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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation] What is the tax treatment of a lump sum received for each of the following items?
(1) the present value of the taxpayer's right to receive future benefits;
(2) forgiveness of a portion of rehabilitation loans;
(3) forgiveness of a portion of overpayments of disability insurance benefits.
Position: (1) The portion of the lump sum corresponding to the present value of the taxpayer's right to receive future benefits is a tax-free capital payment.
(2) The forgiven portion of rehabilitation loans is a taxable benefit to be included in the taxpayer's income from an office or employment.
(3) The forgiven portion of disability insurance benefits has a neutral tax treatment since the overpayments were originally included in the taxpayer's income from an office or employment.
Reasons: The Income Tax Act. Jurisprudence.
May 9, 2006
XXXXXXXXXX Tax Centre Headquarters
XXXXXXXXXX François Bordeleau
Client Services 952-1506
2006-017555
Request for Technical Interpretation - Lump Sum paid to a former member of the Canadian Armed Forces
This is further to your letter dated March 10, 2006, requesting a technical interpretation on the taxation of a lump sum payment to a former member of the Canadian Armed Forces ("CAF") under a disability insurance plan.
RELEVANT FACTS
Your request for a technical interpretation states the following facts:
- The taxpayer is a former member of the CAF;
- As such, he was insured under the Service Income Security Insurance Plan ("SISIP"), administered by the Maritime Life Assurance Company ("Maritime Life");
- As a result of an accident related to his CAF employment, the taxpayer has XXXXXXXXXX;
- Between the years XXXXXXXXXX, the taxpayer received - generally on a monthly basis - the following disability insurance benefits under SISIP:
- The first payment received by the taxpayer in the month of XXXXXXXXXX covered the period from XXXXXXXXXX;
- Under his disability insurance coverage under SISIP, the taxpayer also received the following rehabilitation loans:
- Concurrent with the disability insurance benefits, the taxpayer received benefits from the Department of Veterans Affairs ("Veterans Affairs Canada");
- Through deductions from the taxpayer's monthly payments, Maritime Life obtained partial repayment (in the amount of $XXXXXXXXXX) of the rehabilitation loans;
- In XXXXXXXXXX, SISIP determined that there was an overpayment of benefits under the plan with respect to the taxpayer - the total amount of benefits paid by Veterans Affairs Canada and those paid by SISIP exceeded a certain threshold;
- In the years XXXXXXXXXX (refunded amount of $XXXXXXXXXX) and XXXXXXXXXX (refunded amount of $XXXXXXXXXX), SISIP recovered a portion of the overpayment through a monthly deduction of $XXXXXXXXXX from the disability insurance benefits;
- The amount received by the taxpayer in XXXXXXXXXX included a lump sum payment of $XXXXXXXXXX (the difference between the total amount paid in XXXXXXXXXX and the lump sum payment represents the monthly benefits the taxpayer previously received);
- The lump sum payment was made at the taxpayer's request so that he could administer his assets and thus regain some financial autonomy;
- Upon payment of the above-mentioned lump sum, SISIP and Maritime Life deducted at source an amount on account of the tax payable under the Act;
- The lump sum was paid for the following:
o Final settlement for all future obligations of SISIP and Maritime Life in respect of the taxpayer's disability insurance;
o Remission of the portion of the rehabilitation loans that remained payable by the taxpayer at the date of the lump sum payment;
o Remission of the portion of the overpayment of disability insurance benefits that remained payable by the taxpayer at the date of the lump sum payment;
QUESTION
In your letter you wished to know the tax treatment - under the Income Tax Act (the "Act") - to be accorded to the lump sum received by the taxpayer corresponding to the three elements referred to above.
ANALYSIS
(1) Portion of the lump sum relating to the taxpayer's future benefits
In the Supreme Court of Canada decision in Tsiaprailis v. Canada 1, the taxpayer had received a lump sum payment under a disability insurance plan representing her entitlement to matured benefits as well as a portion of the present value of her entitlement to future benefits. The issue before the Supreme Court of Canada was the tax treatment of the portion of the lump sum payment that represented matured benefits. In her analysis, Charron J. applied the surrogatum principle and asked the following two questions:
(1) What was the payment intended to replace?
(2) Would the replaced amount have been taxable in the recipient’s hands?
With respect to matured benefits, Charron J. determined that the portion of the lump sum that related to such benefits was taxable under paragraph 6(1)(f). In obiter dicta, the justice made the following comments with respect to the portion of the amount relating to the present value of the taxpayer's right to receive future benefits:
The part of the settlement for future benefits is in the nature of a capital payment and is not taxable under s. 6(1)(f) of the Act.
The Canada Revenue Agency ("CRA") has adopted that reasoning, notably in Technical Interpretations 2005-0121521E5 and 2005-0159331E5. In those interpretations, the CRA determined that a lump sum payment in satisfaction of a taxpayer's right to receive future disability insurance benefits represented proceeds of disposition of an interest in an insurance policy under subparagraph 39(1)(a)(iii). Thus, reiterating Justice Charron's comments above, CRA determined that such payments were non-taxable payments of capital.
In this case, we are of the view that the portion of the lump sum paid to the taxpayer in settlement of his entitlement to future disability insurance benefits is not taxable under the Act.
(2) Treatment of forgiveness of a portion of rehabilitation loans
Under subsection 6(15), a taxpayer is deemed to have a taxable benefit within the meaning of paragraph 6(1)(a) when an obligation issued by the taxpayer is settled or extinguished. Under paragraph 6(15)(b), the value of that benefit shall be deemed to be the forgiven amount at the time of its settlement or extinguishment.
Consequently, we are of the view that the amount of the rehabilitation loans that was forgiven by SISIP and Maritime Life for the benefit of the taxpayer should be included in the taxpayer's income in the year of settlement or extinguishment of the debt.
Although not part of your technical interpretation request, a loan to an employee - made at low or no interest - generally results in a taxable benefit under section 80.4.
(3) Treatment of the recovery of a portion of the overpayment of disability insurance benefits
As we understand the facts, the amounts that Maritime Life was seeking to recover as an overpayment of disability benefits were initially included in the taxpayer's income for the year in which they were received.
Where a taxpayer reimburses an amount on account of an amount that was previously included in income from an office or employment, paragraph 8(1)(n) provides that the taxpayer may deduct the repaid amounts from income. However, the following conditions must be satisfied:
1. The amount must be paid by the taxpayer in accordance with an arrangement;
2. The arrangement must not be an arrangement described in subparagraph 6(17)(b)(ii) of the definition of "top-up disability payment";
3. The amount repaid must be in respect of an amount that was paid to the taxpayer for a period during which the taxpayer was not performing the duties of the taxpayer’s office or employment;
4. The amount so paid had been included in the taxpayer's income from an office or employment;
5. The total of the amounts reimbursed does not exceed the total of the amounts received by the taxpayer for the period during which the taxpayer was not performing the duties of the taxpayer’s office or employment.
In this case, the taxpayer received disability insurance benefits from SISIP and Maritime Life for the period from XXXXXXXXXX. During that period, and based on the facts you have provided, the taxpayer was not performing the duties of the taxpayer’s office or employment due to the injury he sustained in the course of his military service.
In addition, you indicated that the disability insurance benefits were included in the taxpayer's income for the years in which they were received and that a T4A was issued in respect of those benefits. Paragraph 6(1)(f) confirms that treatment as it provides for the inclusion in income of an amount in respect of disability insurance benefits received by a taxpayer as long as the disability insurance plan is funded by both the employer and the taxpayer.
Thus, amounts that were reimbursed by the taxpayer in respect of the overpayment of disability insurance benefits may be deducted from the taxpayer's income for the year of repayment.
With respect to the portion of the overpayment that was forgiven by SISIP, we are of the view that there are no associated tax consequences. In particular, we do not consider that subsection 6(15) will apply to include in the taxpayer's income the value of the forgiven debt since its application would result in double taxation.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
François D. Bordeleau, LL.B.
Individuals, Business and Partnerships Section
Income Tax Rulings Directorate
ENDNOTES
1 [2005] 1 S.C.R. 113, confirmed [2003] 4 F.C. 112 (C.A).
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