Received a class-action settlement cheque? Here's everything you need to know about the tax consequences
If you held shares in Penn West Petroleum Ltd., which changed its name to Obsidian Energy Ltd. in mid-2017, from March 2011 through July 2014, you may have just received a cheque from the settlement of a class-action lawsuit brought against the company in 2014.
The plaintiffs in the class action alleged Penn West’s historical financial statements were not prepared in accordance with Generally Accepted Accounting Principles and/or International Financial Reporting Standards.
But you may be wondering: how are these payments taxed?
The letter accompanying your cheque is somewhat vague and simply states: “Please note the tax treatment of this distribution varies based upon the individual circumstances and tax status of each authorized Claimant. Accordingly, neither Counsel nor the Claims Administrator is able to determine the tax consequences, if any, that the distribution of the Compensation Fund Amount may have for you.”
Fortunately, nearly a decade ago, the Canada Revenue Agency issued guidance on the appropriate tax treatment, and it varies depending on whether you held the shares in your RRSP/RRIF or a non-registered account, as well as whether you still own all or some of the shares.
Shares held in an RRSP or RRIF
If you held your “original shares” (to distinguish them from any “new” shares you may have received on settlement) in your RRSP or RRIF, the settlement payment should have been paid directly to the RRSP or RRIF. There is nothing more to do in this case: the amount will remain tax deferred inside the account until it’s withdrawn.
But if a cheque and/or new shares were sent to you instead of to your RRSP/RRIF account, then the CRA’s position is that as long as you return it to your RRSP or RRIF within a “reasonable time,” you won’t have to pay tax on the payment at the time it is received and the settlement payment will be treated as though it was never outside the RRSP or RRIF.
In this case, the CRA considers a reasonable time for the payment to be returned as the later of six months after the settlement is received or the end of the tax year in which it was received.
This transfer of the payment to your RRSP or RRIF to correct the error will not be considered to be an RRSP contribution and, therefore, you can’t claim an RRSP deduction for the amount transferred.
If you received a settlement payment for shares held in your RRSP or RRIF and choose not to transfer the cash (and/or any new shares) to your RRSP or RRIF, then the cash payment and the fair market value of the new shares will be considered income and must be included on your tax return in the year of receipt as an RRSP/RRIF benefit.
All your original shares are still owned in a non-registered account
Good news! You don’t need to include any of the settlement payment in your income. Instead, you simply need to adjust your tax cost or adjusted cost base (ACB) of your shares.
To do this, you deduct the value of the cash settlement from your total ACB and, as such, you will be treated as if you paid less for those shares than when you originally purchased them.
For example, say Bryan owned 10 original shares with a total ACB of $1,200 (or $120 per share.) He just received a settlement payment consisting of $100 in cash plus one additional share of the corporation. Bryan’s adjusted cost base for his 11 (10 + 1) shares is now $1,100 or $100 per share.
None of the original shares are still owned in a non-registered account
If you no longer own any of your original shares when you receive a settlement payment, the CRA considers you to have received additional proceeds of disposition from having sold your original shares.
Assuming you ordinarily treat all dispositions of securities on capital account (i.e., you are not a pro, or a trader or dealer in securities who reports stock trading profits as business income), the value of the settlement payment consisting of the cash plus the current fair market value of any new shares received will be treated as a capital gain.
You would therefore only include 50 per cent of this amount in your income as a taxable capital gain. If you have any capital losses in the current year or carried forward from prior years, they can be used to reduce or even eliminate the tax on that capital gain.
The ACB of any new shares received in the settlement payment is simply equal to their fair market value at the time that you received them.
You’ve disposed of some, but not all, of the original shares in your non-registered account
Here’s where things get a bit more complicated as you need to split the settlement payment in two: one part relating to the original shares you still own and the other relating to the shares that you have sold.
The split is done proportionally based on the relative number of shares disposed of compared to the total number of shares owned.