5 August 1993 Internal T.I. 9310387 F - Legal Fee Reimbursement to Collect From Disability Plan

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.

HALIFAX DISTRICT OFFICE Personal and General DivisionSource Deductions  Section

Attention:  J. Burke

Legal Fee Reimbursement and Prejudgment Interest

We are replying to your memorandum of March 20, 1993 concerning the taxation of a court-ordered legal fee reimbursement and prejudgment interest. We apologize for the delay in our response.

As we understand the facts in the situation under review, an employee was denied benefits by an insurer under a wage loss replacement plan. The employee sued the insurer and was awarded a lump sum settlement equal to the aggregate of periodic payments he would have received had the insurer accepted his claim plus accrued interest (prejudgment interest). The award also included an amount for the partial reimbursement of his legal fees. You have asked whether the legal fee reimbursement is required to be included in the employee's income and secondly, whether the employee will be entitled to a deduction for the legal fees paid under paragraph 8(1)(b) of the Act.

The reimbursement of legal fees is included in income under paragraph 6(1)(j) of the Act to the extent that the legal fees would have been deductible under subsection 8(1) of the Act and the amount is not otherwise included in income or taken into account in determining the amount deductible under subsection 8(1) of the Act.

In considering the issue of whether the employee is entitled to a deduction under paragraph 8(1)(b) of the Act for legal fees incurred to establish or collect the benefits under the wage loss replacement plan, one must first determine whether the benefits awarded by the court are taxable under paragraph 6(1)(f) of the Act and whether the insurer is considered to be an employer for the purpose of paragraph 8(1)(b) of the Act.

While we do not have any details of the plan in question, the correspondence from the employee's representative suggests that the plan was a taxable plan as described in Interpretation Bulletin IT-428 "Wage Loss Replacement Plans" and that it is agreed that the payment in lieu of benefits under the plan is taxable. Subsection 248(1) of the Act defines "salary or wages" as the income from an office or employment as computed under subdivision a of Division B of Part I of the Act which includes amounts described in paragraph 6(1)(f) of the Act.

With respect to the requirement that the salary or wages be owed by the employer or former employer, it is our view that the insurer is not an employer for this purpose. While the definition of "employer" in subsection 248(1) of the Act is not of much assistance in this regard in that it applies in respect of officers only, the definition of "employment" as found in subsection 248(1) has relevance in that an employee is defined therein to be a person holding a position in the service of someone else. Since the employee is presumably not in the service of the insurer, it follows that the insurer is not an employer of the employee for the purpose of paragraph 8(1)(b) of the Act.

While the definition of "employer" in subsection 100(1) of the Regulations is broader in scope than that found in subsection 248(1) of the Act (in that it includes anyone paying remuneration as defined in that Regulation), this definition is only applicable for the purposes of the Regulations. A quick glance at the types of remuneration listed in Regulation 100(1) shows that it includes pension payments, unemployment insurance benefits and other amounts which are typically paid by an entity which is not normally considered to be the recipient's employer for the purposes of the Act.

Consequently, it is our view that the legal fees incurred to establish the employee's right to an amount receivable from the insurer are not deductible under paragraph 8(1)(b) of the Act. Since the legal fees are not deductible under subsection 8(1) of the Act, no amount is required to be included in the employee's income under paragraph 6(1)(j) of the Act.

We note that the taxpayer's representative also asks whether the prejudgment interest awarded by the court is taxable, subject to withholding tax and whether such amount must be reported on an information slip. While it is our position that such interest is taxable as explained in paragraphs 11-14 of Interpretation Bulletin IT- 396R "Interest Income", no amount of withholding is required on such amounts. The T5 supplementary slip is the appropriate information slip for reporting such amounts.

P.D. Fuoco Section Chief Personal and General SectionBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch

c.c.      Client Assistance Directorate c.c.      Assessment of Returns Directorate c.c.      Source Deductions Division, Revenue Collections Programs Directorate