27 August 2010 External T.I. 2010-0377131E5 - Estate Lawsuit 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.

Principal Issues: 1. Is the settlement taxable to the Estate? 2. If yes, is the amount taxable as a capital gain or income? 3. Are the legal fees deductible to the Estate?

Position: 1. The funds awarded should be included in income. 2. Assuming the shares were held on capital account, the award is a taxable capital gain to the Estate. 3. Question of fact, but likely yes.

Reasons: The settlement or award is considered "compensation for property injuriously affected" and would give rise to a capital gain by virtue of paragraph (e) of the definition of "proceeds of disposition" in section 54 of the Act. Assuming that there were no other issues to which the settlement pertained that might require some form of apportionment, we would consider the legal fees in this fact situation as essential to the receipt of the proceeds of disposition and therefore deductible in computing the gain by virtue of subparagraph 40(1)(a)(i) of the Act.

XXXXXXXXXX
									2010-037713
									T. Posadovsky, CMA
	 								(613) 952-8283
August 27, 2010

Dear XXXXXXXXXX :

Re: Estate Lawsuit Settlement.

We are writing in response to your letter of July 13, 2010, in which you requested our opinion on the income tax consequences in respect of proceeds received from a lawsuit settlement.

According to your letter, a testamentary trust (the "Estate") alleged that delays caused by the Estate's financial advisor and lawyer resulted in disposing of equity shares after a precipitous drop in the share price. The settlement was compensation for the loss in share price because of the delays. You wish to know whether the settlement amount is taxable to the Estate. If yes, is the amount taxable as a capital gain or income? You also wish to know if any legal fees incurred in respect of the lawsuit would be deductible against the settlement proceeds.

Written confirmation of the tax implications inherent in a particular transaction is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. As the circumstances outlined in your letter relate to a specific situation involving a particular taxpayer, your inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following general comments.

Our Comments

The tax treatment of any compensation to the Estate as a consequence of the lawsuit you described, or a settlement thereof, is a question of fact which would require a review of all relevant facts and documentation including the statement of claims, relevant correspondence between the parties and the settlement agreement/court order. Our comments that follow assume the shares were held on capital account and properly accounted for upon transfer from the deceased to the Estate. We also assume that the settlement payment was in respect of the loss of shares only and did not represent an award of interest or other damages.

Section 38 of the Income Tax Act (the "Act") determines a taxpayer's taxable capital gain and allowable capital loss in a taxation year (currently 50% of the taxpayer's capital gain or capital loss from the disposition of property). Paragraph 39(1)(a) states that for the purposes of the Act, a taxpayer's capital gain for a taxation year from the disposition of property is the taxpayer's gain for the year from the disposition of the property. Paragraph 40(1)(a) of the Act provides that a taxpayer's gain for a taxation year from the disposition of property is the amount, if any, by which the taxpayer's "proceeds of disposition" exceed the total of the "adjusted cost base" (the "ACB") to the taxpayer of the property immediately before the disposition and any outlays and expenses incurred by the taxpayer for the purpose of making the disposition.

In our view, the award from the lawsuit settlement will give rise to a capital gain as it is considered "compensation for property injuriously affected", by virtue of paragraph (e) of the definition of "proceeds of disposition" in section 54 of the Act. This treatment is consistent with the information provided in Income Tax - Technical News No. 39, Settlement of a Shareholder Class Action Suit - Compensation by Way of Cash and Shares, dated December 4, 2008. The ACB in respect to the proceeds of disposition would be nil since you have indicated that all of the shares were previously sold. As the legal fees appear to have been essential to the receipt of the proceeds of disposition, they would be deductible in computing the capital gain or loss under subparagraph 40(1)(a)(i) of the Act. This is assuming that there were no other issues to which the settlement pertained that might require apportionment, such as an award of interest or other damages. Please note that a current year's taxable capital gain can be reduced or eliminated by any unclaimed net capital losses that the Estate may have available.

For more information, please refer to Income Tax - Technical News No. 39 Settlement of a Shareholder Class Action Suit - Compensation by Way of Cash and Shares, guide T4037 Capital Gains, and Interpretation Bulletin IT-99R5 Legal and Accounting Fees, all of which are available on our website at http://www.cra-arc.gc.ca.

We hope that our comments will be of assistance.

Yours truly,

Randy Hewlett
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch