19 April 1995 Ministerial Correspondence 950054A - STRUCTURED SETTLEMENTS

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 Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

A damages claim of an individual was settled. Part of the settlement was retained by the individual's solicitor for services provided with respect to the settlement. If the legal fees are reduced and an annuity contact is purchased with respect to the reduction, will the payments be non-taxable?

Position TAKEN:

The payments in question would be subject to the provisions of section 12.2 and paragraph 56(1)(d) of the Act.

Reasons FOR POSITION TAKEN:

The positions are based on comments in paragraphs 3 and 5 of IT-365R2.

		950054
XXXXXXXXXX	M. Eisner

Attention: XXXXXXXXXX

April 19, 1995

Dear Sirs:

Re: Structured Settlements

This is in reply to your two letters of December 19, 1994 which is further to our reply of November 20, 1994 (file 942792). The subject matter concerns a damages settlement in respect of personal injury.

At the outset, we wish to mention that the comments set out below are of a general nature. Accordingly, they should not be regarded as having been made in respect of a particular fact situation.

In our letter of November 20, we addressed a type of situation where an individual, as a result of sustaining personal injuries, settled for a lump sum. Part of the lump sum was paid to the individual, another part of the lump sum was "structured" (i.e., it was to be paid in periodic instalments), and the remaining part of the lump sum was retained by the individual's solicitor for services provided with respect to the settlement. Subsequently, the individual commenced legal action against the solicitor on the basis that the fees were too high. The solicitor and the individual then proceeded to settle in a manner under which the solicitor would purchase an annuity contract and direct the issuer to make the related payments to the individual.

You have now requested us to consider two modifications to the above circumstances.

The first modification concerns the part of the lump sum that relates to the periodic instalments. In this regard, you have indicated that the total amount of the settlement was disclosed to the individual. On the basis of the total amount of the settlement, the individual determined the amounts that were required for his or her immediate needs (including the payment of the legal fees) and agreed that the balance would be used with respect to the periodic instalments.

The second modification concerns the manner in which the periodic payments would be made in respect of the reduction of the legal fees. In this regard, the making of the periodic payments would be structured in a manner which would involve the trustee of the casualty insurer (the casualty insurer has ceased operations).

Our Comments

In the case of the first modification, paragraph 5 of IT-365R2 relates to circumstances where a casualty insurer has agreed to make periodic payments to a claimant rather than a situation where periodic payments are to be paid in respect of lump sum or a part thereof. Accordingly, on the basis of the information provided to us, it is still our view that the periodic payments would be subject to section 12.2 and paragraphs 56(1)(d) and 60(a) of the Income Tax Act (the Act).

In relation to the second modification, you have suggested that the Department may have adopted a position which would permit the reduction in legal fees to be received in the form of non-taxable periodic payments. In this regard, you have heard that the Department might accept that periodic payments are non-taxable where the lump sum proceeds of a damages award are paid to the claimant's legal representative who would then make all arrangements for the payment of periodic payments to the claimant including the preparation of the necessary documents for the signature of the relevant parties. We have also assumed that the documentation would reflect a structured settlement described in paragraph 5 of IT-365R2 "Damages, Settlements, and Similar Receipts".

This Department has not adopted a position that would be favourable to the claimant in the above type of circumstances. In the above arrangement, the two legal representatives have dispensed with the negotiation of a damages settlement that involves periodic payments in favour of agreeing on a lump sum that is to be paid. The lump sum is paid on the basis that it is to be held "in trust" and that the plaintiff's legal representative, in arranging for the payment of periodic payments to the plaintiff, acts "as agent" for the casualty insurer. With respect to this type of arrangement, it is our view that the plaintiff's legal representative, (acting, in fact, on behalf of the plaintiff) and the casualty insurer have settled the damages claim upon the payment of a lump sum and that the plaintiff's legal representative, in arranging for a "structured settlement", is factually acting on behalf of the plaintiff. It would follow that the resulting periodic payments would be subject to the provisions of section 12.2, and paragraphs 56(1)(d) and 60(a) of the Act.

We are, accordingly, of the view that if periodic payments were to be made to the individual in respect of the legal fees reduction in the revised scenario, they would be subject to the provisions of section 12.2 and paragraphs 60(a) and 56(1)(d) of the Act.

We trust that our comments will be of assistance to you.

Yours truly,

P.D. Fuoco
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch