18 May 2001 Internal T.I. 2001-0083317 - RRIF - OUT OF COURT SETTLEMENT

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:

Tax treatment of amounts paid directly to spouses and to their RRIFs in settlement of lawsuit for mismanagement of their RRSPs.

Position:

Nature of settlement amounts must be ascertained. Amounts paid in compensation for losses to RRSPs are taxable in hands of spouses but may be transferred to their RRIFs without tax consequences to them. Amounts paid in compensation for legal costs may not be transferred to RRIFs.

Reasons:

Character of underlying claim determines tax treatment of amounts paid in settlement of claim. Amounts in RRSP taxable when paid to annuitants thereof. ATR-24 provides for replenishment of RRSP or successor deferred income plan with damages paid in respect of those funds. Failure to replenish RRSP or RRIF with those damages therefore would result in taxable income to spouses. Property that may be transferred to a RRIF is limited by paragraph 146.3(2)(f) and would not include amounts received in settlement of legal costs

		May 18, 2001

	TORONTO EAST TSO	HEADQUARTERS
R. Maley
	Attention:  Mark Shipowick	(613-957-9226)

2001-008331

RRIF and Out of Court Settlement

This is in reply to your correspondence of May 8, 2001 requesting our comments on the proper tax treatment of sums received by two spouses in settlement of a lawsuit for mismanagement of their registered retirement savings plans ("RRSPs). As we understand it, the spouses' RRSPs have since been converted to registered retirement income funds ("RRIFs), as required by law. Part of the amount paid to the spouses in settlement of their lawsuit was transferred directly to the spouses' RRIFs and part was paid directly to the spouses.

We have reviewed the draft correspondence you have provided and note that no particulars have been provided as to the nature of amounts comprising the settlement sums. For example, the total amount paid to the spouses is greater than the amount claimed. Was an amount paid to the spouses in compensation for the legal costs they had occurred? If so, how much of the settlement sum was paid in respect of legal costs and how much in respect of the principle claim?

It is our view that particulars of the settlement sum will be required in order to assess the tax treatment of those amounts. In general, the character of the underlying claim determines the tax treatment of the amounts paid in compensation therefor: Dumas (Endnote ¹) However, the character of the underlying claim does not attach to amounts paid to the taxpayer in respect of the taxpayers' legal costs. In general, where specific amounts are allocated between damages and costs, the cost amount is excluded. Where no allocation is made between damages and costs, the actual expenses incurred are excluded (Endnote ²).

ATR-24 sets out the CCRA's view as to the tax treatment of a payment of damages to a RRSP. Where an investment management company has caused a loss to an RRSP and damages are paid pursuant to an out-of-court settlement or court order, the amount is not brought into the annuitant's income in the year it is paid to the RRSP trust nor is it included in the calculation of the amount subject to Part X.1 tax under the Income Tax Act (the "Act").

The interpretation in ATR-24 is equally applicable to other registered deferred income plans. Thus where the damages are paid into a RRIF, the amount is neither brought into the plan member's or annuitant's income in the year the damages are paid to the registered plan nor does the payment of such an amount constitute a contribution as prohibited under paragraph 146.3(2)(f) of the Act.

In circumstances where the RRSP that suffered the losses has been converted to a RRIF, damages may be paid into the plan member's RRIF with the same tax consequences as would have resulted had the damages been paid to the original plan.

Therefore, it is our view that, to the extent that the amounts received by the spouses represent compensation for losses to the spouses' RRSPs, the amounts may be returned to the spouses' RRIFs without tax consequences to the spouses. However, if the amounts are not immediately returned to the spouses' RRIFs, the amounts would be taxable to the spouses' in the same manner that proceeds from the RRSPs would have been taxable.

It is also our view, however, that amounts received by the spouses in compensation for their legal costs may not be transferred to their RRIFs, as such amounts would not be a permitted contribution under paragraph 146.3(2)(f).

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (613) 994-2898. A copy will be sent to you for delivery to the client.

F. Lee Workman
for Director
Financial Institutions Division
Income Tax Rulings Directorate

ENDNOTES

¹ 2000 DTC 2603 (FCA).

² Ibid.