Section 118.2 Medical Expense List and PHSP Alignment

Most people assume the Medical Expense Tax Credit works on a principle: if you spent money for a genuine medical reason, it should count. It doesn't work that way.

Why the s.118.2(2) list is exhaustive, not illustrative

Section 118.2(2) of the Income Tax Act does not describe medical expenses in general terms and leave the rest to judgment. It enumerates them, paragraph by paragraph, alongside sections 5700 and 5701 of the Income Tax Regulations, which add further conditions to specific items on that list. That holds even when the expense was incurred for a completely legitimate medical purpose. A treatment can be medically necessary, prescribed by a licensed practitioner, and still fall outside the credit if Parliament never wrote it into the list.

This distinction is not a footnote or a technical quirk that only matters to tax specialists. It is the architectural fact that determines what a PHSP can reimburse, how a plan has to be designed, and where the line sits between a tax-free reimbursement and one that quietly becomes taxable income.

Reading the bare statute doesn't tell the whole story, either. The CRA's primary interpretive document, Income Tax Folio S1-F1-C1, expands on the statutory paragraphs and clarifies how the CRA applies them in practice. The folio itself is revised over time. The folio is a living document: its chapter history records amendments as legislation and CRA interpretation evolve, and the eligible-expense list is not static. Anyone working with a PHSP needs to treat s.118.2(2), the Regulations, and the folio as one connected framework, not three separate documents to check in isolation.

How a PHSP's tax-preferred status derives entirely from s.118.2(2)

Once the closed nature of the list is clear, the next step follows directly: a PHSP has no independent definition of what counts as an eligible medical expense. It borrows the entire concept from s.118.2(2). Expenses reimbursed through a PHSP qualify for tax-preferred treatment only if they would otherwise qualify as medical expenses under that same section. There is no separate, broader standard for what makes an expense health-related enough to belong on a PHSP. The PHSP's eligibility rules and the METC's eligibility rules are the same rules.

The CRA formalizes this relationship through a specific quantitative test. A plan qualifies as a PHSP as long as all or substantially all, interpreted by the CRA as 90% or more, of the premiums paid under it relate to expenses eligible for the credit. That single number is what separates a plan that carries tax-preferred status from one that doesn't.

This is where the relationship becomes genuinely two-directional. Because the PHSP's status is entirely derivative of s.118.2(2), any change to that underlying list changes what a PHSP is allowed to cover automatically, with no separate amendment required to the PHSP itself. Nobody has to rewrite a plan document when Parliament adjusts the eligible-expense list. The plan's coverage shifts on its own, because it was never defined independently in the first place.

It is binary. A plan that dips below the required share doesn't lose a proportional slice of its tax-preferred status. It loses PHSP status entirely, and every reimbursement made under that plan becomes potentially taxable, not just the portion tied to the ineligible expenses that caused the breach. A small drift in plan design can convert the entire arrangement into taxable income for every employee who used it.

A pay-as-you-go health spending account, the kind where a small business sets an annual budget and employees submit claims digitally as they incur expenses, has to be built around the CRA's eligible-expense list specifically. The flexibility of that model, letting employees direct funds toward the expenses that matter most to them, only works if the underlying claims stay inside the boundary s.118.2(2) draws. Design the eligible-expense categories loosely, and the plan risks losing the tax treatment that makes it worth using.

The compliance asymmetry between insured and self-insured plans under the 90% rule

The 90% threshold sounds like one rule, but it gets applied two different ways depending on how a plan is structured, and that split changes whether a plan keeps or loses its tax-preferred status.

For insured plans, the test looks at premiums. The required share of premiums paid into the plan has to relate to METC-eligible expenses, regardless of how the benefits eventually get paid out. A plan can pay some claims for non-eligible expenses and still stay compliant, as long as the premium structure itself was built around eligible coverage.

For self-insured plans, the test moves downstream. It looks at the benefits actually disbursed that fund the plan. The required share of what the plan actually pays out has to be for METC-eligible expenses.

That distinction creates a real design risk. A self-insured plan that reimburses even a modest volume of wellness or lifestyle expenses, gym memberships, general wellness products, anything outside the enumerated categories, risks breaching the 90% threshold at the point where benefits are paid. A plan can look compliant on its cover sheet and still breach the threshold in practice, simply because of the pattern of claims employees submit month to month.

This creates particular exposure for what might be called the combined-plan risk. Administrators who bundle a PHSP with a wellness or lifestyle spending account must ensure the combined structure's premium or benefit allocation does not breach the threshold for the PHSP component. The CRA has not issued updated guidance addressing these combined designs directly, which leaves administrators to apply the existing insured and self-insured tests carefully rather than relying on a bundled-product exception that doesn't exist. Knowing the eligible-expense list is a necessary condition for compliance, but it isn't sufficient on its own. The plan's structure, insured or self-insured, determines which version of the 90% test actually applies, and getting that wrong is just as damaging as misreading the expense list itself.

The METC credit mechanism and the value of the PHSP route for small business owners

The METC is a non-refundable federal credit, and it only applies above a threshold. Expenses below that threshold generate no tax relief whatsoever under the personal claiming route. Someone with modest medical costs and a moderate income can spend money all year on eligible expenses and still see none of it translate into a credit, simply because the total never clears the line.

A PHSP works differently: its deduction reduces taxable income directly, with no threshold to clear first. For an incorporated business owner, the corporation deducts the full expense, and the tax saving equals the combined corporate and personal marginal tax rate applied to every dollar of the medical expense, minus whatever administration fee the plan charges. There's no floor to clear and no percentage of net income to calculate before the benefit starts accruing.

The practical consequence is significant. Many small business owners and incorporated professionals who use a PHSP end up with a larger tax benefit on the exact same medical expense than they would have received claiming the METC personally. The PHSP route takes a credit that only works above a threshold and turns it into a full deduction that works from the first dollar. That is the structural advantage, and it exists only because the PHSP's eligible-expense definition is borrowed directly from s.118.2(2). Without that derivative relationship, none of this alignment would hold.

A pay-as-you-go HSA captures this advantage in a particularly efficient form. A business using this structure pays an administration fee only on claims that are actually approved, with no fixed premiums sitting unused. That model captures the full structural benefit of the PHSP deduction without paying for coverage nobody ends up using, which matters for small businesses trying to manage cash flow alongside tax planning.

The PHSP rules and hard constraints by business structure

The CRA recognizes three distinct routes for medical expense tax treatment in a business setting: the personal METC available to employees, a business deduction claimed on the T2125 for qualifying self-employed individuals, and a corporate deduction for incorporated owners. Which route applies, and how much flexibility it offers, depends entirely on business structure.

Incorporated owners have the most straightforward path. A corporation can reimburse an owner-employee through a compliant PHSP as long as that owner is genuinely employed by the corporation, which is typically evidenced by a regular salary and a T4 slip. The employment relationship has to be real and documented, evidenced by more than the fact that the owner also runs the company.

That documentation requirement exists because of a specific tension the CRA watches closely. Shareholders who can significantly influence business policy are presumed to receive benefits because of their ownership stake, not because of genuine employment. Where that presumption holds, the benefit gets taxed as income to the shareholder and isn't deductible by the corporation at all, which erases the entire tax advantage the PHSP was supposed to provide.

There is a confirmed route around that presumption. CRA Technical Interpretation 2003-0050541E5 establishes that a PHSP can be set up for a corporation where the only employees are shareholders, but the payments qualify only if the shareholder received the benefit in their capacity as an employee. That means the shareholder has to be actively engaged in business activities, and the benefits provided have to be reasonable and consistent with what an arm's-length employee in a comparable role would receive. The employment relationship has to be doing the actual work of justifying the benefit.

Sole proprietors face a harder constraint. A sole proprietor with no employees cannot set up a self-insured HSA for themselves, because the CRA does not accept that arrangement. There's no legal separation between the individual and the business in that structure. Where a sole proprietor does employ arm's-length staff, a different rule kicks in for the proprietor's own coverage: if at least half of the employees are arm's-length, the maximum deduction available for the proprietor and their dependants is capped at the cost of equivalent coverage provided to those arm's-length employees. The business structure a person operates under decides which of these three routes is even available, before any question of eligible expenses comes into play.

The eligible-expense categories and their hard edges

The categories that make up s.118.2(2) and the folio's interpretation of it cover a broad range of genuine health spending. Prescription drugs dispensed by a registered pharmacist qualify, along with dental procedures excluding purely cosmetic work, vision care such as glasses and contact lenses, physiotherapy from an eligible practitioner, licensed medical practitioners' fees, ambulance services, mobility and assistive devices like wheelchairs, crutches, orthopedic devices, hearing aids and cochlear implants, attendant care and nursing home care where qualifying conditions are met, and home oxygen. That range covers the overwhelming majority of what a typical employee benefit plan needs to reimburse.

The edges of the list create the real friction, in cases like cosmetic exclusions and vitamin claims. Cosmetic procedures carry a bright-line exclusion: anything purely cosmetic incurred after March 4, 2010 is non-eligible, along with related services and travel connected to it. Confirmed non-eligible examples include teeth whitening, cosmetic Botox, dermal fillers, facelifts, and hair transplants. That date matters. Procedures incurred before it fall under different rules, but anything after sits firmly outside the list regardless of how the procedure is framed or billed.

Vitamins and supplements sit in a category that trips up plan administrators constantly. A drug prescribed by a licensed practitioner and dispensed by a registered pharmacist is eligible. A vitamin or supplement is not, even when a licensed medical practitioner specifically prescribes it. The line runs through the dispensing mechanism and the product category, not through whether a doctor recommended it.

Cannabis occupies a similarly narrow but genuinely eligible space. The CRA considers cannabis an eligible medical expense where the person holds a valid medical document from a health-care practitioner and purchases from a federally licensed seller with whom they're registered. PHSP administrators frequently flag cannabis claims for additional documentation, because the combination of a valid prescription and a registered licensed-producer relationship is easy for claimants to get partway right and still fall short of full eligibility.

Mental health services can be eligible when a recognized practitioner provides them and proper documentation supports the claim, but which practitioners count as recognized varies by province and territory, which produces real inconsistency in how plans administer these claims depending on where an employee lives.

Two recent clarifications extend the list's reach into areas that didn't have explicit guidance before. Folio S1-F1-C1 was updated in December 2024 to address fees paid for virtual medical services, confirming they're eligible under the same conditions that apply to in-person care. A separate clarification added in the same period confirmed that the cost of an implanted device used in the provision of medical or dental services may qualify under paragraph 118.2(2)(a).

Falling within one of these categories is a necessary condition for reimbursement, but it isn't the only one. Every claim under s.118.2(2) also has to be evidenced by receipts, and those receipts have to support the expense if the CRA reviews the claim. An expense that fits squarely within an eligible category still needs the paperwork behind it to hold up.

How the eligible-expense list changes and its effect on PHSP coverage

Because the PHSP borrows its eligible-expense definition from s.118.2(2) by reference rather than restating it independently, the list is not a fixed document that gets set once and left alone. Any legislative amendment to s.118.2(2) flows straight into PHSP eligibility, automatically, with no separate PHSP amendment required and no plan document that needs to be reissued to reflect the change.

A recent example shows how this works in practice. Paragraph 118.2(2)(v) was amended by S.C. 2024, c.17, s.28(1), applicable to the 2022 and subsequent tax years, adding "embryos" to the list of reproductive material whose acquisition costs qualify for individuals seeking to become parents. The moment that amendment took effect for the METC, it took effect for PHSP reimbursement as well, without any plan sponsor needing to update a policy document or notify the CRA of a change to their arrangement.

That automatic linkage is the clearest demonstration of what this entire structure amounts to. Understanding a PHSP's eligible-expense categories today means understanding s.118.2(2) as it currently stands, and staying current on it means tracking the folio's chapter history and the amendments Parliament makes to the underlying statute, because the PHSP itself will never announce the change independently. The list moves, and PHSP coverage moves with it, every time.