10 July 2006 External T.I. 2005-0153051E5 F - Somme forfaitaire - régime de pension agréé -- translation

Principal Issues: [TaxInterpretations translation] (1) Is the lump sum received by an estate as interest resulting from the settlement of a class action taxable to the estate?

(2) Are the amounts received as reimbursement of "pension" paid into the pension fund taxable to the estate?

Position: Section 110.2 of the Income Tax Act does not apply to the lump sum in this case because it relates to the surplus accumulated in the pension plan. That amount - consisting of interest and principal - will have to be included in the trust's income for the year in which it is received.

Reasons: The Income Tax Act.

XXXXXXXXXX 2005-015305

July 10, 2006

Dear Madam,

Subject: Request for Technical Interpretation - Lump sum payment under a defined benefit registered pension plan__________________

This is further to your letter dated October 3, 2005, in which you requested a technical interpretation on the taxation of a lump sum payment to the estate of a member of a defined benefit registered pension plan following the settlement of a dispute. We apologize for the delay in responding to your question.

Relevant Facts

Your request for a technical interpretation is based on the following facts:

1. The taxpayer - XXXXXXXXXX - died in XXXXXXXXXX;
2. Prior to such death, the taxpayer had been employed by XXXXXXXXXX (the "corporation") but was subsequently dismissed;
3. The Corporation had established a defined benefit registered pension plan (the "pension plan") for the benefit of its employees, of which it was the sponsor and administrator;
4. Under the pension plan, employees and the employer were required to make contributions to the plan to fund pension benefits for employees;
5. Since the mid-XXXXXXXXXXs, the Pension Plan had accumulated a significant actuarial surplus;
6. The pension plan provided that the only members of the pension plan were those employees of the corporation who were members of the pension plan on XXXXXXXXXX;
7. In XXXXXXXXXX acquired the corporation and allowed employees, who were not members of the plan on XXXXXXXXXX, to be pensioners under the plan;
8. The original pension plan documents required that the accumulated funds be used solely for the benefit of the plan's pensioners and that, upon termination of the plan, the funds therein be returned to the pensioners;
9. Through amendments to the pension plan, XXXXXXXXXX implemented the following changes:

• As of XXXXXXXXXX, the reduction in benefit entitlement under the plan to XXXXXXXXXX% (from XXXXXXXXXX%) for each year of service;
• From XXXXXXXXXX, the employer contributions were funded from the pension plan surplus;
• As of XXXXXXXXXX, the withdrawal of pension surplus by XXXXXXXXXX for any purpose;
• In XXXXXXXXXX - as a result of the above amendments - several members of the plan instituted a class action against XXXXXXXXXX;

10. The class action resulted in an out-of-court settlement providing as follows:

• Increasing the benefits paid to pensioners in the plan;
• The payment of a retroactive lump sum;
• A retroactive lump sum payment based on a percentage of the plan's liabilities as of XXXXXXXXXX;
• A retroactive lump sum payment for members who were not contributing to the plan;
• The payment of a top-up amount so that each member of the plan received a minimum of $XXXXXXXXXX;

As a result of the amicably negotiated agreement - and according to what you told us on the phone (Bordeleau/XXXXXX) - the estate of XXXXXXXXXX received a lump sum in XXXXXXXXXX based on a percentage of the plan's liabilities as of XXXXXXXXXX (see point 3 above).

Questions

In your letter you asked the following two questions relating to the application of section 110.2:

1. Was the lump sum received by the estate as interest as a result of the settlement in favour of the pension fund class action claimants taxable to the estate?

2. Are amounts received as reimbursement of "pensions" paid into the pension fund taxable to the estate?

Analysis

As you have previously acknowledged, your letter of October 3, 2005, contained a limited number of facts surrounding the payment made by XXXXXXXXXX.

Section 110.2 allows for the averaging of certain lump sums received by an individual in a particular taxation year. Generally, taxpayers must include in their income any amount received in a year, including any lump sum. Because of the progressive nature of the Canadian tax system, the inclusion of a lump sum in a taxpayer's income may result in a higher marginal tax rate than if the payments are included in income as they become payable.

Section 110.2 is intended to remedy this situation by allowing individuals to pay tax on the lump sum as if the amount had been progressively included in their income. Section 110.2 applies to a "qualifying amount", defined as follows:

• Income from an office or employment received under the terms of an order or judgment of a competent tribunal, an arbitration award, or an agreement to terminate a legal proceeding (including amounts received as damages);
• Unemployment insurance or employment insurance benefits;
• Retirement or pension benefits (excluding non-periodic benefits such as lump sum withdrawals);
• Child, spousal or common-law partner support;
• Wage loss replacement benefits¹.

In this case, the lump sum payment was made by XXXXXXXXXX under the pension plan, which is a registered defined benefit pension plan. Where such benefits are received by an individual - a term including a trust - they must generally be included in the individual's income under subparagraph 56(1)(a)(i) as superannuation or pension benefits.

A "pension benefit" includes amounts received under a pension fund or plan in accordance with the terms of the fund or plan, as a result of an amendment to the fund or plan or as a result of the winding up of the fund or plan².

In examining the amounts that fall within the definition of a "qualifying amount" in subsection 110.2(1), we are of the view that the lump sum amount received by the trust in this case cannot be a "qualifying amount". Indeed, while paragraph 110.2(1)(b) of that definition appears to be applicable on its face (since the amount received by the estate of XXXXXXXXXX appears to be a superannuation or pension benefit), that provision indicates that such benefits must be received on account of, in lieu of payment of or in satisfaction of, a series of periodic payments (other than payments that would have otherwise been made in the year or in a subsequent taxation year).

In this case, and in light of the facts you have communicated to us XXXXXXXXXX, we are of the view that the lump sum payment received by the estate of XXXXXXXXXX is not in respect of a series of periodic payments that should have been made in previous years but rather in respect of the surplus accumulated in the registered pension plan. We refer you to Interpretation 2000-0000165, which is in support.

Notwithstanding the definition of "qualifying amount", there appears to be another reason why section 110.2 is inapplicable in this case. The scheme of that section requires a taxpayer to retroactively add back the "specified portion" of an eligible amount relating to a previous taxation year. Note that the term "specified portion" is defined as the portion of the qualifying amount that relates to the year, to the extent that the individual’s eligibility to receive the portion existed in the year. In this case, the taxpayer was not entitled - in years prior to the year of receipt of the pension plan surplus - to receive any amount in respect of the surplus.

The settlement between the members of the pension plan and XXXXXXXXXX entitles the estate of XXXXXXXXXX to receive a portion of the actuarial surplus, calculated as at XXXXXXXXXX, plus an amount for interest accrued to XXXXXXXXXX. You argue that section 110.2 should apply to the amount received by the estate since it relates to an amount that the late taxpayer was entitled to receive for prior years. We disagree with that position. Indeed, if the lump sum had been paid to the late XXXXXXXXXX in XXXXXXXXXX, the said amount could not have been subject to averaging (assuming for the moment that section 110.2 would have been in force at that time) as the amount would not have been received as or in full or partial payment of a series of periodic payments. By receiving the lump sum in XXXXXXXXXX instead of XXXXXXXXXX, the estate of XXXXXXXXXX is entitled to receive an amount on account of accrued interest. Section 110.2 is clear that it does not apply to the part of a lump sum that relates to interest.

Conclusion

Based on our comments above and the facts you have provided, we are of the view that the lump sum received by the trust in the XXXXXXXXXX taxation year does not qualify for favourable treatment under section 110.2. Consequently, the trust will be required to include the entire lump sum in its income for the XXXXXXXXXX year under subparagraph 56(1)(a)(i).

Best regards,

François D. Bordeleau, LL.B.

Individuals, Business and Partnerships Section
Income Tax Rulings Directorate

ENDNOTES

¹ See the definition of "qualifying amount" in subsection 110.2(1) and Guide T1198, Statement of Qualifying Retroactive Lump Sum Payment.

² See the definition of "superannuation or pension benefit" in subsection 248(1).