10 August 2011 External T.I. 2011-0398651E5 - 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 lump-sum settlement amount received by an employee upon his discharge from employment is exempt from income tax

Position: Question of fact.

Reasons: The settlement amount in question is not a RCMP pension or compensation amount under paragraph 81(1)(i) or workers compensation payment under paragraph 56(1)(v) / subparagraph 110(1)(f)(ii) of the Act. The settlement amount is likely an employment benefit taxable under paragraph 6(1)(a) or a retiring allowance taxable under subparagraph 56(1)(a)(ii) of the Act. There is insufficient information to support that the amount is non-taxable damages described in IT-337R4.

XXXXXXXXXX 							N. Pulandiran
								2011-039865
August 10, 2011

Dear XXXXXXXXXX :

Re: Taxation of Settlement Amount Received from RCMP

I am writing in response to your letter of March 4, 2011 concerning the tax treatment of a settlement amount received from the Royal Canadian Mounted Police ("the employer"). More specifically, you have enquired whether such settlement amount would be exempt from income tax under Interpretation Bulletins IT-397R, Amounts Excluded from Income - Statutory Exemptions and Certain Service or RCMP Pensions, allowances and Compensation or IT-202, Employees' or workers' compensation.

In the situation you described, an employee incurred a work related injury and the employer requested that he/she take a medical discharge. The employee declined the medical discharge. XXXXXXXXXX grievances were filed against the employer. XXXXXXXXXX , the employee agreed to a settlement amount from the employer in exchange for consenting to a medical discharge and withdrawing all grievances and complaints filed against the employer. The settlement amount was separate from the legislative severance received upon early retirement.

Our Comments

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. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca. Where the particular transactions are complete, the inquiry (including all relevant documentation) should be addressed to the relevant tax services office, a list of which is available on the "Contact Us" page of the CRA website. We are, however, prepared to provide the following general comments.

In accordance with paragraph 81(1)(i) of the Income Tax Act (the "Act") and explained in paragraph 14 of IT-397R, pension payments, allowances and other compensation received in respect of an injury, disability or death arising directly out of, or directly connected with, the service of a member in the RCMP under the provisions of the Royal Canadian Mounted Police Pension Continuation Act or the Royal Canadian Mounted Police Superannuation Act, are not to be included in the recipient's income. Based on the information provided, it is our view that the settlement payment was not received in accordance with the provisions under paragraph 81(1)(i) of the Act and therefore would not be exempt from income tax under this provision.

Interpretation Bulletin IT-202R2 deals with the provisions under paragraph 56(1)(v) and subparagraph 110(1)(f)(ii) of the Act and relate to workers' compensation. It is our view that this bulletin does not apply since the settlement amount received does not relate to workers' compensation.

A settlement award or any other amounts received on account of the recognition of an employee's long service, or damages suffered in respect of a loss of employment are specifically included in the definition of "retiring allowance" in subsection 248(1) of the Act and consequently is taxable by virtue of subparagraph 56(1)(a)(ii) of the Act and subject to withholding under paragraph 153(1)(c) of the Act. If an amount is not a retiring allowance, it may be taxable as employment income under paragraph 6(1)(a) of the Act.

The courts have generally taken the view that a retiring allowance includes any compensation on account of damages for a loss of employment, including special damages, as well as general damages received for loss of self-respect, humiliation, mental anguish, etc. Only where an award of damages can be traced to events or actions unrelated to or separate from the loss of employment will damages be treated as non-taxable.

Paragraph 6(1)(a) of the Act generally includes in a taxpayer's income from an office or employment "the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of an office or employment", except any benefit specifically excluded by subparagraphs 6(1)(a)(i) to (v), none of which apply here. It is well established that the phrase "in respect of, in the course of, or by virtue of an office or employment" means that there need only be a small connection between a benefit and the employment in order to trigger the operation of paragraph 6(1)(a). In a number of situations where "damages" have been received as the result of grievances filed against an employer, the courts have found such amounts to be benefits taxable under paragraph 6(1)(a) of the Act.

As noted in paragraph 12 of IT-337R4, Retiring Allowances, where general damages are received in respect of personal injuries sustained before or after the loss of employment (for example, in situations of harassment during employment or defamation after dismissal), or where a loss of employment involves a human rights violation and is settled out of court, general damages will be viewed as unrelated to the loss of employment and therefore non-taxable. In order to claim that damages received upon loss of employment are for personal injuries unrelated to the loss of employment, it must be clearly demonstrated that the damages received relate to events or actions separate from the loss of employment.

The words used in a settlement agreement to label a settlement payment may not always reflect the actual character or reason for the payment. Also, where payments are made to settle a dispute without the dispute being fully addressed, the underlying grievance will still be considered in determining the purpose of the payment. In addition, if there is any indication that there may be more than one purpose for a settlement, a reasonable attempt must be made to allocate amounts between each purpose if the tax consequences will vary.

For more information on retiring allowances and settlements, please refer to Interpretation Bulletin IT-337R4 and Interpretation Bulletin IT-365R2, Damages, Settlements and Similar Receipts.

We trust our comments will be of assistance to you.

Yours truly,

Phyllis Waugh
A/Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch