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: Whether a "release" payment is a non-taxable receipt, business income, on account of capital or a combination of different amounts.

Position: Question of fact.

Reasons: The payment is to compensate for future uncertainties. This includes possible negative impact on income and the assets used to earn that income.

2002-017939
XXXXXXXXXX A. Seidel
(613) 957-2058
February 3, 2003

Dear XXXXXXXXXX:

Re: Release Payment

We are writing in response to your letter dated December 12, 2002, requesting our views as to whether a "release payment" would be considered to be a non-taxable windfall receipt.

Background

In your letter, you describe a situation where a dairy farmer has received a "release payment" "in recognition that there may be uncertainties with respect to the future of the dairy operation" by virtue of the fact that the farmer received a shipment of feed, from the usual supplier, which was determined to be tainted and resulted in health problems for some of the dairy cattle.

The particular circumstances in your letter, on which you have asked for our views, relate to a factual situation, involving a specific taxpayer, and completed transactions. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling and advance income tax rulings are not provided in respect of transactions that are substantially completed. Completed transactions are reviewed by the local tax services office. This review is completed after you have submitted all the relevant facts and documentation. However, we are prepared to offer the following general comments which may be of assistance.

Interpretation Bulletin IT-334R2 - Miscellaneous Receipts ("IT-334R2") discusses the tax treatment of various receipts that do not readily come within any of the more usual categories of receipt. IT-334R2 also discusses whether or not, and under what circumstances, a particular type of receipt is to be included in calculating income for tax purposes.

In general, section 3 of the Income Tax Act (the "Act") brings into income, for tax purposes, a taxpayer's income from all sources and the taxable portion of capital gains net of allowable capital losses. Unless specifically exempted by a provision of the Act, a taxpayer will usually be taxable in full on all non-capital receipts from a source. Paragraph 3 of IT-334R2 discusses the factors that would indicate that a particular receipt is not from a source and is therefore a non-taxable windfall. There are also several court cases that have dealt with the issue of whether an amount is taxable, either as an income receipt or a capital receipt, or a non-taxable windfall.

The following comments in Catherine Dumas v. Her Majesty the Queen, [2000 DTC 2603 (TCC)], and The Queen v. Canadian General Electric Company Limited, [87 DTC 5070 (FCA)] are relevant to your question:

"In income tax law, there is nothing magic about an amount recovered by a plaintiff in civil litigation whether it be the result of a favourable judgment or a negotiated settlement. The amount recovered is compensatory in nature. That alone will not determine its character for tax purposes as being income or capital or something else. The real question is to determine why the compensatory amount was paid."

"The solution to the problem is not to be found by any rigid test or description. It has to be derived from aspects of the whole set of circumstances some of which may point in one direction, some in the other. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer."

The solution often "depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process".

A very useful summary of the basic principles applicable in such cases is found in the reasons for judgment of Strayer, J. in Canadian National Railway Company v. The Minister of National Revenue [88 DTC 6340, (FC-TD)]. They include the following:

"It appears to me that there are two aspects which a court must consider in examining such a situation ... : was the purpose of the payment to replace capital or income; and, whether or not the purpose can be reliably determined, was the effect of the payment to replace capital or income? It is therefore necessary to look at both purpose and effect."

"With respect to purpose, the essential question is to determine what the compensation - whether paid pursuant to a contract, a court award of damages, or otherwise - is intended to replace."

"With respect to the effect, when the benefit surrendered on cancellation does not represent the loss of an enduring asset ... where for example the structure of the recipient's business is so fashioned as to absorb the shock as one of the normal incidents to be looked for and where it appears that the compensation received is no more than a surrogatum for the future profits surrendered ... the compensation received is ... to be treated as a revenue receipt and not a capital receipt."

The purpose and effect of a payment will generally be determined by reviewing the details of the agreement(s)/settlement between the parties involved.

Although we have not reviewed the actual agreements between the parties, the payment received by the farmer is stated to be for the purpose of compensating for the effect that the tainted feed may have on the dairy operation. In "accident" type situations, it is not unusual for an insurance company to make a payment in respect of possible future adverse consequences. This could be for future lost dairy income or the replacement cost of cattle adversely affected by the tainted feed. It is our view that this would be an example of a payment that does not represent the loss of an enduring asset and a situation where "the structure of the recipient's business is so fashioned as to absorb the shock as one of the normal incidents to be looked for and where ... the compensation received is no more than a surrogatum for the future profits surrendered". As such, the compensation received by the dairy farmer, from the insurance company, is to be treated as a revenue receipt and included in computing farming income in the year the amount is received/receivable, depending on the method normally used by the recipient in reporting income from farming for tax purposes.

Yours truly,

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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