We are writing in reply to your letter of March 19, 1991, wherein requested clarification of our position regarding the income tax implications for amounts paid by an employer to a former employee in respect of legal fees incurred by the employee in pursuing an action for wrongful dismissal. In this regard, you specifically requested confirmation of this Department's previously stated administration position.
Our Comments
The Department's previous administrative position, which permitted such amounts to be excluded from income, has been replaced by amendment to the Income Tax Act (the Act) with the enactment, on October 23, 1990, of paragraphs 56(1)(1.1) and 60(o.1) of the Act applicable to the 1986 and subsequent taxation years.
Paragraph 56(1)(1.1) of the Act requires a taxpayer to include in computing income amounts received as an award or reimbursement of legal expenses paid to collect or establish a right to a retiring allowance or benefits under a pension fund or plan in respect of employment. This inclusion arises only to the extent that the legal expenses to which it relates are deductible under paragraph 60(o.1) of the Act.
Paragraph 60(o.1) of the Act provides for the deductibility of eligible legal expenses paid after 1985 to collect or establish a right to a retiring allowance or pension benefits. Eligible legal expenses do not include legal expenses relating to a division or settlement of property arising from marriage or other conjugal relationships or to CPP or QPP benefits. In the case of the CPP and QPP, a deduction for legal expenses is provided under paragraph 60(o) of the Act.
Eligible legal expenses may be deducted in a taxation year to the extent they do not exceed retiring allowances or pension benefits to which such expenses relate. The non-deductible portion of such expenses may be carried forward and deducted in any of the seven subsequent taxation years, to the extent further related income arises.
The income against which eligible expenses may be deducted may, however, be reduced by virtue of a transfer to a registered retirement savings plan or registered pension plan under paragraph 60(j) or (j.1) of the Act. Where an employee has effectively transferred all or a portion of the retiring allowance or pension benefits on a tax-free basis under either of those paragraphs, the income against which related legal expenses may be deductible is correspondingly reduced.
Although there is a requirement to withhold tax under paragraph 153(1)(c) of the Act, you may wish to contact the Source Deductions Section of the appropriate District Taxation Office in order to obtain a waiver from such withholding.
We trust that these comments are of assistance to you.
Yours truly,
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch