20 August 1997 External T.I. 9720015 - DISABILITY INSURANCE 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.

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:

Income tax treatment of a lump-sum payment received from an insurer on a "personal" accident, sickness and disability policy.

Position:

Question of fact but generally where amount of premium is paid personally and is not employment related any lump-sum settlement amount would not be taxable. Any interest included in the lump-sum settlement is taxable pursuant to 12(1)(c) of the Act.

Reasons:

If any portion of the amount received is legally interest then paragraph 12(1)(c) of the Act applies.

XXXXXXXXXX 972001

Attention: XXXXXXXXXX

August 20, 1997

Dear Sir\Madam:

Re: Disability Insurance Settlement

This is in reply to your letter of June 27, 1997, concerning the treatment under the Income Tax Act (the "Act") of a disability insurance settlement in a particular fact situation.

To briefly restate the facts in your letter, you outline a situation whereby a key employee of a business purchased one or more disability and sickness insurance policies directly from an insurer using personal funds on an after-tax basis (i.e., the premiums were paid by the employee and no portion of the premiums were deducted by the employee or the employee's employer). Subsequently, the individual began having serious health problems such that he/she became unable to work. The individual made a claim for disability benefits but the insurer denied the individual's claim and the individual was forced to sue the insurer for payment. Before the lawsuit went to trial, the insurer offered to settle the claim by offering certain lump-sum payments if the individual would drop the lawsuit and relinquish the policies. The individual agreed to these terms and accepted the lump-sum payment(s). Such amounts may or may not include an amount(s) in respect of pre-settlement interest. Your questions are what portion, if any, of the lump-sum settlement(s) received by the individual are taxable and are the legal fees incurred by the individual to collect such amounts deductible.

As discussed (by telephone - Cooke/XXXXXXXXXX on August 12, 1997), we are unable to address specific fact situations in a general letter of opinion. Confirmation of the income tax consequences of a completed transaction may be requested from the appropriate tax services office and such a determination would involve a finding of fact which can only be determined upon a review of all the relevant documentation and information. However, we are prepared to provide you with some general comments on the above subject matter that we caution may or may not be applicable to your particular fact situation.

Our Comments

Where an individual is the owner of and beneficiary under an accident, sickness and disability policy and such individual pays all the policy premiums out of their own funds as a personal expense (i.e., such premiums are not paid or otherwise reimbursed by the individual's employer) any lump-sum benefit paid by the insurer under the policy to the individual would be received by the individual on a tax-free basis (see for example paragraph 16 of IT-428). Similarly, except as discussed below, where the individual commences an action against the insurer to enforce payment of a claim under such a policy any lump-sum amount awarded by a court or any lump-sum amount of an out-of-court settlement in respect of policy benefits or damages would also be received by such an individual on a tax-free basis. Any legal costs incurred by an individual to collect such an amount would not be deductible (i.e., paragraph 8(1)(b) of the Act does not apply).

To the extent that any portion of a court awarded amount or out-of-court settlement amount constitutes interest, it is our view that such interest would be required to be included in the individual's income pursuant to paragraph 12(1)(c) of the Act (see paragraphs 12 and 13 of IT-396R).

While we trust the foregoing comments are useful we again caution that they are given in accordance with the practice referred to in paragraph 22 of Information Circular 70-6R3 dated December 30, 1996 and are not binding on the Department.

Yours truly,

F. Lee Workman
Section Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch