Dear Sirs:
Re: Taxation of Compensation Payments
This is in reply to your letter of October 11, 1991 wherein you requested clarification with respect to the taxation of compensation payments. In particular you presented the following situation and questioned how the resulting payments would be taxed.
Facts
24(1)
Our Comments
As the above scenario is an actual situation it should be the subject of an advance income tax ruling requested according to Information Circular 70-6R2 (a copy of which is enclosed). We are, however prepared to offer the following comments:
a) Interpretation Bulletin IT-202R2, Employees' or Workers' Compensation (copy enclosed), states that compensation "refers to the amount of an award, as adjudicated by a compensation board, which a worker or his or her dependants will receive as a result of the worker having suffered illness, injury, or death" in performing his or her employment duties. In our opinion, payments received from third parties would not be excluded from the meaning of the word compensation. However, the taxability of annuity payments depends largely on the arrangements and structure of the annuity.
b) Where the capital element of the annuity vests indefeasibly in the beneficiary at the time of purchase, then the individual would be considered to have constructive receipt of the amounts paid by the former employer to purchase the annuity. Although the individual would continue to receive his monthly annuity he would be deemed in effect to have received a settlement payment. The lump sum would be included in the former employee's income under paragraph 56(1)(v) of the Act, however, he would be entitled to a deduction for the entire amount under paragraph 110(1)(f) of the Act. The problem here is that the monthly annuity payments will be included in his income under paragraph 56(1)(d) of the Act. From this income he may then deduct the capital element of these annuity payments pursuant to paragraph 60(a) of the Act, thereby being taxed on the interest element of the annuity payment. Although the individual may receive the same monthly payment as he received before the annuity was purchased, he will be taxed on the interest element of the annuity.
Retaining the tax free status of compensation payments may be difficult if an annuity is purchased to fund these payments under which the employee is either owner or annuitant. There may, however, be other ways to arrange payment to avoid such difficulties. Funding alternatives, however are legal matters and should be discussed with your legal counsel. You may wish to raise the possibility of using the services of the Provincial Public Trust with your legal advisors. These comments represent our general views with respect to the subject matter of your letter. The facts of a particular situation may lead to different conclusions. The foregoing opinions are not rulings and, in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990, are not binding on the Department.
Yours truly,
G. Thornley for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch