15 June 1995 Internal T.I. 9514267 - CALC OF H&W TRUST INCOME -LATE FEE CHARGED TO CONTRIBUT

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:

1) is the late fee a penalty or liquidated damages

2) whether the late fee charged to employers by a H&W trust is included in trust income

Position TAKEN:

1) liquidated damages

2) whether penalty or damages, it is included in income

Reasons FOR POSITION TAKEN:

1) finding of fact

2) trusts are taxed on income under 104 which does not include capital contributions to the trust. Based on the purpose of the trust & the purpose of the late payment, the late fee can be distinguished from that of a capital contribution & as such is taxable as incidental income

For liquidated damages as income, the CNR case says,

"Relevant Legal Principles

There is much jurisprudence on the question of whether compensation paid on the occasion of the termination of some business arrangement is capital or income. To a large extent each case turns on its own facts. It appears to me that there are two aspects which a court must consider in examining such a situation retrospectively: was the purpose of the payment to replace capital or income; and, whether or not the purpose can be reliably determined, was the effect of the payment to replace capital or income? It appears to me to be a dual test because the purpose may not be discernible, or it may not be reliably discernible in the sense that parties to settlements should not, by misstating the real purpose, determine the tax consequences of the receipt of such compensation. It is therefore necessary to look at both purpose and effect."

In this case the liquidated damages are clearly intended to compensate for legal/collection expenses which is not capital, not the loss of an enduring asset

June 15, 1995
Toronto North Tax Services HEADQUARTERS
Business Audit Division A. Humenuk
957-8953
Attention: Claira Mark
951426

Liquidated Damages received by the
XXXXXXXXXX Health and Welfare Plan

We are replying to your memorandum of May 17, 1995 concerning the taxation of the XXXXXXXXXX Health and Welfare trust (the Trust).

XXXXXXXXXX

The collective agreement provides that an employer who is in default in remitting the required contribution to the trust within 10 days of the due date is required to pay to the Trust an amount equal to 10% of the required contribution as "liquidated damages and not as a penalty".

You have asked whether the amounts described in the collective agreement as liquidated damages should be included in the trust's income as incidental income, as a reduction in administrative expenses or as a non-taxable capital contribution to the trust.

As discussed with you on June 6, 1995 (Mark/Humenuk), our initial review suggested that the 10% fee for late payments was a penalty and not liquidated damages and that the charge to the defaulting party for costs incurred in collecting the required contribution as specified in article 5(e) of the Trust Agreement was in addition to the amounts required by the collective agreement. However, the trustees have administered the agreement on the basis that the 10% fee represents the charge to the defaulting party specified in article 5(e) of the Trust Agreement. In addition, the trustees have confirmed that they are not entitled to collect any amount beyond that specified by the collective agreement. Notwithstanding our initial reservations about categorizing the 10% fee as liquidated damages, the administration of the trust and the additional information submitted support a finding that the payment in question is liquidated damages and not a penalty.

Characterizing the 10% payments as liquidated damages, it is our view that such amounts would be included in the trust's income as incidental income. Two of the leading cases in the taxation of liquidated damages, Pe Ben Industries Company Limited v. The Queen (88 DTC 6347) and Canadian National Railway Company v. MNR (88 DTC 6340), focus on whether the payment of damages is on account of income or capital. If it is on account of income, the liquidated damages received are included in income whereas liquidated damages to compensate for the loss of an enduring asset would properly be excluded from income. While the collective agreement does not specify the nature of the damages likely to be incurred in the event of a late payment by the employer, the likeliest cost to be incurred by the trust is that of collecting the contributions due or the loss of investment income on that capital for the period of the default. Since damages of this nature would be on account of income, such amounts would be included in the income of the trust as incidental income.

You indicated that the trustee would likely argue that the liquidated damages were on account of the loss of the capital contribution. However, article 5(e) of the Trust Agreement, the additional information and the administration of the trust make it clear that the liquidated damages are intended to compensate for the additional expense to be incurred by the trust in collecting overdue payments. The only other damage or loss likely to be suffered by the trust from the delay in receiving the capital contribution would be the loss of income earned on that capital contribution. A late payment involves no loss of capital as the contribution is still required to be made. A loss of income earning potential or the increased expense is on account of income and damages payable in respect of such loss would be included in the trust's income.

P.D. Fuoco
Section Chief
Personal and General Section
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch