When the federal government announced, in the recent budget, that it was tightening eligibility rules for the medical expense tax credit (METC) to exclude medications, preparations and other items available without a prescription, it seemed to make sense. In light of a number of recent cases where over-the-counter (OTC) items, including vitamins, were held to be METC-eligible under current Income Tax Act (ITA) provisions, it was understandable that the government would move to close what it saw as a loophole. However, closing that loophole has opened a can of worms for insurers and employers. At issue now is whether private health services plans (PHSPs) can continue to provide coverage for OTCs in light of the change to the METC rules and maintain their tax-preferred status.
As defined by the ITA, PHSPs are contracts of insurance or insurance plans covering eligible hospital or medical care or expenses other than those covered by provincial health insurance plans. PHSPs are attractive because of the tax benefits they offer. For example, contributions made to a PHSP by an employer on an employee’s behalf are excluded from the employee’s income, except under Quebec income tax. Similarly, employee-paid premiums, contributions or other consideration qualify for the METC if certain conditions are met.
The road linking PHSPs and the METC is rather tortuous, as it takes one out of the ITA and into interpretation materials provided by the Canada Revenue Agency (CRA). 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 the Budget has changed the METC rules to exclude OTCs, this means that such items can no longer be covered under PHSPs…or does it?
When Finance drafted the changes to the METC rules, it appears officials were solely focused on closing the loophole noted earlier, not on changing the PHSP rules. They also were not trying to exclude items such as insulin and other diabetic supplies from eligibility for the METC—that they have effectively done so is a topic for another day. In the aftermath of the budget, Finance has stated that its move had nothing to do with changing whether OTCs could be covered by PHSPs. Problem solved? Not really, since, as noted earlier, the decision regarding what can and cannot be covered by a PHSP is the responsibility of the CRA, not Finance. So, what is the actual answer?
CRA has yet to decide what its position on this issue will be, and is currently reviewing all material on the issue. As the link between the METC rules and PHSPs is based on policy and not legislation, CRA has a range of options, none of which require legislative amendment.
The impact of CRA’s decision—when it is made—will be significant. This is especially true for PHSPs covering employees in Quebec, which must cover at least those drugs on the RAMQ Formulary—including some OTCs. 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. CRA could also charge penalties for non-compliance. CRA is aware that there is potentially a lot at stake, and has stated that it is sensitive to the concerns of plan sponsors, and is working diligently to reach a decision.
It is said that nature abhors a vacuum, and recent discussions regarding the impact of the METC changes on PHSPs seem to support this. Despite the fact that CRA has not taken a position, stakeholders have. At one end of the spectrum, some are relying solely on Finance’s statement as authority for the position that PHSPs can continue to cover OTCs, and that no amendments are required. Based on CRA’s historic position, and its responsibility for administering PHSP rules, this is incorrect.
At the opposite extreme, some are using CRA’s historic position as evidence of their current views on the issue, and stating that PHSPs can no longer cover OTCs, and those that do must be amended. Given the lack of a definitive statement from CRA, this is presumptive.
Until stakeholders hear from CRA, the best course of action for sponsors of PHSPs covering OTCs is to stay the course. No plan amendments should be made until information is available regarding what changes, if any, are required to ensure that a PHSP continues to comply with CRA policy.
Karen DeBortoli is director with the Canadian Research & Innovation Centre of Watson Wyatt and François Poirier is senior consultant, Group & Health Care, Central Canada with Watson Wyatt. They can be reached at: Karen.DeBortoli@watsonwyatt.com /Francois.Poirier@watsonwyatt.com