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: The characterization of a settlement payment for income tax purposes.
Position: Question of fact.
Reasons: Based on the legal principle of surrogatum, it must be determined what the amount is intended to replace.
XXXXXXXXXX 2011-040623
J. Gibbons, CGA
August 15, 2011
Dear XXXXXXXXXX :
Re: The Income Tax Treatment of a Settlement Payment
This is in reply to your letter dated April 28, 2011, concerning a payment (the "Settlement Payment") you received in settlement of a class action suit (the "Class Action Suit") brought by you and other unitholders (the "Unitholders") of XXXXXXXXXX (the "Limited Partnership") against the Limited Partnership XXXXXXXXXX . Although you reported the full $XXXXXXXXXX as proceeds of disposition of your interest in the Limited Partnership (the " LP Units"), you believe that part of this settlement related to non-taxable damages for pain and suffering and mental anguish as stated in the settlement agreement (the "Settlement Agreement").
During the telephone conversation (Gibbons/XXXXXXXXXX ) of June 12, 2011, you referred to a copy of the Settlement Agreement on the website of the firm that represented you and the other Unitholders in the Class Action Suit. It should be noted that according to the Settlement Agreement on this website, the Class Action Suit was actually settled out of court, and there was no judgment from the XXXXXXXXXX Court, as indicated in your letter. The Settlement Agreement states that "XXXXXXXXXX " You determined that $XXXXXXXXXX from the Settlement Payment should be treated as a return of invested capital and the remainder of $XXXXXXXXXX should be treated as non-taxable damages, on the basis that the Invested Amount was $XXXXXXXXXX . You further indicated that that the difference between your initial investment of $XXXXXXXXXX and the return of capital should be treated as a limited partnership loss.
Our Comments
The characterization of damages or settlement payments for income tax purposes is a question of fact that can only be determined after reviewing all of the relevant facts and circumstances of the particular case. Further, as the situation outlined in your correspondence involves completed transactions, the issue should be addressed by your local tax services office. Although we are unable to give you definitive comments relating to your particular situation, we have provided some general comments which we hope will be of assistance to you.
A payment in settlement of a damages claim to avoid or terminate litigation may generally be accorded similar treatment as damages for tax purposes, even though there may be no admission of wrongdoing. In reviewing the tax repercussions of damage receipts, the essential question is to determine what the compensation is intended to replace. A settlement payment will be treated as ordinary income if it compensates for the loss of an amount that would have been income, be it from business, property or employment sources, whereas a settlement payment received as compensation for loss of, or damage to, a capital asset, will be considered on account of capital. A portion of a settlement payment may also represent damages in respect of personal injury or death, in which case, this portion would be exempt from tax. These issues are discussed more fully in Interpretation Bulletin IT- 365R2, Damages, settlements and similar receipts, which is available on our website at www.cra-arc.gc.ca.
Although it is a question of fact how a settlement payment should be treated, it would appear from the Settlement Agreement that part of the Settlement Payment represents non-taxable personal damages. In this regard, the statement of claim made on behalf of the Unitholders in the Class Action Suit (the "Statement of Claim") demands an amount equivalent to the capital amount of each Unitholder's initial investment, other damages to be determined, and exemplary damages of $XXXXXXXXXX , while, as indicated above, the Settlement Agreement states that "XXXXXXXXXX "
The term "Invested Amount" term is described in the Settlement Agreement as "the net cash amount actually paid at the time of acquisition of the investment." For conversion, you used the 2010 exchange rate. In our view, the appropriate exchange rate to use is the one that prevailed when the Units were acquired in XXXXXXXXXX , which was the rate you used to determine that the initial cost and the adjusted cost base of the Units was $XXXXXXXXXX . Using this amount for the Invested Amount, the amount received as a return of capital would be approximately $XXXXXXXXXX leaving an amount of approximately $XXXXXXXXXX as non-taxable damages.
The amount received as a return of invested capital would either be a reduction in the ACB of the Units pursuant to subparagraph 53(2)(c)(iv) of the Income Tax Act (the "Act") or, if the Units have been disposed of, would be "proceeds of disposition" within the meaning of the definition of this term in section 54 of the Act. Although the Statement of Claim requested the annulment of the Limited Partnership Agreement, and you reported the disposition of the Units on your 2010 tax return, we couldn't find any indication in the Settlement Agreement or elsewhere in the information available to us that the Limited Partnership was terminated or that the Units were disposed of. Unless there was a disposition of the Units, whether as a result of the winding up of the Limited Partnership or by other means, there would be no capital loss on the Units. However, if there was a disposition of the Units resulting in a loss, it would be a capital loss and not a limited partnership loss.
We trust these comments will be of assistance.
Yours truly,
G. Moore
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2011
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2011
Email this Content