Principal Issues: Whether settlement payments made by a farmer for property damage and personal injury suffered in connection with a tractor-vehicle collision are deductible from business income. Whether the related legal fees incurred in the payment of the settlement are deductible from business income.
Position: Question of fact.
Reasons: The income tax treatment of settlements can be conclusively determined in any particular case only after an examination of all the relevant facts. Reasonable legal fees incurred in the payment of damages will be deductible if the damages themselves are deductible.
XXXXXXXXXX 2008-028080 Saskia deLang-Lenters November 26, 2008
Dear XXXXXXXXXX :
Re: Settlement for damages and related legal fees
This is in response to your correspondence received on June 5, 2008. You asked for our comments regarding whether a settlement payment made by a farmer for property damage and personal injury suffered in connection with a tractor-vehicle collision is a deductible business expense. You further asked for our comments regarding whether the related legal fees incurred by the farmer is also a deductible business expense.
The particular situation outlined in your letter relates to factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on completed transactions involving specific taxpayers. You should submit all the relevant facts and documentation to the appropriate tax services office for their views. We are prepared, however, to provide the following general comments, which may be of assistance.
Our Comments
Paragraph 5 of Interpretation Bulletin IT-467R2, "Damages, Settlements and Similar Payments", which can be found on our website at www.cra-arc.gc.ca, outlines the requirements for the deductibility of damages, settlements and similar payments. It states that such payments are deductible from business income, if they meet the following tests:
(a) they must be made for the purpose of gaining or producing income from the business,
(b) they must not be made on account of capital,
(c) they must not be made for the purpose of gaining exempt income
(d) they must not be personal in nature, and
(e) they must be reasonable in the circumstances.
The Interpretation Bulletin IT-467R2 further states, in part, that "for purposes of establishing whether damages have been incurred for the purpose of gaining or producing income:
- the taxpayer need not have attempted to prevent the act or omission that resulted in the damages; and
- the taxpayer need only establish that there was an income earning purpose for the act or omission, regardless of whether that purpose was actually achieved."
The fact that the farmer was "conducting business" when the accident occurred does not mean, in and of itself, that the settlement was incurred for the purpose of gaining or producing income. Such a determination can only be made after a review of all of the surrounding facts and circumstances in each particular case. This review would be carried out by audit officials in the local tax services office and would include a review of the all relevant documents and agreements between the parties.
The legal fees incurred in the payment of damages will be deductible if the damages themselves are deductible and the fees are reasonable. If based on the facts the settlement for damages is determined to be a deductible business expense, then reasonable related legal fees would likely also be deductible.
We trust these comments will be of assistance.
Yours truly,
Nerill Thomas-Wilkinson
Acting Manager
for Acting Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch