5-8150
G. Ozols
19(1) Tel (613) 957-2127AUG 10 1989
Dear Sir:
Re: Damages in Respect of Residential Property
This is in reply to your letter of May, 1989 inquiring as to the tax treatment under the Income Tax Act (the "Act") of certain damages claimed by the taxpayer in a lawsuit.
As we understand it, the taxpayer (the purchaser) entered into an agreement for the purchase and sale of a residential home which he intended to occupy as his principal residence.
The vendor repudiated the agreement after it was executed. The taxpayer commenced an action, claiming damages equal to the increase in the value of the property from the time of the agreement to the time the taxpayer accepted the repudiation. You wish to know whether the damages, if awarded, will be taxable, and if taxable as a capital gain, whether the principal residence exemption is available.
The characterization of damages received as either taxable or non-taxable is a question of fact to be determined after a review of all of the relevant circumstances in each case.
Without knowing more about the basis of the claim and without a Judgement having been rendered, we cannot say with any certainty whether or not the damages would be taxable and on what basis.
However, we can provide you with the following general comments.
Damages can be received either on account of income or on account of capital. Interpretation Bulletin IT-365R2 , in paragraphs 8 and 9, discusses the distinction between an income receipt and a capital receipt in the context of non-performance of business contracts. Paragraph 10 of IT-365R2 discusses compensation for loss of business income or business property.
Although the situation you have described apparently does not involve a commercial transaction, the principle is the same i.e., if the compensation is received for the failure to receive a sum of money that would have been an income item if it had been received, the compensation will likely be an income receipt.
If it is a capital and not an income receipt, the damages may or may not be taxable. A tax liability will exist when the damages can be considered to be a capital gain. A capital gain (or loss) will arise where the damages are awarded for the sale, loss or abandonment of the plaintiff`s capital property as a result of the defendant's actions and which are considered to be proceeds of disposition. Paragraphs 54(c) and (h) of the Act describe some of the events and types of transactions which will give rise to a "disposition" and "proceeds of disposition" respectively. This can include any transaction or event which settles a debt or other right of a taxpayer to receive an amount. Where the damages do not relate to a specific asset, they may be characterized as an "eligible capital amount" for the purposes of subsection 14(1) and subparagraph 14(5)(a)(iv) of the Act and may result in a tax liability. Where the property in question qualifies as a principal residence, any capital gain from its disposition is reduced to the extent permitted by paragraph 40(2)(b) or (c) of the Act. A property will qualify as a principal residence in a particular year if it is:
(a) a housing unit, a leasehold interest in a housing unit or a share of the capital stock of a cooperative housing corporation,
(b) owned by the taxpayer solely or Jointly with another person,
and
(c) ordinarily inhabited in the year by the taxpayer, his spouse or former spouse or any of his children provided it otherwise qualifies under paragraph 54(g) of the Act.
There are some exceptions to requirement (c) provided for in the Act, but they would not appear to apply in the situation you describe. Since the taxpayer never acquired the property which was the subject of the agreement of purchase and sale, the rules in the Act pertaining to a principal residence would not apply to exempt from tax the amount of damages received by the taxpayer in the circumstances.
We trust the above is of assistance to you.
for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental
Affairs Branch