ELHTs: tax issues employers need to know about

Rebecca Hughes | June 01, 2011

A new type of employee benefit trust—the employee life and health trust (ELHT)—was created recently after amendments to the Income Tax Act received royal assent. This new trust maintains the basic principles of health and welfare trusts (HWTs), codifying many of the Canada Revenue Agency’s (CRA) administrative positions with respect to them.

HWTs are an administrative concession established by the CRA and governed under the guidance of Interpretation Bulletin 85-R2. The administrative rules governing HWTs led to a continuing series of technical interpretations and court cases in which the CRA had to defend, and sometimes amend, its administrative policies.

Although ELHTs do not replace existing HWTs, they both provide group sickness and accident benefits, private health services plan benefits or group term life insurance benefits for employees or former employees. The following are some of the key tax issues that will affect employers contributing to ELHTs.

Eligible employees
The ELHT legislation introduces a new defined term: key employee. Generally, these are employees who are significant shareholders or high-income earners. Key employees are to be treated in the same manner as other employees under the trust. This may restrict the ability of small companies to set up ELHTs, because they may not have enough non-key employees to qualify.

Trust beneficiaries
Beneficiaries of HWTs were never clearly defined, but the new legislation attempts to do so for ELHTs. Qualifying beneficiaries of these new trusts include current and former employees, spouses and members of the employee’s household who are related to the employee. Another ELHT can also qualify as a beneficiary, meaning that if a group of employees wishes to leave an existing ELHT to join a different one or to create a new one, the funds held in the trust for their benefit may be moved to the other ELHT.

Deductions and contributions
The timing of employer deductions must match the use of contributions over time, and total deductions cannot exceed total contributions. ELHTs will, therefore, require greater compliance and record-keeping than HWTs. Administrators will have to determine the amount spent on designated employee benefits and report this information to employers for their deductibility calculations. The use of actuarial determinations should lessen this burden.

Although the timing of an employer’s deduction must match the benefit payments to employees, a concession has been made for specified multi-employer ELHTs: employer contributions may be deducted in the year contributed.

Promissory notes
ELHTs may be funded with promissory notes; however, they are not considered contributions and are not deductible by the employer. From the CRA’s perspective, a contribution is made to the trust only when the principal and/or interest are paid.

The new legislation applies to ELHTs created after 2009. While the federal government has indicated that it does not intend to make changes to the tax treatment of HWTs, it is likely that Interpretation Bulletin 85-R2 will be updated to reflect current assessing practices and perhaps clarify the interaction between these two vehicles. Meanwhile, employers that are considering establishing a new trust to provide employee health benefits should seek clarity from a tax professional in order to determine the advantages and drawbacks for the trust, its sponsors and its members.

Rebecca Hughes, CA is a tax associate with BDO Canada LLP.

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