19 February 1998 External T.I. 9731615 - REIMBURSEMENT OF LEGAL FEES

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:

Withholding requirements on the reimbursement of legal fees in wrongful dismissal cases.

Position:

There are no withholding requirements with respect to reimbursements of legal fees described in paragraph 56(1)(l.1). Appropriate withholdings required for reimbursement of legal fees included in income by virtue of 6(1)(j). However administrative policy to waive the withholding requirements if the reimbursement is deductible under 8(1)(b).

Reasons:

Paragraph 56(1)(l.1) is not a payment described in subsection 153(1) nor is it included in the definition of "remuneration".

Amounts included under paragraph 6(1)(j) are payments described in subsection 153(1) and therefore subject to withholdings.

									5-973161
XXXXXXXXXX							Karen Power, C.A.

Attention: XXXXXXXXXX

February 19, 1998

Dear Sirs:

Re: Reimbursement of Legal Fees

We are responding to your letter of November 28, 1997, concerning the reimbursement of legal fees. You have asked that we clarify the Department's position as to when withholding of tax is required on awards or reimbursements of legal fees in a wrongful dismissal case.

You have also asked for clarification on the following statement contained in letter 9618015: "amounts paid directly to the attorneys in respect of legal costs in circumstances where the settlement award is not subject to tax would not attribute to the employee as a taxable amount and no withholding would be required from the amounts paid by the employer".

Our Comments

Reimbursements or awards for legal fees in connection with the collection or establishing a right to a retiring allowance:

Paragraph 56(1)(l.1) of the Income Tax Act (the "Act") requires a taxpayer to include in computing income amounts received as an award or reimbursement of legal expenses paid to collect or establish a right to a retiring allowance.

Paragraph 60(o.1) of the Act provides for the deductibility of eligible legal expenses paid after 1985 to collect or establish a right to a retiring allowance or pension benefits. Eligible legal expenses may be deducted in a taxation year to the extent they do not exceed the retiring allowances or pension benefits to which such expenses relate. The non-deductible portion of such expenses may be carried forward and deducted in any of the seven subsequent years, to the extent further related income arises.

The income against which eligible expenses may be deducted may, however, be reduced by virtue of a transfer to a registered retirement savings plan or registered pension plan under paragraph 60(j) or (j.1) of the Act.

The Department's position is that the reimbursement of legal fees described in paragraph 56(1)(l.1) of the Act is not a payment described in subsection 153(1) of the Act nor it is an amount included in the definition of "remuneration" as found in subsection 100(1) of the Regulations. Accordingly, there is no statutory requirement for an employer to withhold tax in respect of such amounts or to report such amounts on an information slip.

Reimbursement of legal fees are usually received by the taxpayer; however, the tax treatment would generally be the same where the former employer is directed by legal documents to make a payment directly to the taxpayer's legal counsel, on the taxpayer's behalf. In such a case, where an amount is included in income under paragraph 56(1)(l.1), a deduction under paragraph 60(o.1) would be available.

Reimbursements or awards for legal fees in connection with the collection or establishing a right to income from employment:

Reimbursements or awards for legal fees in connection with the collection or establishing a right to income from employment are included in income from an office or employment by virtue of paragraph 6(1)(j) of the Act.

Paragraph 8(1)(b) of the Act provides for the deductibility of eligible legal expenses paid to collect or establish a right to salary or wages owed to the taxpayer by the employer or former employer.

Amounts included in income under paragraph 6(1)(j) would be payments described in subsection 153(1) of the Act. As such, the employer would be technically required to make the appropriate withholdings and prepare the appropriate information slip in respect of any such payments. However, to the extent that the legal fees incurred in obtaining a settlement are otherwise deductible under paragraph 8(1)(b) of the Act and the reimbursement of those legal fees has not been taken into account in determining the amount of deduction under that paragraph the Department is generally prepared to waive the withholding requirement in respect of such reimbursements. The appropriate information slip must still be prepared (generally a T4, not a T5 as suggested in your letter).

Reimbursements or awards for legal fees in respect of damages received for personal injury or death:

Paragraph 2 of Interpretation Bulletin 365R2 dated May 8, 1987, states that "All amounts received by a taxpayer or the taxpayer's dependant, as the case may be, that qualify as special or general damages for personal injury or death will be excluded from income regardless of the fact that the amount of such damages may have been determined with reference to the loss of earnings of the taxpayer in respect of whom the damages were awarded."

The reimbursement or awards of legal fees paid in respect of damages received for personal injury or death are also excluded from income and therefore not subject to withholding taxes pursuant to subsection 153(1) of the Act.

The above noted comment contained in our correspondence 9618015 was in relation to non-taxable items only, such as general damages for pain and suffering. Paragraph 56(1)(l.1) will apply to reimbursed legal fees in circumstances where the retiring allowance is transferred to an RRSP within the limits set out under paragraph 60(j.1) of the Act.

As you have suggested, we have brought your concerns forward to the attention of the Departmental authors of the Employer's Guide to Payroll Deductions. If you have any further questions regarding the withholding requirements on the reimbursement of legal fees with respect to specific circumstances we suggest you contact your client's Taxation Services Office.

We trust our comments will be of assistance to you.

Roberta Albert, C.A.

for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

cc. Guy Levesque

Ray Cousineau