Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
A damages claim of an individual was settled for a lump sum. Part of the amount was paid to the individual, another part was structured (i.e., it was to be paid in periodic amounts), and the remaining part was retained by the individual's solicitor for services provided with respect to the settlement. If the legal fees are reduced and an annuity contact is purchased by the solicitor with respect to the reduction, will the payments be non-taxable?
Position TAKEN:
The payments in question would be subject to the provisions of section 12.2 and paragraph 56(1)(d) of the Act. It was also indicated that the part of the settlement that was "structured" would also be considered to be subject to the provisions of 12.2 and paragraph 56(1)(d) of the Act.
Reasons FOR POSITION TAKEN:
The positions are based on comments in paragraphs 3 and 5 of IT-365R2.
942792
XXXXXXXXXX M. Eisner
Attention: XXXXXXXXXX
November 20, 1994
Dear Sirs:
Re: Structured Settlements
This is in reply to your letter of October 31, 1994 concerning a damages settlement in respect of personal injury.
Your have outlined a set of circumstances in your letter that relates to an actual fact situation. In order to obtain the Department's position thereon, you should submit the relevant details to your Local District Taxation Office. We are, however, providing you with the following general comments.
Based on the information provided in your letter, it appears that you are concerned with the type of situation where an individual's claim for personal injury damages was settled for a lump sum. Part of the lump sum was paid to the individual, another part of the lump sum was "structured" (i.e., it was to be paid in periodic instalments), and the remaining part of the amount was retained by the individual's solicitor for services provided with respect to the settlement.
The individual subsequently commenced legal action against his or her solicitor with respect to the amount of the fees that were charged in connection with the damages claim. On the basis that the solicitor and the individual settle in a manner under which the solicitor will purchase an annuity contract and direct the issuer to make the related payments to the individual, the issue is whether the periodic payments would be non-taxable in the hands of the individual. The annuity contract would be non-commutable, non-assignable, and non-transferable.
The Department's general position on damages received in respect of personal injury is set out in Interpretation Bulletin IT-365R2 "Damages, Settlements, and Similar Receipts". For the purposes of our comments set out below, we have assumed that paragraphs 81(1)(g.1) and (g.2) of the Income Tax Act (see paragraphs 6 and 7 Of IT-365R2) are not applicable.
Consistent with the comments in paragraph 3 of IT-365R2, periodic payments are regarded as being non-taxable where the settlement agreement indicates that the damages are to be paid in that manner (such payments are not considered to be annuity payments for the purposes of the Act). In addition, paragraph 5 of that bulletin sets out a manner in which a settled claim for personal injury or death, usually against a casualty insurer, is to be paid pursuant to a settlement agreement in periodic payments such that the payments are tax free in the hands of the claimant. With respect to this type of arrangement which is referred to in IT-365R2 as a "structured settlement", we would, in particular, note the requirement in paragraph 5(b) of IT-365R2 which states that "the claimant and the casualty insurer must have reached an agreement under which the latter is committed to make at least periodic payments to the claimant for either a fixed term or the life of the claimant". These comments can be contrasted with those in paragraph 3 of IT-365R2 which state that "an annuity contract purchased by a taxpayer or a taxpayer's representative with the proceeds of a lump sum award received for damages for personal injury or death will be an annuity contract for all purposes of the Act". Of course, where an annuity contract is considered to have been purchased, a deduction for the capital element of each annuity payment would be available to the extent permitted under paragraph 60(a) of the Act.
In relating the situation under consideration to the above comments, it is our view that, since the claim was settled for a lump sum of which a part thereof was used to pay the individual's legal fees, the arrangement under which periodic payments would be made to the individual by the solicitor is not a structured settlement described in paragraph 5 of IT-365R2. Accordingly, the periodic payments in question would be regarded as being annuity payments which are subject to the provisions of section 12.2 and paragraph 56(1)(d) of the Act.
As a further comment, we are mentioning that, in our view, the periodic payments being received by the individual in respect of the part of the settlement amount that was "structured" are also considered to be annuity payments which are subject to the provisions of section 12.2 and paragraph 56(1)(d) of the Act. The basis of these comments is that part of the settlement lump sum was applied towards the purchase of an annuity contract rather than the settlement agreement specifying that part of the damages were to be paid in periodic payments.
We trust the foregoing comments explain the Department's position on the matters raised.
Yours truly,
P.D. Fuoco
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch
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