2002 Ruling 2001-0115733 - damage settlement

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues

The taxpayers were victims of fraud committed by an employee of a bank. A settlement has been proposed whereby the taxpayers will receive a lump sum payment that the taxpayers wish to allocate as:

1. Restitution of lost capital;
2. Interest from the date of the fraud; and
3. General damages for pain and suffering.

The issue is the tax treatment of the settlement.

Position TAKEN

1. Restitution is non-taxable.

2. Interest is taxable under paragraph 12(1)(c).

3. Damages are non-taxable.

Reasons:

1. Restitution is making the taxpayers whole.

2. CCRA position, confirmed by the courts is that amounts paid to compensate for lost income from business and property is taxable.

3. Consistent with CCRA position. Amounts in 1 and 2 compensate taxpayers for losses.

XXXXXXXXXX 2001-011573

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (Claimant 1)
XXXXXXXXXX (Claimant 2)
XXXXXXXXXX (Claimant 3)
XXXXXXXXXX (Claimant 4) and
XXXXXXXXXX Claimant 5)
(referred to collectively as the "Claimants")

We are writing in response to your letter of XXXXXXXXXX, requesting an advance income tax ruling in respect of a proposed negotiated settlement. We also acknowledge your correspondence of XXXXXXXXXX.

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

(i) dealt with in an earlier tax return of the Claimants or a related person;

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed return of the Claimants or a related person;

(iii) under objection by the Claimants or a related person;

(iv) before the Courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

Our understanding of the facts and proposed transactions is as follows:

STATEMENT OF FACTS:

1. The Claimants are all resident in Canada.

2. The Claimants' tax returns are filed at the XXXXXXXXXX Taxation Centre except for Claimant 5, whose tax returns are filed at the XXXXXXXXXX Taxation Centre.

3. XXXXXXXXXX, an employee of the XXXXXXXXXX (the "Defendant") misappropriated funds from the Claimants.

4. In a statement of claim dated XXXXXXXXXX, the Claimants commenced an action against the Defendant seeking compensation for damages sustained by the Claimants.

5. The Claimants have not, for income tax purposes, made any deductions or claims in respect of the loss, impairment or expenditure of the amounts listed as Principal in paragraph 7 below.

PROPOSED TRANSACTIONS:

6. The Claimants are proposing an out-of-court settlement with the Defendant for $XXXXXXXXXX, although the amount of the final settlement (hereinafter referred to as the Final Settlement) may be different. The amount of the Final Settlement will provide for:

(i) full recovery by the Claimants of the actual amounts owing by the Defendant, which were embezzled by the Defendant's employee (hereinafter referred to as the Principal),

(ii) interest that would have been paid by the Defendant to the Claimants had the Principal not been embezzled (hereinafter referred to as the Interest), and

(iii) damages for pain and suffering (hereinafter referred to as the Damages).

7. The amount of the Final Settlement will be divided as follows:

Description
Taxpayers
Principal
Interest
Total
(a) Investments
Claimant 1
XXXXXX
XXXXX
XXXXXX
(b) RRSP
Claimant 2
XXXXXX
XXXXX
XXXXXX
(c) Loan - settlement
Claimant 4
XXXXXX
XXXXX
XXXXXX
(d) Bank accounts - replacement
Claimant 5 (Business Account)
XXXXXX
XXXXX
XXXXXX
(e) Duplicate cheques - replacement
Claimant 2 & Claimant 3
XXXXXX

XXXXX

XXXXXX

(f) Duplicate cheques - replacement
Claimant 5 (Trust Account)

XXXXXX

XXXXX

XXXXXX
(g) Reimbursement of various expenses
Claimant 2, Claimant 3 & Claimant 5

XXXXXX

XXXXXX
Subtotal

XXXXXX
XXXXX
XXXXXX
(h) Damages
Claimant 2, Claimant 3 & Claimant 5

XXXXXX

Total estimated amount of the Final Settlement

$XXXXX

8. The Principal will be restored as described in paragraphs 5 and 6 above. In addition:

(a) The Principal described 7(b) will be paid in compensation for an RRSP belonging to Claimant 2, which was cashed in XXXXXXXXXX and was reported as income by Claimant 2 in XXXXXXXXXX. It was Claimant 2's understanding that the RRSP was being converted into a RRIF in XXXXXXXXXX. The amount received in respect of the RRSP is to compensate Claimant 2 for Claimant 2's after-tax proceeds of the RRSP had it been converted to a RRIF at that time.

(b) The Principal and Interest described in paragraph 7(e) is to be divided equally between Claimant 2 and Claimant 3, since the funds were originally owned jointly by the two claimants and 50% of any income earned on these funds was taxable to each claimant.

9. The amount of Interest has been calculated from XXXXXXXXXX, using the prevailing interest rate paid by the Defendant in effect during this period. The final amount of Interest will increase to reflect the amount of interest earned from XXXXXXXXXX, to the date the Final Settlement is paid, calculated in the same manner.

10. The actual amount in respect of Damages will be equal to the amount of the Final Settlement less Principal and Interest. Damages will be divided proportionately among Claimant 2, Claimant 3 and Claimant 5 (but not to Claimant 4) in compensation for the stress, anxiety, mental anguish and embarrassment they have endured through the negotiations with the Defendant.

PURPOSE OF PROPOSED TRANSACTIONS:

The purpose of the proposed transactions is to settle the claim of the Claimants against the Defendant in respect of the losses sustained by the Claimants, and to provide for the payment of damages in respect of such claim.

RULING GIVEN

Provided that the above facts and proposed transactions are accurate and constitute complete disclosure of all the relevant facts and proposed transactions, that a settlement agreement is reached containing substantially the same proposed transactions as the documents provided to us, and that the transactions are carried out as described herein, we confirm the following:

A. The amounts to be paid as Principal and Damages will be non-taxable to the Claimants.

B. The amounts to be paid as Interest will be taxable to the Claimants pursuant to paragraph 12(1)(c) of the Income Tax Act (the "Act").

This ruling is given subject to the general limitations and qualifications set forth in Information Circular 70-6R5, dated May 17, 2002, issued by the Canada Customs and Revenue Agency ("CCRA"), and is binding on the CCRA provided the Final Settlement is reached and executed on or before XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch