COST PLUS BENEFIT PLANS: A CAUTIONARY NOTE FOR SHAREHOLDER-EMPLOYEES

Many Canadian employers offer cost-plus benefit arrangements for employees. When these arrangements qualify as a "private health services plan" under the Income Tax Act, they are afforded favourable tax treatment. In general, this means employers can deduct plan contributions from business income while, at the same time, benefits received by employees can be excluded from their income tax.

However, when an employee is also a shareholder, the tax implications can be reversed. In certain cases, the Canada Revenue Agency (CRA) has determined that a cost-plus benefit arrangement should be characterized as a taxable payment to a shareholder (which is not deductible by the employer) rather than a private health services plan.

This goes back to a 2004 decision of the Tax Court of Canada, Spicy Sports Inc. v. R. In this case, the shareholder-employee was reimbursed by his employer (the company he owned) for elective knee surgery performed in the United States at a cost of approximately $38,000. The CRA auditor determined that the shareholder-employee received payment under the cost-plus arrangement in his role as shareholder - not as an employee.

The court upheld the auditor's decision, concluding that it was unlikely the company would have provided the cost-plus plan to an arm's length employee. As such, the payment in question was categorized as a payment to a shareholder and not as a payment to an employee under a private health services plan. As a result, not only was the payment to the shareholder fully taxable but the company could not deduct the payment from its income.

CRA policy released since the Spicy Sports decision provides further clarification regarding its current position on this issue. In summary:

When an employee-shareholder receives a benefit under a cost-plus plan, there is a presumption that the shareholder-employee receives the payment by virtue of his or her shareholdings in situations where the shareholder can significantly influence business policy.

Notwithstanding this presumption, a cost-plus plan provided to persons in their capacity as employees (not shareholders) may be accepted by the CRA if it passes the following test:

the benefit is available to all employees, including those who are neither a shareholder nor related to a shareholder (regardless of whether they have chosen to participate in the plan); or
the benefit is not available to all employees, but there is a logical reason to exclude some employees; or
it is reasonable to conclude that the benefit has been provided as part of a reasonable remuneration package for the individual as an employee; or
the benefit is comparable to that offered to non-shareholder employees of businesses of a similar size who perform similar responsibilities.