4 November 2011 External T.I. 2011-0399991E5 - Taxation of a 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.

Principal Issues: 1. Are amounts received in settlement of a class action lawsuit taxable? 2. Where taxable, would the amounts be included into income in the year of receipt or apportioned to all taxation years covered by the lawsuit?

Position: 1. Question of fact. 2. Amounts are taxable in the year of receipt.

Reasons: 1. Based on the surrogatum principle, a settlement has the same tax treatment as the amount it is intended to replace. Generally, only the portion of a settlement payment which represents damages in respect of personal injury or death would be exempt from tax. 2. Lump sum payments received on account of income are taxable in the year of receipt.

XXXXXXXXXX 							2011-039999
								T. Baltkois
November 4, 2011

Dear XXXXXXXXXX :

Re: Taxation of Settlement Payments

We are writing in response to your email of March 22, 2011, concerning whether amounts received pursuant to a settlement agreement would be taxable or considered to be a non-taxable amount. Where the amount is held to be taxable, you have also inquired whether the payment should be included into income in the year of receipt or apportioned to all taxation years covered by the settlement.

In the situation you described, a group of XXXXXXXXXX were involved in a class action lawsuit, XXXXXXXXXX . As the litigation was settled out of court, there was no judicial ruling issued per se. However, you maintain that the compensatory payments made to the parties involved served to acknowledge that there was a wrongdoing.

Our Comments

The characterization of settlement payments for income tax purposes is a question of fact that can only be determined after reviewing all of the relevant facts and circumstances of the particular case. Although we are unable to give you definitive comments relating to your particular situation, we have provided some general comments which we hope will be of assistance to you.

A payment received from a settlement of a damages claim to avoid or terminate litigation may generally be accorded similar income tax treatment as damages received pursuant to a judicial ruling, even though there may be no explicit admission of wrongdoing. In assessing the tax consequences of a settlement payment receipt, the essential question is to determine what the receipt is intended to replace.

Any portion of a settlement payment received that is determined to represent damages in respect of personal injury or death would be exempt from tax. A settlement payment received that compensates for the loss of an amount that would have been income, be it from business, property or employment sources, will be taxable as income. Similarly, a settlement payment received as compensation for loss of, or damage to, a capital asset, will be considered on account of capital and it will likely be treated as proceeds of disposition where the capital asset has been disposed of. These issues are discussed more fully in Interpretation Bulletin IT- 365R2, Damages, Settlements and Similar Receipts, dated May 8, 1987.

For income tax purposes, a settlement payment received on account of income or capital is generally reported in the year of receipt.

We trust these comments will be of assistance to you.

Yours truly,

Nerill Thomas-Wilkinson
A/Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch