What are Tax Windfalls?
Windfalls are various categories of unexpected monetary gain such as lottery winnings, inheritances, and gifts. Canada's income tax system is based on the "source doctrine", which means that to be taxable, income has to come from one or more of the following categories.
- Capital gains
Since windfalls don't fall into any one of the following categories, they are not considered as "income" under the Canadian Income Tax Act and as such are not taxable.
Early Cases on Windfalls
One early case of windfalls differentiated gifts from taxable income in Federal Farms Limited v MNR (1959 CTC 98). The taxpayer, in this case, was a farmer who had received voluntary payments from a charitable hurricane relief fund. Even though the taxpayer had no legal entitlement to these funds, the CRA argued that the charitable funds had effectively substituted the farmer's usual revenue and therefore should count as income. The court rejected this argument based on several factors. First, the farmer had no legal right or practical expectation to the payments from the relief. There was no contract between the farmer and the donors. The money received was a voluntary gift that was received without anything given in return. Finally, such payments were unlikely to happen again.
From here we can see the court work out some of the main factors that distinguish windfalls from taxable income. Income as contemplated by Canada's income tax act is often related to an enforceable claim as it relates to a salary or some other contractually enforceable business relationship. Employment or business income often have a foreseeable element of recurrence and expectation. A windfall, by comparison, tends to be thought of as an unexpected, unpursued gift of money or valuables that is unlikely to be repeated.
Another early case that distinguishes taxable income from prizes or awards was the case of Abraham v MNR (1960 ABC 133) where the taxpayer from Ottawa won a car as a prize from a ticket draw. Because the taxpayer opted to accept cash sum instead, the CRA went after him, claiming that his prize was taxable income. But again, the court sided with the taxpayer, ruling that the prize had been a windfall due to the nature of the winnings as a result of chance rather than remuneration.
Of course, there are also plenty of cases in which certain earnings can be tied to chance and yet are still characterized as income for the purposes of taxation. In the past, tax law has had to distinguish the earnings of professional gamblers, athletes and stock traders from windfalls. After all, the earnings of the aforementioned individuals often have an element of skill tied to the earnings and a clear expectation of profit.
Characteristics of Windfalls
Over the years, numerous cases regarding windfalls have developed a general set of factors to indicate whether or not a particular receipt is a Windfall. The Canada Revenue Agency's own interpretation folio lists the following factors to be indicative of a Windfall.
- Taxpayer has no enforceable claim to the payment
- No organized effort on the part of the taxpayer to receive payment
- The payment was not sought after or solicited by the taxpayer in any manner
- The payment was not expected by the taxpayer, either specifically or customarily
- The payment had no foreseeable element of recurrence;
- The payor was not a customary source of income to the taxpayer
- The payment was not in consideration for or in recognition of property, services or anything else provided or to be provided by the taxpayer; it was not earned by the taxpayer, either as a result of any activity or pursuit of gain carried on by taxpayer or otherwise.
If any of the above factors seem characteristic of a recent inflow of cash, there may be an argument that the funds received was a windfall.
Tax Tip – Consider Carefully Whether or Not a Recent Inflow of Cash is Actually a Windfall
The way Canada treats windfalls isn't universal. For example, with our neighbor to the south, the USA, the IRS is all too happy to tax lottery winnings, treating it as no different from income. By comparison, Canadian courts have traditionally viewed "income from a source" narrowly and are generally reluctant to recognize new sources of income. As such unexpected, unplanned and non-recurrent gains are generally not income under the Canadian Income Tax Act. If you think you have received a windfall that is not taxable, contact our experienced Canadian tax lawyers for a determination.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.