10 May 2012 External T.I. 2011-0423761E5 - Settlement Awards

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.

Principal Issues: Whether amounts received pursuant to a settlement agreement are subject to tax.

Position: Question of fact.

Reasons: When personal injury relates to the loss of employment, the related damage award would generally be considered a retiring allowance. However, where a portion of the damages awarded is separate from the loss of an office or employment, that portion may not be taxable.

XXXXXXXXXX
									 K.G. Weir
									 2011-042376
May 10, 2012

Dear XXXXXXXXXX:

Re: Settlement

We are writing in response to your letter of October 9, 2011, concerning the appropriate tax treatment of the amount awarded in the Minutes of Settlement with your former employer regarding your Human Rights Complaint. Based on the information provided, the settlement amount was agreed upon through mediation without either party admitting liability.

Our Comments

Generally, compensation received by an individual from the individual’s employer or former employer may be considered employment income, retiring allowance, non-taxable damages, or a combination thereof.

Damages

A “retiring allowance” is defined in subsection 248(1) of the Income Tax Act (ITA) as

“an amount (other than a superannuation or pension benefit, an amount received as a consequence of the death of an employee or a benefit described in subparagraph 6(1)(a)(iv)) received

(a) on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer's long service, or

(b) in respect of a loss of an office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal,

by the taxpayer or, after the taxpayer's death, by a dependant or a relation of the taxpayer or by the legal representative of the taxpayer.”

The definition of “retiring allowance” uses the words “in respect of a loss of an office or employment of a taxpayer”. The words “in respect of” are words of the widest possible scope. They import such meanings as “in relation to”, “with reference to” or “in connection with”. As such, the use of these words denotes a connection between the loss of employment and the subsequent receipt of funds. Accordingly, if an individual receives compensation on account of damages as a result of a loss of employment, the amount received will generally be taxed as a retiring allowance.

The courts have formulated the following two-step test to determine whether the connection between a payment and the loss of employment is sufficient to meet the requirement that an amount be “in respect of” a loss of office or employment:

(a) Were it not for the loss of employment, would the employee have received the payment? and

(b) Was the goal of the payment to indemnify the individual for the loss of employment?

Only if the answer to the first question is no and the answer to the second question is yes, will the amount be considered to be a retiring allowance. This would include both special damages and general damages received for loss of self-respect, humiliation, mental stress, etc. arising from an individual’s loss of employment as noted in paragraph 11 of Interpretation Bulletin IT-337R4, Retiring Allowances.

As noted in paragraph 12 of IT-337R4, general damages received in respect of personal injuries sustained before or after the loss of employment (for example, in cases of harassment during employment or defamation after dismissal) or resulting from a human rights claim that is settled out of court, may be considered unrelated to the loss of employment and non-taxable. In order to claim that damages received are for personal injuries unrelated to the loss employment, taxpayers must clearly demonstrate that the damages received relate to events or actions separate from the loss of employment. In making such a determination, consideration should be given to the amount of severance that the taxpayer would have reasonably been entitled to under his or her contract of employment.

Based on the information provided, it is likely that a reasonable portion of the settlement amount could be considered a non-taxable amount to compensate for personal injuries unrelated to the loss of employment.

Personal Expenses

Generally, personal living expenses are not deductible from employment income unless specifically provided for in the ITA. For example, individuals may claim a tax credit for certain personal medical expenses to the extent that the expenses were not reimbursed by the individual’s employer or through an insurance plan. Where taxpayers have deducted personal expenses on their tax return in error, an amended tax return must be filed if an assessment or reassessment has not been issued. Where an employee is reimbursed by their employer for personal expenses, the reimbursement is generally required to be included in income under paragraph 6(1)(a) of the ITA as employment income in the year of receipt.

Legal Fees

Paragraph 8(1)(b) of the ITA permits a deduction for legal fees paid in the year to collect, or to establish a right to, an amount owed to a taxpayer that, if received, would be required to be included in computing the taxpayer’s employment income. Reimbursements of legal fees deducted under paragraph 8(1)(b) of the ITA are included in income from an office or employment by virtue of paragraph 6(1)(j) of the ITA.

An amount received as a reimbursement of legal fees incurred to collect or to ensure a right to collect a retiring allowance is required to be included in income under paragraph 56(1)(l.1) of the ITA. However, a deduction for legal fees paid to collect or to ensure a right to collect a retiring allowance is available under paragraph 60(o.1) of the ITA, but is limited to the amount of retiring allowance received in the year minus any of the retiring allowance that was transferred into the taxpayer’s registered retirement savings plan or registered pension plan. Please refer to paragraph 26 of Interpretation Bulletin IT-99R5, Legal and Accounting Fees (Consolidated) for a more detailed discussion of this issue.

Lastly, an amount received as a reimbursement of legal fees incurred to collect or to ensure a right to collect a non-taxable receipt is not required to be included in income. In such cases, the legal fees so incurred are not deductible as they would not have been incurred to earn income from business, property, or employment sources.

The determination of what portion of the reimbursement of legal fees would be taxable and/or deductible would require a review of all the facts and circumstances. In general, the taxpayer’s allocation of reimbursed legal fees between taxable and non-taxable would be acceptable where a reasonable basis of allocation was used.

We trust these comments will be of assistance.

Yours truly,

Nerill Thomas-Wilkinson
Manager
for Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch