Holiday Gifts and Disability Settlements
An update on recent tax cases
by Jamie Golombek
In my final column for 2005, I'd like to follow up on two issues previously addressed: one on holiday gift giving and the other on disability insurance settlements.
Gifts of food and beverages
In my December 2002 column, ""Tis the season", I wrote about the tax rules for gift giving and holiday parties and specifically addressed the issue of gifts of food and beverages by advisors to their clients.
I referred to a 2001 Canada Revenue Agency (CRA) technical interpretation that addressed whether the general 50 per cent limitation on the deductibility of meals and entertainment applied to gifts of frozen turkeys, fruit baskets, liquor and other items that are given out as gifts to customers at Christmas time. The CRA confirmed that "indeed the restriction of 50 per cent deductibility applies to any amount paid for any of the items above since they are paid "in respect of the human consumption of food or beverages.'"
A recent tax case (Stapley v. The Queen, 2005 TCC 374) decided earlier this year, however, may put a wrench in CRA's plans to tax such gifts. The case involved Mark Stapley, a self-employed real estate agent who, in 2000, 2001 and 2002, deducted between $14,000 and $20,000 of meals and entertainment expenses annually. Mr. Stapley did not actually personally consume any food nor attend any entertainment with his clients but rather gave his clients vouchers or tickets, which the clients could use as they saw fit.
Mr. Stapley claimed the full cost of these vouchers and tickets on his tax returns as fully deductible business expenses that were incurred both to thank his current clients who bought and sold homes through him as well as to encourage his clients to send him more business.
The CRA reassessed him, only allowing 50 per cent of the amounts he deducted, citing its published administrative position on restaurant gift certificates based on the broad interpretation of the phrase "in respect of" meals and entertainment. The judge, however, disagreed with the CRA's interpretation and concluded Mr. Stapley's purchases "were for the purpose of, or in respect of, earning income from his business and not consumption or entertainment".
The judge further likened Mr. Stapley's purchase of the food vouchers or entertainment tickets "a form of discount" for the purpose of gaining income or profit and thus should be fully deductible as a business expense and not subject to the 50 per cent restriction.
While at first glance this decision seems to overturn the CRA's long-standing administrative policy on such gifts, it should be noted that the case was heard under the "informal procedure" process and is therefore not legally binding on other judges, although it certainly would be persuasive. That being said, the CRA has launched an appeal and it will now be up to the Federal Court of Appeal to establish a new legal precedent. The case is expected to be heard in 2006.
Disability insurance settlement
In August's column ("DI Settlements"), we reviewed the Supreme Court of Canada's (SCC) March decision in Tsiaprailis [2005 SCC 8], which dealt with the taxation of a lump-sum settlement under a disability insurance policy.
The majority (4-3) opinion in the SCC concluded that the portion of the lump-sum settlement that was paid to compensate Ms. Tsiaprailis for past disability benefits was, indeed, taxable. With respect to the portion of the settlement paid to settle future liability, however, the SCC concluded that "The part of the settlement for future benefits is in the nature of a capital payment and is not taxable".
The original technical interpretation
On April 21, 2005, the CRA issued a confusing technical interpretation (2005-0121521E5) that seems to contradict the SCC's comments in Tsiaprailis concerning the taxation of the portion of a DI settlement relating to future benefits. (See the August issue of FORUM, page 32, for details.)
Many practitioners simply assumed that, based on Tsiaprailis, the portion of the payment for future benefits was tax-free. CRA seems to have interpreted the court's use of "capital" as meaning "capital gain", suggesting that while it may not be taxable as employment income, any such payment would still constitute "proceeds of disposition" resulting from "the disposition of a right". This would suggest that, in fact, capital gains treatment may apply (assuming the adjusted cost base of that right was zero).
The new technical interpretation
The good news is that, in September, the CRA released a new technical interpretation (2005-0141511E5) clarifying this confusing tax treatment. The CRA clarified that while generally the proceeds of disposition of capital property are used to calculate the vendor's capital gains for the taxation year in which the disposition occurs, the Income Tax Act does provide that capital gains from the disposition of certain types of property will not result in a capital gain. Specifically, the Act excludes from the determination of a taxpayer's capital gains any gains arising from the disposition of an insurance policy, including a life insurance policy, but excluding segregated funds.
As a result, the CRA concluded that where an individual receives a lump-sum payment in respect of future benefits under an employer long-term disability plan, in circumstances such that the lump-sum payment can reasonably be considered to be proceeds of disposition of an interest in an insurance policy, it was their view that the recipient of the proceeds will not have realized a capital gain in respect of such proceeds. This much-needed clarification certainly bodes well for the future of DI settlements.