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: We have been asked to be of assistance with respect to a settlement (out-of-court or in court) that an individual may receive. Taxable and non-taxable may be involved.
Position: General comments were provided.
Reasons: Specific information not available.
983196
XXXXXXXXXX M. Eisner
(613) 957-2138
January 7, 1999
Dear XXXXXXXXXX:
Re: Nature of a Potential Damages Settlement
This is in reply to your letter of November 16, 1998 concerning the above subject.
You have indicated that a claim was filed by a plaintiff (the “Plaintiff”) against a company (the “Defendant”). The Plaintiff alleged in the claim that the Defendant issued malicious and false opinions which resulted in the Plaintiff being eliminated from consideration for employment by another group of employers. It is also alleged that the opinions were issued over a period of years without the awareness of the Plaintiff and that the opinions were contrary to written references issued to the Plaintiff by the Defendant. You have also indicated that these actions by the Defendant may have had destructive effects on the Plaintiff’s career.
In relation to the above situation, you have asked a number of questions concerning the tax consequences of a settlement that might be awarded to the Plaintiff.
At the outset, we wish to note that you have not provided documentation with respect to the initial claim or draft documentation with respect to any proposed settlement. Both the timing and the nature of the claim in relation to the Plaintiff’s former employment is not clear.
When an individual files a claim against an employer or former employer, there can be a number of issues that result from that relationship. The most common considerations can be the extent that a settlement can be regarded as being in the nature of employment income or a retiring allowance, which are taxable, or non-taxable personal damages. A further problem may arise with respect to the reasonableness of an allocation set out in a court decision or an out-of-court settlement. As each such settlement is unique, the tax consequences of a particular settlement can only be determined following a review of the relevant facts and documentation on a case-by-case basis. Nonetheless, we are making the following general comments that should not be regarded as having been made in respect of a particular fact situation.
The following comments relate to a scenario where an employee has filed a claim against an employer or a former employer.
Legal and Travel Expenses
Subject to some exceptions, legal fees in respect of a claim are generally not allowable. Two of the exceptions relate to salary or wages and a retiring allowance. For general comments in this regard, you should refer to paragraph 1 of Interpretation Bulletin IT-99R4 “Legal and Accounting Fees” (copy enclosed) which sets out the general rule, paragraphs 19 and 20 which deal with legal fees in respect of salary and wages, and paragraphs 21 to 23 which deal with legal fees in respect of a retiring allowance.
Where an individual travels between two cities with respect to a claim filed against his or her employer or former employer, there is no provision in the Income Tax Act (the “Act”) which would allow the individual to claim the related travel expenses.
Award of Damages Prior to a Court Hearing Date
A portion of an amount received in respect of a settlement could be taxable or non-taxable. For a discussion of this issue, we refer you to the comments in paragraph 9 of Interpretation Bulletin IT-337R3 “Retiring Allowances” and paragraph 2 of Interpretation Bulletin IT-365R2 “Damages, Settlement, and Similar Receipts” which have been enclosed. With respect to IT-365R2, where the settlement is neither employment income or a retiring allowance, the consideration is whether the settlement is in respect of special or general damages for personal injury. Such damages are generally non-taxable.
The Act makes no distinction on the tax treatment of an amount that results from an out-of-court settlement or a decision of a court.
Apportionment and Timing of Taxation of an Award
A breakdown of the various components is necessary in determining the income tax consequences in respect of an award. However, as indicated above, the reasonableness of an allocation within a settlement is also a consideration.
Employment income is taxed on a “received” basis. Where such income is received as a result of a settlement, it is normally available to the plaintiff within a short time following the time that the settlement becomes legally effective. Subject to subsection 6(11) of the Act, if the actual receipt of the amount were to be deferred, it would generally be the Department’s position that the amount has been received by the plaintiff when it was considered to be unconditionally available.
On the other hand, it is not uncommon for a retiring allowance to be received over a period of time. If the settlement indicated that an amount that was in the nature of a retiring allowance was to be received by the plaintiff over a period of time, it is the Department’s position that it would normally be taxable as it is actually received during the period of time.
Subject to the above comments on a retiring allowance, there is no alleviating provision in the Act with respect to the taxation of the receipt of a taxable sum that represents employment income or a retiring allowance. However, as indicated in paragraph 12 of IT-337R3, it may be possible to claim a deduction for part or all of a retiring allowance that has been included in a taxpayer’s income where all or part of such an amount has been transferred to a registered pension plan or a registered retirement savings plan under which the taxpayer is the annuitant.
In the event that a settlement has already been reached with respect to your situation, you may wish to make a submission to the Vancouver Island Tax Services Office so that the tax consequences could be determined. On the other hand, the tax consequences of a proposed transaction is only given by way of an advance income tax ruling described in Information Circular 70-6R3 “Advance Income Tax Rulings” (copy enclosed). Please note that the current rate for an advance income tax ruling is $90 an hour.
We trust that these comments will be of assistance to you.
Yours truly,
Jim Wilson
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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