25 January 2001 2000-004956A - RETROACTIVE LUMP-SUM PAYMENT

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:

Is a retiring allowance payment made to a former employee a "qualifying amount" for the purposes of subsection 110.2(1) ITA?

Position:

Depends on the facts.

Reasons:

To benefit from the rules in new section 110.2 ITA, an individual must have received a "qualifying amount" during a taxation year. In addition, a "specified portion" must relate to an "eligible taxation year" during which the individual's eligibility to receive the portion existed. The payment of a retiring allowance does not necessarily satisfy these requirements. To qualify, it must represent a payment on account of or in lieu of damages paid pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding (i.e. in settlement of a lawsuit).

XXXXXXXXXX 	2000-004956
		Patrick Massicotte
January 25, 2001

Dear XXXXXXXXXX:

Re: Application of subsection 110.2(1) of the Income Tax Act

We are writing in response to your facsimile received on October 2, 2000 regarding the application of section 110.2 of the Income Tax Act (the "ITA").

You mentioned that the issue arose in the following situation:

1. An individual's employment is terminated on XXXXXXXXXX but an agreement was not reached regarding severance;

2. An out of court settlement was reached in XXXXXXXXXX;

3. On XXXXXXXXXX the former employee was paid a retiring allowance, a portion of which was paid into his registered retirement savings plan and the balance paid directly to the employee in full, in cash.

QUESTION

You mention that you have been requested to produce form T1198 and attribute the settlement paid to taxation years 1999, 2000 and 2001 even though it was fully paid in the year 2000. You wish to obtain our opinion on whether the retiring allowance paid to the individual in the situation described above, in respect of the loss of employment, is a "qualifying amount" for the purposes of section 110.2 ITA.

Our comments

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R3 dated December 30, 1996. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments which are of a general nature.

New section 110.2 ITA sets out rules regarding retroactive lump sum payments received by a taxpayer in a taxation year. These were introduced as part of the February 16, 1999 federal budget measures dealing with tax fairness.

For individuals, income from most sources is taxable in the year in which it is received. As a result, individuals are generally taxable on retroactive lump-sum payments in the year they are received, even though a significant portion may relate to prior years. Due to the progressive rate structure of the income tax system, the tax payable on those lump-sum payments may, therefore, be significantly higher than it would have been if payments had been received and taxed on an on-going basis from the date of eligibility.

The purpose of the new rules is to provide relief to individuals in these circumstances and allow them to use a special mechanism to compute the tax on those payments as if they had received them year by year as the income arose. The rules will apply where the payment received is a "qualifying amount", as defined in section 110.2 ITA.

Subsection 110.2(2) ITA allows an individual (other than a trust) to deduct in computing taxable income for a taxation year, the total of all amounts each of which is a "specified portion" of a "qualifying amount" received by the individual in that year, if the total is $3,000 or more. These expressions are defined in subsection 110.2(1) ITA. Under section 120.31 ITA, tax will be computed on such amount deducted.

A "qualifying amount" received by an individual in a taxation year means, inter alia, "...an amount (other than the portion of the amount that can reasonably be considered to be received as, on account of, in lieu of payment of or in satisfaction of, interest) that is included in computing the individual's income for the year and is

(a) an amount

(i) that is received pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding, and

(ii) that is

(A) included in computing the individual's income from an office or employment, or

(B) received as, on account of, in lieu of payment of or in satisfaction of, damages in respect of the individual's loss of an office or employment,

[...]."

In your situation, the payment is in respect of the individual's loss of an office or employment and qualifies as a "retiring allowance".

Subsection 248(1) ITA defines "retiring allowance" to include inter alia amounts received in respect of a loss of an office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal.

The payment of a retiring allowance in that context would not be considered a "qualifying amount" for the purposes of section 110.2 ITA, as described above, unless the amount is paid as, on account of, in lieu of payment of or in satisfaction of, damages in respect of the individual's loss of an office or employment.

In addition, the amount must be paid pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding. In our opinion, this latter expression refers to proceedings authorized or sanctioned by law, and brought or instituted in a court or legal tribunal, for the acquiring of a right or the enforcement of a remedy.

According to the facts provided, we cannot conclude if the settlement reached with your former employee terminates a legal proceeding or if it simply results from negotiations between the parties. Also, we cannot determine based on the facts provided if the amount is received in satisfaction of or in lieu of payment of damages in respect of the individual's loss of employment or if the payment is on account of amounts payable pursuant to an employment contract or other contractual obligation.

Although an amount paid in the above circumstances may represent a "qualifying amount" as defined in subsection 110.2(1) ITA, the mechanism will only apply to a "specified portion" of a "qualifying amount" received by the individual in a year.

The "specified portion" of a "qualifying amount" means the portion of the amount received that relates to an "eligible taxation year", to the extent that the individual's eligibility to receive the portion existed in the year. An "eligible taxation year" is essentially a preceding taxation year in respect of which the lump sum payment is received, as defined in subsection 110.2(1) ITA.

Generally, where special damages are paid it may be considered that a portion of the lump-sum payment relates to previous taxation years. These are usually awarded in relation to income lost or unearned, such as wages or employee benefits, for a period of time (from the date the individual lost his employment to the date of the settlement for example) during which the individual would have otherwise been eligible to receive a portion in respect of an eligible taxation year. Such portions that relate to eligible taxation years could be designated on form T1198 allowing the individual to benefit from the treatment provided in section 110.2 ITA.

However, where an amount is paid on account of or in lieu of general damages, that is, damages for loss of self­respect, humiliation, mental anguish, hurt feelings, etc., it is our opinion that no portion would relate to any eligible taxation year for the purposes of section 110.2 ITA. The individual in receipt of such damages was not eligible to receive any portion during the taxation years ending before the year the amount is awarded or the settlement reached. In those cases, no amount can be attributed to preceding taxation years for the purposes of section 110.2 ITA and form T1198.

Based on the above comments, the retiring allowance paid to your former employee would not be considered a qualifying amount for the purposes of section 110.2 ITA unless it can be shown that it represents an amount paid pursuant to a contract by which legal proceedings are terminated, on account of or in lieu of damages in respect of the loss of employment and is determined in relation to the income which the individual would have otherwise been eligible to receive. Moreover, if the retiring allowance can be considered a qualifying amount, only the portion computed in reference to the 1999 taxation year could be designated on the form T1198, being the only "eligible taxation year" for the purposes of section 110.2 ITA based on the facts submitted.

We trust our comments will be of assistance to you. However, as indicated in paragraph 22 of Information Circular 70-6R3, this opinion is not an advance income tax ruling and, accordingly, it is not binding on the Canada Customs and Revenue Agency.

Yours truly,

Ghislaine Landry, CGA
Manager
Individual, Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate

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