11 March 1996 Income Tax Severed Letter 9605565 - Disability — lump sum

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:

An employer has established a disability insurance plan for its employees and pays the related insurance premiums. An employee who was covered by the plan became disabled; however, the insurance company declined to make any disability payments. After having commenced an action against the insurance company, the insurance company made a lump sum payment to the individual in settlement of all payments to which the individual was previously entitled.

• 1. Is the lump sum taxable under paragraph 6(1)(f) of the Income Tax Act?
• 2. Would the result be different if no action had been commenced but legal counsel had been retained by the individual?
• 3. What would the result be if a lump sum had been received in respect of all entitlements (past and future) to disability benefits.

POSITION:

With respect to 1 and 2, the benefits would be taxable under paragraph 6(1)(f) of the Act. In the case of 3., it is not possible to provide meaningful comments.

REASONS:

1 and 2 - The benefits were payable on a periodic basis (how and when the benefits were paid is not relevant)

3 - It would be necessary to review the relevant facts and documentation.

960556
XXXXXXXXXX M. Eisner

Attention: XXXXXXXXXX

March 11, 1996

Dear Sirs:

Re: Disability Coverage

This is in reply to your letter of February 1, 1996 in which you asked us for our comments on the tax consequences of a payment made to an individual in respect of disability insurance coverage.

The situation which has been set out in your letter appears to relate to an actual set of circumstances. Confirmation of the tax consequences of proposed transactions will only be provided by this Directorate in response to a request for an advance income tax ruling following a review of the relevant facts and documentation. The procedures for requesting an advance income tax ruling are set out in Information Circular 70-6R2 and the related Special Release dated September 30, 1992. On the other hand, if the transactions have already occurred, you may wish to submit the relevant information to your local Tax Services office. We are, however, prepared to provide you with the following general comments.

Our Comments

You are concerned with the type of situation where an employer has established a disability insurance plan for its employees. The employer pays the related insurance premiums. An employee who was covered by the plan became disabled; however, the insurance company declined to make any disability payments. After having commenced an action against the insurance company, the insurance company made a lump sum payment to the individual in settlement of all periodic payments which the individual was previously entitled to receive.

With respect to this situation, paragraph 6(1)(f) of the Income Tax Act (the Act) in part refers to "the aggregate of amounts received by him ... that were payable to him on a periodic basis ... pursuant to a disability insurance plan". In relation to this wording, we have referred to the decisions rendered by the Tax Court Of Canada in Peel v. MNR [] 87 DTC 268 and Marchand v. MNR [] 87 DTC 630.

In the Peel case, the taxpayer received a lump sum in settlement of his rights under the insurance contract. Since the taxpayer was unable to establish his right to the periodic payments payable under the plan to the satisfaction of the insurer, the only right the taxpayer had was the right to sue the insurer in order to establish that right. The court agreed that the payment in question was a payment in satisfaction of his rights to sue under the contract rather than as a payment in lieu of actual periodic payments which were payable to the taxpayer pursuant to the contract. Consequently, the lump sum payment to the taxpayer was considered to be non-taxable.

In the Marchand case, the taxpayer received a lump sum payment in respect of disability insurance benefits that involved the years 1982 and 1983. Pursuant to the insurance contract, the disability payments were to be made on a periodic basis under the insurance contract. The court, in concluding that the lump sum was required to be included in the taxpayer's income for 1983 indicated that the issue was how the benefits were payable rather than how and when the benefits were paid.

In our view, the circumstances of the above situation, as briefly described in your letter, are similar to those in the Marchand case with the result that the lump sum payment would be subject to tax under paragraph 6(1)(f) of the Act. It is also our view that such would be the case if no action had been commenced but legal counsel had been retained by the individual.

With respect to the situation, you have also requested our comments where the facts are changed in that a lump sum is received by the individual in respect of all entitlements (past and future) to disability benefits. In such a case, it is unfortunately not possible to provide meaningful comments without a review of all the relevant facts and documentation surrounding the settlement of the case.

We trust our comments will be of assistance to you.

Yours truly,

J.A. Szeszycki
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch