Tax Court Releases Precedent Setting Decision on Taxability of Certain Benefit Claims in Nortel Insolvency Proceeding
December 21, 2017
On November 11, 2017, the Tax Court of Canada released Scott v. The Queen, 2017 TCC 224 (CanLII), a precedent setting decision regarding the taxation of payments made in relation to the termination of employment benefits in the context of the Nortel insolvency. The Tax Court “overruled”, in part, an Advanced Tax Ruling issued by the Canada Revenue Agency (“CRA”) relating to lump-sum payments made to former employees in respect of the termination of life insurance benefits. The Court confirmed the CRA’s Ruling with respect to the taxation of payments made for the termination of survivor income benefits. The time in which to appeal these decisions has now passed, with no parties appealing the decision.
The four cases before the Court served as test cases for four different groups of former Nortel employees and beneficiaries who received distributions from the underfunded health and welfare trust (the “HWT”) established by Nortel to provide various employment benefits. The payments at issue in the appeals related to the termination of life insurance coverage and monthly survivor income benefits. Koskie Minsky, serving as Representative Counsel to the pensioners, former employees and long-term disability beneficiaries of Nortel brought the test cases on behalf of approximately 10,000 former Nortel employees and beneficiaries.
The payments were made pursuant to a settlement agreement – approved by the Ontario Court in the insolvency proceeding – in order to compensate for the loss of life insurance coverage and monthly survivor income benefits. The CRA ruled that all of these payments were taxable. Koskie Minsky sought to challenge the CRA Ruling, primarily based on the principle affirmed by the SCC in Tsiaprailis, that a payment in settlement of a right to receive future benefits is in the nature of a capital payment and not taxable as income under the ITA. As capital payments, tax should only be payable if the beneficiaries earned a capital gain.
Notwithstanding Tsiaprailis and other SCC decisions on which Tsiaprailis relied, the Tax Court held that it was not aware of any authority that would suggest that capital payments are not taxable.
However, the Tax Court held that the lump-sum payments to the former employees whose lives were insured under a group term life insurance policy were not taxable because they did not fall within the scope of subsection 6(4), which imposes tax on life insurance premiums for any time in the tax year when “a taxpayer’s life is insured under a group life insurance policy”. The Tax Court also rejected the Crown’s alternative argument that the payments should be taxed under section 6(1)(a), the catchall provision imposing tax on employment income and benefits. However, the Court confirmed the CRA Ruling with respect to the survivor income benefits, which were taxable as death benefits prior to their termination. The section of the ITA which taxes death benefits is worded much more broadly, and includes in taxation “any amount received . . . on account or in lieu of payment of, or in satisfaction of, . . . a death benefit.” The Court concluded that the language was broad enough to capture any payment in replacement of future survivor income benefits, even if the payment is properly characterized as a capital payment.
As none of the parties are appealing, the way is now clear for thousands of former Nortel employees to recover amounts that were improperly deducted from their claim amounts.
Pension and Benefits