10 November 2011 External T.I. 2011-0421931E5 - Taxability of Settlement Amount

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 a settlement payment made to relinquish an employee's potential right to reinstatement is taxable as income.

Position: The settlement as described appears to meet the definition of a retiring allowance.

Reasons: The payment satisfies the two-prong test established by the courts for the purpose of determining whether a payment is a retiring allowance.

XXXXXXXXXX 					2011-042193
						Andrea Boyle
November 10, 2011

Dear XXXXXXXXXX ,

Re: Taxability of Settlement Amount

I am replying to your letter of September 12, 2011 inquiring about the taxability of a settlement payment made from XXXXXXXXXX ("the Employer") to a former employee ("the Taxpayer").

According to your correspondence the settlement payment was made for general damages relating to the Taxpayer's grievances and "specifically, the relinquishment of her potential right to reinstatement".

You have also indicated that the settlement is in respect to two grievances filed by the union on behalf of the taxpayer. The first grievance alleged that the Employer unreasonably delayed the Taxpayer's return to work and accommodation for a medically disabling condition; the second grievance alleged that the Employer inappropriately terminated the Taxpayer by refusing to accommodate her medically disabling condition. You wish to know whether the settlement payment in these circumstances would be considered non-taxable as damages received for a human rights violation.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of a request for an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5 Advanced Income Tax Rulings, dated May 17, 2002. We are prepared to provide the following comments in respect of the issues, however these comments are of a general nature only and are not binding on the Canada Revenue Agency (the "CRA").

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended ("the Act").

OUR COMMENTS

The determination of whether a particular amount received by an employee upon or after termination of employment constitutes employment income, a retiring allowance, or other damages can only be made after a thorough review of all of the circumstances relevant to the particular situation. Based on the information available in this case we can not determine what portion of the amount, if any, might be considered a reasonable award with respect to a human rights violation. As indicated in paragraph 12 of the CRA Interpretation Bulletin IT-337R4 Retiring Allowances:

...When a loss of employment involves a human rights violation and is settled out of court, a reasonable amount in respect of general damages can be excluded from income. The determination of what is reasonable is influenced by the maximum amount that can be awarded under the applicable human rights legislation and the evidence presented in the case. Any excess will be taxed as a retiring allowance.

With respect to the amount of the settlement payment that may be considered as being non-taxable, we note that paragraph 7 of the Human Rights Tribunal's Information Sheet No. 22 indicates that, while the highest damage award to date for injury to dignity, feelings and self respect is $35,000, most damage awards are under $10,000.

A specific valuation issue is a question of fact and is not the domain of the Income Tax Rulings Directorate of the CRA. Generally, in order to properly determine the portion of the settlement payment that might reasonably be considered as a damage award for human rights violations, Human Rights Tribunal decisions would need to be reviewed to find the most comparable situations to the Taxpayer's situation. The reasonableness of the non-taxable amount arrived at in any situation may be challenged should the assessment be subject to later review by the CRA. Therefore information should be retained by the Taxpayer in case it is requested by the Taxpayer's tax services office as support for any amount the Taxpayer may claim as being non-taxable.

In any case, in our view, based on the description given it seems very unlikely that the entire amount of the payment would be considered to have been received with respect to a human rights violation.

Subparagraph 56(1)(a)(ii) of the Act requires a taxpayer to include in computing income for a taxation year the amount of a retiring allowance received by the taxpayer in the year. The definition of "retiring allowance" in subsection 248(1) includes an amount received "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."

The CRA's general views regarding retiring allowances are set out in Interpretation Bulletin IT-337R4 Retiring Allowances. Paragraph 5 states:

A retiring allowance includes an amount received in respect of a loss of office or employment. In this context, the words "in respect of" have been held by the Courts to imply a connection between the loss of employment and the subsequent receipt, where the primary purpose of the receipt was compensation for the loss of employment... Two questions set out by the Courts to determine whether a connection exists for purposes of a retiring allowance are as follows:

1 - But for the loss of employment would the amount have been received? and,

2 - Was the purpose of the payment to compensate a 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 received be considered a retiring allowance.

Damages received in connection with a loss of employment clearly fall within the definition of a retirement allowance. In our view, because the amounts described are received in relinquishment of the potential right to reinstatement and for inappropriate termination, it is likely that a large portion, if not all of the amount paid would be considered a retiring allowance which should be included in taxable income.

We trust that these comments will be of assistance.

Yours truly,

Guy Goulet CA, M.Fisc.
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch