18 October 2004 External T.I. 2004-0063421E5 - Retroactive Lump-Sum Payment

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: 1.Whether the amount received under the terms of a settlement agreement to terminate a class action lawsuit is a qualifying amount under subsection 110.2 of the Act.

2. If not, could the amount be included in income in the year of the settlement agreement instead of the year the payment is received?

Position: 1. Question of fact;

2. No, the amount is taxable in the year it is received.

Reasons: To benefit from the rules in new section 110.2 of the Act, an individual must have received a "qualifying amount" during a taxation year. In addition, a "specified portion" must relate to an "eligible taxation year" during which the individual's eligibility to receive the portion existed. The payment of a retiring allowance does not necessarily satisfy these requirements. To qualify, it must represent a payment on account of or in lieu of damages paid pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding (i.e. in settlement of a lawsuit).

XXXXXXXXXX 							2004-006342
C. Lalonde
October 18, 2004

Dear XXXXXXXXXX:

Re: Statement of Qualifying Retroactive Lump-Sum Payment ("QRLSP") Form T1198(02)

This is in response to XXXXXXXXXX e-mail of February 19, 2004 requesting our views with respect to the taxation of a lump-sum payment received by a former employee (the "Employee") in 2004 in settlement of a class action suit filed against your company (the "Employer"). As we understand the situation in XXXXXXXXXX e-mail, the Employee's employment was terminated in 2002 as a result of a XXXXXXXXXX. The lawsuit was settled in 2003 but the amount of the settlement was not paid out until 2004. You have indicated that the settlement in this situation was for additional severance in respect of the individual's loss of an office or employment and qualifies as a "retiring allowance".

The Employee is requesting that the settlement be shown on Form T1198 as a QRLSP.

Alternatively, if the amount of the settlement does not qualify as a QRLSP, could he include it in his income for 2003, which is the year in which the settlement agreement was reached, instead of 2004, when the amount was paid out.

Qualifying Retroactive Lump Sum Payment

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 an advance income tax ruling request. Where the particular transactions are completed, as in this situation, the inquiry should be addressed to the relevant tax services office. However, we are prepared to provide the following general comments which may be of assistance.

Section 110.2 of the Income Tax Act ("Act") provides special rules for the taxation of certain lump sum amounts. These rules provide relief to individuals who received a QRLSP relating to prior years and whose tax liability with respect to that amount is higher than it would have been if the amount had been taxed on an on-going basis from the date of eligibility. Form T1198 is the appropriate form to use for the special tax treatment available for QRLSPs.

Section 110.2 of the Act allows an individual to deduct in computing taxable income for a taxation year, the "specified portion", in relation to an "eligible year," of a "qualifying amount" received by the individual in that year, if the total is $3,000 or more. These expressions are defined in subsection 110.2(1) of the Act. Under section 120.31 of the Act, tax will be computed on such amount deducted.

A "qualifying amount" received by an individual in a taxation year means, inter alia, "...an amount (other than the portion of the amount that can reasonably be considered to be received as, on account of, in lieu of payment of or in satisfaction of, interest) that is included in computing the individual's income for the year and is

(a) an amount

(i) that is received pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding, and

(ii) that is

(A) included in computing the individual's income from an office or employment, or

(B) received as, on account of, in lieu of payment of or in satisfaction of, damages in respect of the individual's loss of an office or employment,

(...)."

Subsection 248(1) of the Act defines "retiring allowance" to include inter alia amounts 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. Whether a particular payment is a retiring allowance is a question of fact.

The payment of a retiring allowance, in a particular scenario, would not be considered a "qualifying amount" for the purposes of section 110.2 of the Act, as described above, unless the amount is paid as, on account of, in lieu of payment of or in satisfaction of, damages in respect of the individual's loss of an office or employment. In addition, the amount must be paid pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding.

According to the situation provided, we cannot determine if the amount is received in satisfaction of or in lieu of payment of damages in respect of the individual's loss of employment or if the payment is on account of amounts payable pursuant to an employment contract or other contractual obligation. Although an amount paid in these circumstances may represent a "qualifying amount" as defined in subsection 110.2(1) of the Act, the mechanism will only apply to a "specified portion" of a "qualifying amount" received by the individual in a year.

The "specified portion" of a "qualifying amount" means the portion of the amount received that relates to an "eligible taxation year", to the extent that the individual's eligibility to receive the portion existed in the year. An "eligible taxation year" is essentially a preceding taxation year in respect of which the lump sum payment is received, as defined in subsection 110.2(1) of the Act.

Where an individual receives compensation on account of damages as a result of a loss of employment, the amount received will be taxed as a retiring allowance. This applies to both special damages, as well as general damages received for loss of self-respect, humiliation, mental anguish, hurt feelings, etc. Based on the above information provided concerning the years involved, a portion of a retiring allowance that is, in fact, a qualifying amount can be designated on Form 1198 with respect to the year 2002, when the loss of employment occurred.

You also asked whether an amount that does not qualify as a QRLSP, could be included in income for the year 2003, that is the year in which the amount became payable pursuant to the terms of the settlement agreement rather than in 2004 when the Employee received the payment. In our view, the portion of the settlement representing a retiring allowance that is not a qualifying amount must be included in income in the year received pursuant to subparagraph 56(1)(a)(ii). Similarly, the portions of the settlement representing interest or the reimbursement of legal fees incurred in establishing a right to a retiring allowance must be included in income in the year they are received pursuant to paragraphs 12(1)(c) and 56(1)(l.1), respectively.

We trust that these comments will be of assistance.

Yours truly,

Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate