18 November 2009 External T.I. 2009-0345611E5 - Settlement payment for a human rights violation

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.

Principal Issues: Whether an amount paid by an individual's former employer under a settlement agreement and described as general damages for an alleged human rights violation are taxable? Can the portion of the amount paid under the settlement agreement and described as a retiring allowance be transferred to the individual's RRSP under paragraph 60(j.1) of the Act? What are the withholding and reporting requirements and other related tax consequences?

Position: A portion of the settlement payment in respect of the alleged human rights violation is likely non-taxable. However, the determination of the non-taxable amount remains a question of fact. We have provided a general discussion of rules under paragraph 60(j.1) of the Act and the reporting and withholding requirements for any amount described as a retiring allowance. A brief discussion of the rules concerning deductibility of legal fees for establishing a right to a retiring allowance under paragraph 60(0.1) of the Act has also been provided.

Reasons: See above.

XXXXXXXXXX 								2009-034561
									Michael Cooke, C.A.
November 18, 2009

Dear XXXXXXXXXX :

Re: Taxation of Settlement Payment

This is in response to your letter dated October 22, 2009, concerning the taxation of a proposed payment to your client, XXXXXXXXXX (the "Taxpayer"), pursuant to a negotiated settlement between the Taxpayer and the Taxpayer's former employer XXXXXXXXXX (hereinafter referred to as the "Former Employer").

The proposed payment is in respect of the settlement of the Taxpayer's legal action against the Former Employer that the Taxpayer's employment was terminated without just cause (the "wrongful dismissal complaint") and that the Taxpayer was being discriminated against because of age and a physical disability (the "human rights complaint"). While none of these allegations have been proven in court, we understand that the XXXXXXXXXX (the "Tribunal") dismissed the "physical disability" portion of the Taxpayer's human rights complaint but agreed to consider arguments pertaining to the "age" portion of the human rights complaint.

Pursuant to the terms of the proposed settlement, the Former Employer has agreed to pay the Taxpayer a total of $XXXXXXXXXX , which will include $XXXXXXXXXX to settle the human rights complaint (i.e., injury to dignity, feelings and self respect) and $XXXXXXXXXX as a retiring allowance, presumably to settle the wrongful dismissal complaint. We understand that the Taxpayer's counsel for the human rights complaint matter has indicated that the $XXXXXXXXXX amount to settle the human rights complaint is reasonable and well within the range of damages normally awarded by the Tribunal.

Our Comments:

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca. Where the particular transactions are complete, the inquiry should be addressed to the relevant tax services office, a list of which is available on the "Contact Us" page of the CRA website.

As discussed with you (Shields/XXXXXXXXXX ), we are unable to provide a ruling on this matter since, as described in paragraph 15(1)(j) of IC 70-6R5, this matter in involves various questions of fact and the circumstances are such that all the pertinent facts cannot be fully established at the time of the request for the ruling.

Notwithstanding the above, we are prepared to offer the following general comments which may be of assistance.

Retiring Allowances and Human Rights Awards

Pursuant to subparagraph 56(1)(a)(ii) of the Income Tax Act (the "Act"), a retiring allowance is included in computing the income of a taxpayer in the year it is received. A "retiring allowance" is defined in subsection 248(1) of the Act to mean an amount received

(a) on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer's long service, or

(b) in respect of a loss of 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,

by the taxpayer or, after the taxpayer's death, by a dependant or a relation of the taxpayer or by the legal representative of the taxpayer.

Moreover, as described in paragraph 11 of Interpretation Bulletin IT-337R4, Retiring Allowances ("IT-337R4"), where an individual receives compensation on account of damages as a result of a loss of employment, such damages will be treated as a retiring allowance, including both special damages, as well as general damages, that are received for loss of self-respect, humiliation, mental anguish, hurt feelings, etc. However, paragraph 12 of IT-337R4 also states that:

"...general damages relating to human rights violations can be considered unrelated to a loss of employment, despite the fact that the loss of employment is often a direct result of a human rights violations complaint. If a human rights tribunal awards a taxpayer an amount for general damages, the amount is normally not required to be included in income. When a loss of employment involves a human rights violation and is settled out of court, a reasonable amount in respect of general damages can be excluded from income. The determination of what is reasonable is influenced by the maximum amount that can be awarded under the applicable human rights legislation and the evidence presented in the case. Any excess will be taxed as a retiring allowance."

As indicated above, the proper resolution of this issue would require a review of all the relevant facts including the terms of settlement and the nature of the various claims. However, based on the limited information that has been provided, it appears that a portion of the settlement payment will relate to damages for an alleged human rights violation. XXXXXXXXXX . (endnote 1)

In the above-described situation, $XXXXXXXXXX (of the total settlement payment of $XXXXXXXXXX ) is being described as non-taxable damages for the human rights violation. While this amount does not on its face appear to be unreasonable, in order to properly determine the portion of the settlement payment that can reasonably be considered as a damage award for human rights violations you should review the Tribunal decisions and find the most comparable situations to the Taxpayer's situation. Such information should be retained by the Taxpayer in case it is requested by the Taxpayer's tax service office as support for any amount the Taxpayer may claim as being non-taxable.

Rollover of a Retiring Allowance

Paragraph 60(j.1) provides for a deduction for all or part of a retiring allowance included in a taxpayer's income and transferred to an RPP or to an RRSP under which the taxpayer is the annuitant. In general terms, the deduction under paragraph 60(j.1) is limited to the least of:

(a) the amount of retiring allowance included in income for the year;

(b) the "eligible portion" of the retiring allowance, less all amounts deducted under paragraph 60(j.1) in respect of retiring allowances paid by the employer in a previous year or paid by a person related to the employer in the current or a previous year; and

(c) the total of all amounts paid by the taxpayer in the year or within 60 days after the end of the year,

(i) to an RPP (other than any portion thereof deductible either for current or past service contributions or as a transfer of superannuation benefits); or

(ii) to the taxpayer's own RRSP (other than any portion thereof that has been designated as a transfer of superannuation benefits or as a refund of premiums under an RRSP)

to the extent such amounts were not deducted in computing income for a preceding taxation year.

The "eligible portion" of the retiring allowance for these purposes is generally the total of:

(a) $2,000 multiplied by the number of years before 1996 during which an employee for whom the payment was made was employed by the employer or a person related to the employer; and

(b) $1,500 multiplied by (i) the number of years before 1989 during which the employee was employed by the employer or a person related to the employer, minus (ii) the equivalent number of years before 1989 in respect of which contributions to a pension plan or a deferred profit sharing plan of the employer or a person related to the employer had vested in the employee at the time the retiring allowance was paid.

Paragraphs 19 through 22 of IT-337R4 discuss the interpretation and application of paragraph 60(j.1) of the Act in detail should you require further information on this topic.

Reporting and Withholding Requirements

A person paying a retiring allowance is required to report the amount paid on form T4A Supplementary and pursuant to paragraph 153(1)(c) of the Act, such person is required to deduct or withhold therefrom such amount as is determined in accordance with the Income Tax Regulations (the "Regulations"). In this regard, under subsection 100(3) of the Regulations, no withholding will be required on the eligible portion, as determined by paragraph 60(j.1) of the Act, if it is transferred directly to the annuitant's RRSP. However, paragraph 100(3.2)(a) of the Regulations provides that the non-eligible portion of a retiring allowance is subject to withholding tax whether or not such an amount exceeds the individual's RRSP deduction limit.

Deductibility of Legal Fees

Lastly, eligible legal expenses paid by a taxpayer to collect or establish a right to a retiring allowance (including a right to damages for wrongful dismissal) may generally be deducted under paragraph 60(o.1) of the Act. We note that where legal fees are paid in connection with various matters, they should be apportioned on a reasonable basis to determine what fees were paid in connection with collecting or establishing a right to a retiring allowance. The amount of the deduction in the year is limited to the total of any reimbursement of legal expenses included in income in the year or a preceding taxation year and the amount of the retiring allowance received and included in income in the year or a preceding taxation year less any portion thereof that has been transferred to an RPP or an RRSP and deducted under paragraph 60(j.1) of the Act. Any non-deductible portion of eligible legal expenses may be carried forward and deducted in any of the seven subsequent taxation years, to the extent the taxpayer receives a further retiring allowance. For a further discussion of the deductibility of legal fees, reference should be made to IT-99R5, Legal and Accounting Fees.

We trust our comments will be of assistance to you.

Yours truly,

Renée Shields
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
ENDNOTES

1 This Information Sheet is available on the Tribunal's website XXXXXXXXXX .