A Refresher on Cost Plus

Will your Cost Plus Program be Audited? Is it set up properly?

As a result of recent Canada Revenue Agency (CRA) audits of some plan sponsors’ Cost Plus programs, we felt it was timely to review the “do’s and don’ts” of setting up a Cost Plus plan.

What is Cost Plus?

Cost Plus is an arrangement offered by most carriers that allows you to provide your employees with additional coverage for health and dental expenses not covered under your existing group benefits plan.

Why set up a Cost Plus arrangement?

• As long as the Cost Plus plan meets the definition of a Private Health Services Plan (PHSP) from the Income Tax Act, it is a tax-effective way of offering enhanced coverage that would not normally be eligible under the regular benefits program without impacting the claims experience of the plan. (Note: In Quebec, although Cost Plus benefits are taxed provincially, they are not taxed federally and therefore still generate a savings to the employee.)
• You can differentiate benefits for a specific class of employees without the extra cost of upgrading the insured plan (e.g. orthodontia coverage for executives).
• You can “top-up” the regular plan where maximums, deductibles and coinsurance may be impacting the perceived value of the plan.
• You are able to pay “exception” claims on a case by case basis.

How do I set up a Cost Plus plan?

Most carriers offer one of two options in setting up a Cost Plus program:

1. “Ad hoc” or “Unique” Cost Plus

Cost Plus is not formally set up under the benefits plan contract with this arrangement. You, as the employer, determine which expenses are to be paid. Each “claim” is dealt with on a case by case basis and submitted with a Cost Plus reimbursement form along with a cheque (from the employer) including the amount of the expense and the carrier’s Cost Plus administration fee and applicable taxes. The carrier then processes the Cost Plus “claim” and reimburses the employee the amount of the submitted expense, usually on a tax-free basis. The employer can deduct this payment as a business expense. The only limitation is that the expense must be considered an eligible medical expense as defined under subsection 118.2 (2) of the Income Tax Act. This type of arrangement is sometimes used to recognize the financial burden of an employee when faced with a significant health care expense that the regular plan does not fully reimburse.

2. Cost Plus Benefit

An alternative approach that most carriers offer is to formally set up a Cost Plus benefit as part of the benefits plan contract where the eligible employees are clearly defined. Typically, they must be a distinct class of employees. For example, this type of Cost Plus arrangement is often offered to executives to “top-up” their benefits, as a perk of their position. Most formal Cost Plus plans are set up to allow for any expenses that would be covered under subsection 118.2 (2) of the Income Tax Act; however, eligible expenses can also be defined in the contract to narrow the scope of what is covered under the Cost Plus arrangement. The claiming process is essentially the same as “Unique” Cost Plus, although some carriers offer the option of billing the employer separately for Cost Plus claims on a monthly basis (as opposed to submitting a cheque along with each claim).

Which is the best option?

In order to be considered a Private Health Services Plan (PHSP) and maintain tax deductibility, a Cost Plus plan must be a part of the insurance contract. “Unique” Cost Plus, in some circumstances, may not be considered a PHSP as claims are paid extra-contractually. When these types of ad hoc claims are paid to ‘arm’s length’ employees, this type of arrangement normally does not present as much of a concern, although they are subject to audit at any time. Ad hoc claims paid to a business owner or shareholder, however, have their own set of taxation issues. Recent rulings on some ad hoc plans have found that claims paid to business owners/shareholders were not eligible to be considered under a PHSP. As a result, the CRA has levied taxes and disallowed the deductions as business expenses.

Another concern with “unique” Cost Plus arrangements is the issue of fair treatment. Paying a claim for an employee on a “one-off” basis may lead to discussions between employees and the perception of discrimination and/or favoritism.

The preferred approach would be option 2 where eligible employees and covered expenses are clearly defined in the contract. By formally including Cost Plus as a “benefit” under the benefits plan contract you:

• Bring clarity to who is eligible to participate and what expenses are covered, simplifying administration of the plan
• Minimize the likelihood of the CRA ruling against the tax deductibility of expenses
• Ensure fair treatment of all employees participating (through clearly defined eligibility criteria using distinct classes of employees) Please note that issues surrounding the eligibility of business owners and shareholders are still a concern, regardless of the option you choose. As with any benefit decision with tax implications, we urge you to discuss your options with your tax advisor. This information is not intended as tax advice – your tax advisors will be familiar with your specific tax and/or legal situation and is in a better position to advise you on the most appropriate approach.

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