathered passive investments and those that are subject to the new rules.  Further the scope of passive income is yet to be defined, particularly whether certain capital gains may be scoped out.

The Department of Finance intends to release the related draft legislation as part of the 2018 Budget. Any proposals will apply on a going-forward basis.

Next Steps

Significant concerns were raised during the consultation period in response to the July 18, 2017 tax proposals. The Government announced it will address the unintended consequences of these proposals and will make changes to the tax treatment of private corporations with the intention to reflect the following five guiding principles:

  • “Support small businesses and their contributions to our communities and our economy.
  • Keep taxes low for small businesses, and support owners to actively invest in their growth, create jobs, strengthen entrepreneurship and grow our economy.
  • Avoid creating unnecessary red tape for hard-working small businesses.
  • Recognize the importance of maintaining family farms, and work with Canadians to ensure we don’t affect the transfer of a family business to the next generation.
  • Conduct a gender-based analysis on the finalized proposals, to ensure any changes to the tax system promote gender equity.”

 

For more information on this proposed policy contact one of Smythe’s tax advisors here.

 

 

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