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The recent Federal Budget contained an announcement that modified the Income Tax Act (ITA) provisions governing the medical expense tax credit (METC). While not highlighted by the government or in the news when the budget was released, this change may end up having significant implications for sponsors of private health services plans (PHSPs). In light of the announced amendments, the question that currently has not been answered is whether PHSPs can continue to cover over-the-counter drugs (OTCs) while maintaining their tax-preferred status.
To answer the question, information is required from the Canada Revenue Agency (CRA) on how its policy regarding PHSPs will or will not change in light of the change to the METC. They have yet to rule on this issue.
In the face of this uncertainty, we provide information below on the nature of the issue and where matters currently stand for PHSPs.
Q: What is the METC?
A: The METC is designed to recognize the effect of specific above-average medical and disability-related expenses on an individual's ability to pay income tax. It currently provides tax relief equal to 15% of such eligible expenses in excess of a threshold (the lesser of 3% of the taxpayer's net income and $1,962). Caregivers can also claim the METC for eligible expenses they incur in order to care for a dependent relative.
Q: What changes were made to the METC rules by the 2008 Federal Budget?
A: The Budget announced that the ITA would be amended to specifically exclude coverage for OTCs from eligibility for the METC. Specifically, the Budget proposes to amend ITA subsection 118.2(2) to restrict drug eligibility for the METC to those medications “that can lawfully be acquired for use by the patient only if prescribed by a medical practitioner or dentist.” This change was in response to a number of court rulings where OTCs, such as vitamins, were found eligible for the tax credit.
Q: What is a PHSP?
A: A PHSP is a specific type of insurance plan that provides coverage for medical, hospital and/or dental care benefits, and offers a number of tax benefits. For example, contributions made to a PHSP by an employer on an employee’s behalf are excluded from the employee’s income, except under Québec income tax. Similarly, employee-paid premiums, contributions or other considerations qualify for the METC if certain conditions are met.
Q: How does the change to the METC rules impact PHSPs?
A: CRA Interpretation Bulletin IT-339R2, Meaning of Private Health Services Plan, states that the hospital or medical expenses covered by a PHSP are those “which normally would otherwise have qualified as an expense” under the METC provisions of the ITA. While this wording seems quite broad, CRA has issued a number of rulings stating that the only items that can be covered under a PHSP are those eligible for the METC. As METC eligibility requirements are changing, this means that PHSPs will need to be amended unless CRA modifies its position to include OTCs in addition to METC-eligible expenses.
Q: What happens to a PHSP that does not comply with CRA policy?
A: If a plan does not comply with CRA policy, it could lose its PHSP status. If this happens, employer contributions become taxable income to the employee, while employee contributions lose their eligibility for the METC. Different implications operate if the plan qualifies as an Employee Benefit Plan. CRA could also charge penalties for non-compliance. It is important to note that a PHSP that covers items over and above those listed in ITA subsection 118.2(2) is not automatically non-compliant. A determination of compliance is made by CRA on a plan-by-plan basis.
Q: How many plans cover OTCs?
A: Many PHSPs provide coverage for some OTCs. Quebec plans are actually required to provide coverage of specific OTCs included on the provincial drug plan formulary. Accordingly, amendments to plans offering coverage for OTCs will be required unless CRA allows PHSPs to continue covering such medications. If Quebec plans cease covering the OTCs in the provincial formulary, they will become illegal pursuant to the province’s prescription drug insurance legislation.
Q: What is the position of Finance on the METC/PHSP issue?
A: Finance has stated that its position is that the change to the METC provisions of the ITA was only intended to affect the eligibility of OTCs for the METC. It was not designed to affect PHSPs. While comforting, the PHSP rules are actually administered by CRA, not Finance.
Q: What is the position of CRA on the METC/PHSP issue?
A: CRA has not yet determined its position on this issue, but is in the process of doing so. The Business and Health Section of CRA’s Rulings Directorate is aware of the concerns of PHSP sponsors, and is reviewing all bulletins, policies and documents on the issue. As of March 5, 2008, the CRA advised that it had yet to formulate its response to this issue. It will likely be a matter of weeks before further communication is forthcoming from CRA.
Q: What should sponsors of PHSPs covering OTCs do now?
A: As CRA has yet to decide on a course of action, it is precipitous to amend a PHSP to remove coverage for OTCs at this time. Watson Wyatt is closely monitoring progress of this issue. Your best course of action is to wait for CRA’s official position, speak with your consultant and then take steps as required.
Please contact Karen DeBortoli , Francois Poirier or your Watson Wyatt consultant for additional information.
For other information about Watson Wyatt research and services: call 1-866-206-5723 or email infocanada@watsonwyatt.com.
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