Private Health Services Plan (PHSP) Canada: CRA Rules and Eligibility

A Private Health Services Plan (PHSP) is a Canadian plan for medical and hospital expenses that meets the definition in section 248(1) of the Income Tax Act and the Canada Revenue Agency's administrative requirements. When a PHSP qualifies, employer-paid medical expenses are generally not taxable to the employee, and the employer can generally deduct the cost as a business expense. Health Spending Account (HSA) and Health Care Spending Account (HCSA) are common product names, but the tax result depends on the arrangement actually qualifying as a PHSP. This guide explains the current CRA tests, who may participate, and what changes between insured and self-insured plans.

How does a PHSP work?

A PHSP can take several forms. Under the Income Tax Act definition and current CRA guidance, it may be backed by an insurance contract or operated as a self-insured arrangement. Many small businesses use a reimbursement plan administered by a third party, but reimbursement is not the only possible PHSP structure.

Here is the basic flow:

1. The business sets a plan limit. The employer documents how much each employee, or employee class, can claim under the plan.
2. An employee pays a medical expense. They pay out of pocket and keep the receipt and any supporting documents the plan requires.
3. The employee submits the claim. Usually this happens through the administrator's portal or claims process.
4. The claim is reviewed. The administrator or plan sponsor confirms whether the expense fits the plan terms and CRA-eligible medical expense rules.
5. The employee is reimbursed. If the claim is approved, the employee receives the reimbursement under the plan.
6. The business deducts the expense. A valid PHSP reimbursement is generally deductible to the business as an ordinary business expense, along with reasonable administration fees.

In a reimbursement arrangement, the employer funds eligible claims as they arise. An insured PHSP instead uses premiums paid under an insurance contract. The CRA applies a different 90% test to each structure, so the plan documents and annual records need to identify which model is being used.

What are the CRA requirements for a valid PHSP?

The CRA explains the current PHSP tests in its guidance on medical expenses and payments from a PHSP. The statutory definition is in section 248(1) of the Income Tax Act. Archived bulletins such as IT-339R2 remain useful background, but the current CRA page should be the first reference for the administrative tests below.

The plan has to be in the nature of insurance

A PHSP needs a real pre-agreement to cover future medical expenses and an element of risk for the party that is on the hook for the payments. In practice, that is why many businesses use a reimbursement arrangement or third-party administrator.

The CRA also recognizes self-insured plans, but those plans need to be documented carefully and operated consistently. A third-party administrator is common because it simplifies claims handling, but it is not a statutory requirement.

The plan has to stay within the METC medical expense rules

The CRA requires all expenses covered by a PHSP to be medical or hospital expenses, connected expenses, or a combination of those categories. The plan must also meet the "all or substantially all" test, which the CRA generally treats as 90% or more. The calculation changes with the plan structure:

The CRA's current examples show an insured plan qualifying when 92% of premiums relate to METC-eligible expenses and a self-insured plan qualifying when 93% of benefits paid are eligible. These percentages illustrate the test; they are not targets or safe-harbour plan designs.

In practical terms, a PHSP cannot operate like a general wellness allowance. A self-insured plan that pays benefits for gym memberships, purely cosmetic treatments, or other non-eligible items can fail the annual test if those payments exceed the permitted portion. Common eligible categories include dental care, prescriptions, vision care, physiotherapy, mental health services, fertility treatment, and medical devices, subject to the CRA rules, the plan terms, and the required documentation.

For the full list, see HSA eligible expenses in Canada.

The plan has to be documented and applied consistently

If a shareholder-employee is involved, CRA will look at whether the benefit is being provided because of employment and under a real plan, rather than as a disguised shareholder distribution. Different employee classes can exist, but the plan should be clear, documented, and applied according to its terms.

For a shareholder-employee, the key question is whether the plan is actually an employment benefit under the facts. A plan for a one-person corporation may qualify when the shareholder actively works in the corporation's day-to-day operations and receives the benefit because of that employment, not simply because they own shares. This is fact-dependent, and the CRA has challenged self-insured arrangements that mainly reimburse a sole shareholder's family expenses. T4 income is Frontier's preferred evidence. Dividend-only cases require other supporting documentation and confirmation from the corporation's accountant.

PHSP compliance checklist

A PHSP should be reviewed against each of these points before the business relies on the intended tax treatment:

• The written plan identifies the employer, eligible employees or employee classes, dependants, annual limits, and claim rules.
• The arrangement is in the nature of insurance and covers future, uncertain medical expenses rather than reimbursing expenses after the fact without a prior obligation.
• Covered expenses are medical, hospital, or connected expenses permitted by the plan.
• The insured-premium or self-insured-benefit calculation meets the applicable 90% test for the calendar year.
• Claims are supported by the receipts, prescriptions, certifications, or other documents required for that expense.
• A shareholder-employee receives the benefit because of employment under the facts, not merely because they own shares.
• The business retains plan documents, claim decisions, funding records, and annual calculations that support the treatment used.

Meeting one item does not cure a failure elsewhere. A provider's use of the words HSA or PHSP also does not establish that a particular arrangement qualifies.

What is the difference between a PHSP and an HSA?

This is the most common question business owners ask when researching health benefits. The short answer: an HSA that meets CRA requirements is a PHSP. They refer to the same underlying tax structure, but not every plan marketed as an HSA necessarily qualifies.

Think of it this way: PHSP is the legal category, while HSA is the market term. When you sign up with a reputable HSA provider in Canada, you are usually buying a plan that is intended to meet PHSP requirements.

The CRA does not use the term "HSA" in the Income Tax Act. The official term is Private Health Services Plan. The CRA has also warned that some health care spending accounts marketed to consumers may not actually qualify as PHSPs.

For a deeper look at how HSAs work in practice, see What is a Health Spending Account in Canada?

How does a PHSP compare to group health insurance?

A PHSP and group insurance can both help cover employee health expenses, but they work differently.

For many small businesses, a PHSP covers day-to-day medical expenses efficiently. Insurance is better when you need broader insurance-style coverage, such as disability or life insurance.

For the full comparison, see HSA vs insurance in Canada.

Who can set up a PHSP?

Your business structure determines whether you can establish a PHSP and what rules apply.

The biggest distinction is between an employer-style HSA reimbursement arrangement and the separate self-employed PHSP-premium deduction. The CRA has issued a buyer-beware warning about sole proprietors with no arm's-length employees using an HSA to reimburse their own medical costs. Separately, section 20.01 of the Income Tax Act may permit an actively self-employed individual to deduct qualifying PHSP premiums when the statutory income, contract, employee-coverage, and dollar-limit conditions are met. Those are different arrangements and should not be presented as interchangeable.

For detailed rules by business type, including when sole proprietors have employees, see our guides for sole proprietors and incorporated professionals.

How is a PHSP taxed?

The tax treatment is what makes PHSPs valuable. Here is the basic picture.

For the business:

• Employer reimbursements under a valid PHSP are generally deductible as business expenses.
• Administration fees are also generally deductible if they are reasonable and incurred to earn business income.

For the employee:

• Reimbursements under a valid PHSP are generally excluded from employment income federally under ITA section 6(1)(a)(i).
• They are not usually reported as employment income on the employee's T4 for federal purposes.

The Quebec exception: In Quebec, employer-paid contributions and coverage under a PHSP are treated as a taxable benefit at the provincial level. For plans not backed by insurance, Revenu Quebec calculates the taxable value using the benefits paid plus administration costs, less any employee contributions. The federal treatment can still be tax-free, but Quebec employees may have an additional provincial amount.

PHSP vs paying health expenses with after-tax income

To see why a PHSP matters, use an illustrative example. Assume a qualifying shareholder-employee has $5,000 of eligible medical expenses, faces a combined personal marginal tax rate of about 40%, and uses a PHSP with an 8% administration fee.

Without a PHSP, the owner would need to pull roughly $8,300 of pre-tax income out of the business to net $5,000 after tax for the medical bill. With a PHSP, the corporation pays about $5,400 total, the reimbursement is generally tax-free to the employee, and the corporate deduction can improve the after-tax result further.

For a more detailed breakdown, see the HSA tax guide for corporations.

What expenses can be claimed through a PHSP?

A PHSP is generally built around medical expenses that fit the CRA medical expense rules in ITA section 118.2. The plan also has to satisfy CRA’s all-or-substantially-all test, which CRA commonly treats as meaning 90% or more of the plan’s premiums or benefits should relate to METC-eligible medical expenses.

In other words, a PHSP should be overwhelmingly medical. It is not supposed to be a mixed lifestyle account where a large share of the spending goes to non-eligible perks.

Common categories include:

• Dental care
• Prescription drugs
• Vision care
• Physiotherapy, chiropractic, and massage therapy, subject to the provider and province
• Mental health services
• Fertility treatment
• Medical devices
• Hospital and ambulance services

Not eligible: gym memberships, purely cosmetic surgery, over-the-counter vitamins, and general wellness programs.

One advantage of a PHSP over insurance is that the reimbursement rules are often more flexible than a traditional insurance formulary. The plan still has terms, ceilings, and documentation rules.

For the complete list, see HSA eligible expenses in Canada. For province-specific practitioner rules, see CRA medical expenses in Canada.

How do you set up a PHSP for your business?

There are two paths.

Option 1: Use a third-party administrator. This is a common approach. A provider like Frontier HSA can help with plan setup, claim review, reimbursement administration, and plan documentation. Pricing and service levels vary by provider.

Option 2: Self-insured plan. The CRA does recognize self-insured PHSPs, but structuring one correctly requires careful attention to documentation and compliance. You need a written plan, a clear reimbursement process, and records that show the plan is operating in the nature of insurance.

When choosing a provider, look for:

• Clear plan documentation
• A claims process that matches the plan terms
• Reasonable administration fees
• Good recordkeeping for audit purposes

FAQ

What does PHSP stand for? Private Health Services Plan. It is the legal term used in the Income Tax Act for a qualifying health reimbursement arrangement.

Is a PHSP the same as an HSA? An HSA that is properly structured to meet CRA requirements can qualify as a PHSP. The CRA uses the term PHSP in legislation, while HSA and HCSA are product names used by providers. Not every plan marketed as an HSA will qualify.

Can a sole proprietor set up a PHSP? A sole proprietor with at least one arm's-length employee may be able to establish an employer-style PHSP if the arrangement meets the CRA rules. A sole proprietor working alone cannot use the same HSA self-reimbursement model, although section 20.01 may allow a separate deduction for qualifying PHSP premiums when all statutory conditions are met.

What happens if my PHSP is not CRA-compliant? CRA may deny the intended tax treatment, and the amounts can be recharacterized depending on the facts. The corporation may lose the deduction and the employee may have a taxable benefit.

Are PHSP benefits taxable in Quebec? At the provincial level, yes, employer-paid PHSP contributions and coverage are generally treated as a taxable benefit. The federal treatment can still be different.

Does a PHSP have a contribution limit? There is no fixed federal dollar cap in the PHSP definition itself for an employer plan, but the plan still has to meet the CRA's PHSP rules. The separate section 20.01 deduction for self-employed individuals has statutory limits. In an employer plan, the business sets the annual limit and should make sure it is reasonable for the employee class and plan design.

Can I use a PHSP and also claim the Medical Expense Tax Credit (METC)? Not for the same expense. If a PHSP reimburses an expense, you generally cannot also claim it personally as a METC. Expenses not reimbursed by the PHSP may still be claimable if they otherwise qualify.

Primary sources

• CRA: Medical expenses, including payments from a private health services plan
• Income Tax Act, section 248(1): PHSP definition
• Income Tax Act, section 20.01: PHSP premiums for self-employed individuals
• Revenu Québec: Contributions to a group insurance plan, including a PHSP

Related reading

• What is a Health Spending Account in Canada? - How HSAs (PHSPs) work step by step
• HSA vs insurance in Canada - Full cost and coverage comparison
• HSA tax guide for corporations - Tax treatment and CRA compliance
• CRA medical expenses in Canada - Eligible expenses, practitioners, and provincial rules
• HSA eligible expenses: complete list - Everything you can claim
• HSAs for sole proprietors - Eligibility rules for unincorporated businesses
• HSA for incorporated professionals - Guide for professional corporations