2015-0564671E5 Damages payment from an insurer

Principal Issues: Whether an amount received from an insurer as damages is taxable?

Position: In this particular situation, likely not.

Reasons: Jurisprudence.

Author: Danis, Sylvie
Section: 148(1)

XXXXXXXXXX
                                                                                                                                                     2015-056467
                                                                                                                                                     Sylvie Danis

April 22, 2015

Dear XXXXXXXXXX:

Re:  Damages payment from an insurer

This is in response to your facsimile received January 12, 2015 and subsequent discussions (XXXXXXXXXX/Danis) wherein you requested a review of the tax treatment of a payment to be made by your insurer.  In particular, you asked us whether a settlement payment to be made by your insurer for damages would be subject to tax.

In the situation you describe, your insurer has agreed to pay you a sum of $XXXXXXXXXX as settlement for the damages you incurred resulting from your life insurance policy losing its exempt status without your knowledge and the loss of value to the policy. The settlement offer is the result of ongoing discussions you have had with your insurer. Both you and your insurer believe this payment for damages should not be taxable.

This technical interpretation provides general comments about the provisions of the Income Tax Act (the Act) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Generally, an amount is taxable under the Act if it constitutes income from a source or if a specific provision of the Act applies to the type of payment. In the case of settlement payments, the underlying claim determines the tax treatment of amounts paid in settlement of the claim. A payment in settlement of a damages claim to avoid or terminate litigation may generally be accorded similar treatment for tax purposes as damages awarded in a judicial ruling, even though there may be no admission of wrongdoing. In reviewing the tax consequences of a settlement, the essential question is to determine what the settlement was intended to replace. A settlement payment will be treated as ordinary income and taxable, if it compensates for the loss of an amount that would have been income, be it from business, property, or employment sources. A settlement payment received as compensation for loss of, or damage to, a capital asset, will generally be considered on account of capital and taxable as proceeds of disposition from property. 

Paragraph 2 of Interpretation Bulletin IT-365R2, Damages, settlements and similar receipts provides that a settlement payment, or a portion thereof, may also represent damages in respect of personal injury (including general damages for pain and suffering), in which case it or a portion thereof would be exempt from tax, regardless of the fact that the amount of such damages may have been determined with reference to the loss of earnings. 

As noted above, the taxation of settlement payments is generally based on the nature and purpose of the settlement payment, which is a question of fact. In most cases, the parties to the settlement agreement are in the best position to make this determination. Based on our understanding of the facts provided, it appears that the payment from the insurer is intended to compensate you for stress and anxiety endured over time as a result of your policy losing its exempt status without your knowledge.  If this is the case, the payment would be considered damages for personal injury and not taxable. However, if any part of the settlement payment is intended to compensate for income which would otherwise be taxable, that part must be included in computing income for tax purposes.

We trust the above comments are of assistance.

Yours truly,

Jenie Leigh
for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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