Revenue Canada Clarifies Budget Proposal on Treatment of Retroactive Lump-Sum Payments.
For individuals resident in Canada, income from many sources is taxable in the year in which it is received. This generally applies to employment and pension income, arbitration awards, and to spousal and taxable child support payments. As a result, individuals are generally taxable on retroactive lump-sum payments in the year they are received, even though a significant portion may relate to prior years.
A Canadian individual's tax liability on retroactive lump-sum payments may be higher than it would have been if payments had been made, and taxes, year-by-year as the income arose. This is due to the progressivity of the Canadian individual income tax system.
To remove any inequity, the February 1999 federal budget proposed that individuals receiving qualifying retroactive lump-sum payments be allowed to use a special mechanism to compute the tax on those payments. These taxpayers are to be able to request that Revenue Canada determine if the special mechanism is advantageous to them for qualifying retroactive lump-sum payments received after 1994.
In order to clarify how this budget proposal will operate in practice, Revenue Canada has issued a series of questions and answers that are reproduced below:
Q1. What is a "qualifying retroactive lump-sum payment" as announced in the February 16, 1999 budget?
A1. A qualifying retroactive lump-sum payment is the portion of a lump-sum payment received that relates to principal that is attributed to one or more years preceding the year of payment. For greater certainty, it does not include any interest element or the portion of the principal that is attributed to the year in which the amount was received.
Q2. In order to be eligible for the special tax calculation, how much of a qualifying retroactive lump-sum payment must have been received in the year and when must the lump-sum payment have been received?
A2. The qualifying retroactive lump-sum payment (see A1) must be at least $3,000 and must have been received in any year after 1994 to be eligible for the special tax calculation.
Q3. What types of retroactive lump-sum payments qualify for the special tax calculation?
A3. The types of retroactive lump-sum payments that qualify for the special tax calculation are:
- Periodic superannuation or pension benefits
- Employment insurance benefits
- Spousal or child support payments
- Employment income payments if they are received under a court judgement, an agreement to terminate a lawsuit, or under an arbitration award (other than as a result of arbitration under normal collective bargaining).
Q4. Is an individual who receives more than one type of qualifying retroactive lump-sum payment still eligible for the special tax collection, even though each such payment is less than $3,000?
A4. Yes, if an individual receives more than one type of qualifying retroactive lump-sum payment in a year, the individual is eligible for the special tax calculation as long as the sum of the payments that relates to one or more preceding years is at least $3,000.
For example, if in 1999, an individual receives a lump-sum employment insurance payment of $2,500, of which $900 relates to a preceding year or years, and an eligible lump-sum employment income payment of $6,000, of which $2,100 relates to a preceding year or years, the individual is eligible for the special tax calculation.
Q5. If a lump-sum payment includes an interest element, is any part of the interest eligible for the special tax calculation?
A5. No. The interest element of any lump-sum payment has to be fully included in income for the year in which it is received. It is only the prior year portion of the principal part of a lump-sum payment that is eligible for the special tax calculation.
Q6. What information does a payor of a qualifying retroactive lump-sum payment have to provide to the recipient of the payment?
A6. The payor has to provide the following information in writing to the recipient of the payment:
- The year in which the qualifying payment was made to the recipient
- A complete description of the qualifying payment and the circumstances that required it to be paid;
- The total amount of the qualifying payment, including a breakdown between the principal and the interest element, if any, of the payment;
- The principal amount of the payment that relates to the current and each of the preceding years covered by the payment. For example, if the retroactive part of the principal amount applies to four preceding years, a breakdown of the principal amount that relates to each of those four preceding years has to be provided.
Q7. How does an individual who has received a qualifying retroactive lump-sum payment in any of the years 1995 to 1998 request the special tax calculation to be applied?
A7. For the 1995 to 1997 years, an individual who wants the special tax calculation to be applied has to send a written request to the tax centre that processes the individual's 1998 income tax return. The written request has to include the information from the payor as set out in A6 above.
For the 1998 year, an individual also has to request the special tax calculation in writing, including all of the information as indicated above. However, the request has to be sent separate from the filing of the 1998 return but should be sent to the tax centre that processed the return.
The 1998 return has to fully include the lump-sum payment in income. The determination as to whether the special tax calculation is beneficial will be made at a later date and, if the calculation is beneficial a reassessment will be done.
Q8. When will the review of requests for the years 1995 to 1998 start?
A8. Revenue Canada's computer systems cannot process these special tax calculations until such time as the necessary systems changes are made. Although these changes have been given a priority, Revenue Canada does not expect to start reviewing requests until February 2000. Individuals can be assured, though, that Revenue Canada is working towards having the required systems changes in place as soon as possible.
Q9. When the review starts, will an individual be advised in writing if the special tax calculation is not beneficial?
A9. Yes. Each individual for whom it is determined that the special tax calculation is not beneficial will be advised in writing.
Q10. Will the special tax calculation for preceding years affect deduction and credits that were claimed for preceding years?
A10. No. There will be no changes to any deduction or credit that was claimed for a preceding year. Similarly, no change will occur to any income-tested benefit such as the Goods and Services Tax Credit that was paid to an individual in a preceding year.
Q11. Will the special tax calculation be available for a qualifying lump-sum payment received by the estate of a deceased individual?
A11. Yes. As long as the qualifying lump-sum payment is reported on the final return of the deceased, the special tax calculation will be available. However, due to the nature of the calculation, it will not be available for payments reported either on a trust return or on a "rights or things" elective return.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
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