Principal Issues: Whether a settlement amount for personal legal expenses incurred to defend against criminal charges for an incident that occurred while performing employment duties is taxable?
Position: Question of Fact
Reasons: The Courts have concluded that the words "in respect of" (as noted in 6(1)(a)) are words of the widest possible scope and CRA has taken the position that there need only be a small connection between a benefit and the employment in order to trigger the operation of paragraph 6(1)(a). Generally, where an employer makes a payment to an employee or former employee for a personal expense, it is taxable under paragraph 6(1)(a).
XXXXXXXXXX 2010-039144 P. Waugh
April 11, 2011
Dear XXXXXXXXXX :
Re: Settlement - Legal Fee Reimbursement
I am writing in response to your letter of December 23, 2010 concerning the tax treatment of a settlement payment between an individual and his employer. More specifically, you have enquired whether the portion of the settlement payment relating to the reimbursement of personal legal fees incurred to defend against criminal charges is considered taxable income.
In the situation you described, XXXXXXXXXX . As a result of this incident, the individual was terminated and separate criminal charges were filed against him. The individual filed a grievance relating to his termination which was settled on XXXXXXXXXX . A settlement payment was received in exchange for his withdrawal of the grievance. Part of the settlement was allocated to cover his legal expenses incurred to defend against the criminal charges. The employer's collective agreement provides for the payment of legal fees where criminal action is taken against an employee related to the employee's actions while carrying out his/her normal work duties.
Our Comments
Written confirmation of the tax implications inherent in particular transactions may only be provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at http://www.cra-arc.gc.ca. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to provide the following general comments.
Subject to certain listed exceptions, paragraph 6(1)(a) of the Income Tax Act (the "Act") requires that the value of any benefits received or enjoyed by a taxpayer in the year in respect of, in the course of, or by virtue of an office or employment be included in the taxpayer's income from employment. It is well established that the phrase "in respect of, in the course of, or by virtue of an office or employment" means that there need only be a small connection between a benefit and the employment in order to trigger the operation of paragraph 6(1)(a).
Generally, legal fees incurred by an individual to defend against criminal charges are personal expenses. As indicated in paragraph 32 of IT-99R5 (Consolidated) - Legal and Accounting Fees, where personal legal fees of an employee are paid or reimbursed by the employer, the amount paid is a taxable benefit to the employee. Whether the legal fees reimbursed by an employer to an employee are the employee's personal expense is a question of fact that can only be determined after a complete review of the facts, circumstances, and relevant documents in the situation. Without the opportunity to examine the settlement agreement that was reached between the individual and his employer and based on the limited information provided, we are not in a position to make such a determination in the situation you described.
Any payment made to an employee or former employee that is taxable under section 5 or 6 of the Act is required to be reported on a T4 slip. For further information, please refer to CRA Guide RC4120, Filing the T4 Slip and Summary - Employers' Guide.
We trust these comments will be of assistance.
Yours truly,
Guy Goulet CA, M.Fisc.
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch