November 30, 2020
On Friday, November 27, 2020 the Department of Finance released its long awaited legislative proposals to amend the Income Tax Act provisions governing Employee Life and Health Trusts (“ELHTs”). For the most part, these new draft proposals include some welcome changes and should facilitate the transition to an ELHT. It should be noted that the Department of Finance announced a one year extension to the current administrative rules with respect to Health and Welfare Trusts (“HWTs”). These administrative rules were originally supposed to no longer apply after the end of 2020. These administrative rules will now apply until the end of 2021.
In its 2018 budget, the federal government announced its intention to discontinue the Canada Revenue Agency’s (“CRA”) administrative policy (Income Tax Folio S2-F1-C1) regarding HWTs, and create a framework for the conversion of HWTs to ELHTs. Draft legislative proposals in furtherance of this announcement were released for consultation on May 27, 2019 (the “Initial Proposals”). Following a lengthy consultation process, Finance has indicated that legislation to enact revised proposals will be introduced “at an early opportunity”.
Summary of Proposals
The revised proposals contain a number of changes affecting both the taxation and operation of the trust, the benefits that may be offered under the trust, the beneficiaries who may participate in the trust, the governance of the trust, and investments of the trust. These are summarized below.
Designated Employee Benefits
Like HWTs governed by CRA administrative policy, ELHTs are currently only permitted to offer “designated employee benefits,” namely, benefits under a group term life insurance policy, a private health services plan, a group sickness or accident insurance plan, or any combination of the three. The proposals will amend the ITA to permit ELHTs to provide additional benefits, namely, benefits from counselling services described in subparagraph 6(1)(a)(iv) of the ITA (counselling services in respect of the mental or physical health, or re-employment or retirement counselling services) and death benefits up to a maximum of $10,000.
Additionally, and perhaps more significantly, ELHTs will be permitted to offer additional benefits to members, provided that the cost of “all or substantially all” of the benefits under the ELHT are attributable to designated employee benefits. This change aligns with previous CRA administrative policy in respect of benefits under an HWT. However, to the extent that otherwise ineligible benefits are provided through an ELHT, the cost of such benefits will not be deductible against the trust’s income.
The ELHT provisions are being amended to clarify that former and retired employees of an employer who no longer contributes to the trust are permitted to receive benefits under the trust.
The key employee provisions are also being amended. Currently, the ELHT rules require that an ELHT provide benefits to at least one class of beneficiaries that represents at least 25% of all beneficiaries of the trust who are employed by the same participating employer, as well as a requirement that at least 75% of the members of the class cannot be “key employees” of that employer. This provision will be amended, such that the 25% and 75% restrictions will be applied globally across the trust, rather than in respect of a single participating employer. In addition, the current restriction on key employees participating in an ELHT will not apply if the key employees deal at arm’s length from their employer, and if contributions made on their behalf are determined under a collective agreement. Alternatively, if the annual cost of private health service plan benefits payable to key employees and their family members are limited to $2,500, then there are no limits on the number of key employees who may participate in an ELHT. Finally, the prohibition on an ELHT being operated primarily for the benefit of key employees is being removed.
Non Capital Losses
ELHTs are currently permitted to carry-forward and carry-back non-capital losses for a three year period. Section 111(7.4) will be amended to permit the carry-back of non-capital losses for seven years.
Residency of the Trust
Subsection 144.1(2)(c) currently requires an ELHT to be resident in Canada. This provision will be amended to provide that an ELHT can be resident outside of Canada, provided that the trust provides benefits to both residents and non-residents of Canada, and that at least one participating employer is resident outside of Canada where the trust is resident.
Change to Trustee Rules
Currently, a board of trustees may not be comprised of a majority of employer representatives. This provision will be modified, to specify that the majority of a board of trustees may not be comprised of trustees who do not deal at arm’s length with one or more participating employers.
The current ELHT rules prohibit the investment of trust assets in a participating employer – where this occurs, the trust is prohibited from deducting the expenses permitted under ss. 104(6) of the ITA (i.e. the cost of designated employee benefits paid from the trust). This provision is being repealed, and replaced with a provision which will impose a new tax on the value of such prohibited investments.
Violation of ELHT Rules
The current ELHT provisions specify that, where an ELHT is not operated in accordance with the ITA, the trust may not deduct the expenses permitted under ss. 104(6). This provision is being amended to specify that the ELHT will not have breached these requirements where the trustees could not reasonably have known about the participation of ineligible beneficiaries.
Deductibility of Contributions – Single Employer Plans
Currently, employer contributions to a multi-employer ELHT are deductible where the contributions are made pursuant to a collective bargaining agreement in accordance with a negotiated contribution formula, provided that:
– no more than 95% of the employees will be employed by a single or related group of employers,
– and at least 15 employers contribute to the trust, or at least 10% of the employees who are beneficiaries will be employed by more than one participating employer); and
– contributions are determined, in whole or in part by reference to hours worked by employees.
This provision will be replaced with new contribution rules applicable to collectively bargained ELHTs, which will permit the participating employers to deduct contributions where the following conditions are met:
– employer contribute to the trust according to a formula that does not vary based on the financial experience of the trust, and either 1) if there is a collective bargaining agreement, the trust provides benefits negotiated under the collective bargaining agreement, or pursuant to a participating agreement; or, 2) the trust provides benefits in accordance with an arrangement pursuant to which there is a legal requirement for each employer to participate in the ELHT, there are a minimum of 50 trust beneficiaries who are employees of participating employers, and each employee who is a beneficiary deals at arm’s length with each participating employer; and
– contributions are determined with reference to the number of hours worked by employees, or some other measure specific to each employee.
New transition provisions are being introduced, which will permit existing HWTs to elect to be “deemed” ELHTs, provided certain conditions are met. This will permit these HWTs to qualify as ELHTs until the earliest of the end of 2022, the date the trust satisfies the ELHT conditions, and the day that the trust no longer meets the ELHT conditions.
New subsection 144.1(18) sets out an election process, pursuant to which an existing trust will be required, on or before its first filing due date after 2021, to notify the Minister, in prescribed form, that it is an employee life and health trust, if 1) prior to February 27, 2018, it provided employee benefits, all or substantially all of which were designated employee benefits, 2) after February 26, 2018, it becomes an ELHT because it satisfies the ELHT requirements; and, 3) the deemed election rules do not apply to the trust.
A new subsection 144.1(16) will facilitate trust mergers, by permitting the tax free rollover of assets from an existing trust to an ELHT, provided the benefits under the trust are all or substantially all designated employee benefits
Improvements from Initial Proposal
The new proposal contains significant improvements over the Initial Proposal, most significantly in relation to the benefits that an ELHT may provide. Many collectively bargained HWTs have, in accordance with CRA administrative policy, provided benefits which do not qualify as designated employee benefits, and the Initial Proposal did not adequately respond to this reality. These changes will greatly facilitate the conversion of existing HWTs.
In addition, the delay in introducing the new proposals following consultation has led to some uncertainty regarding the required timing for the implementation of HWT conversion, in light of the absence of final legislative provisions applicable to the conversion of ELHTs. The extension of the application of current CRA administrative policy in respect of HWTs to the end of 2021 will greatly alleviate the challenges that could have been faced by existing HWTs in complying with a December 31, 2020 deadline for conversion.
Pension and Benefits