A-40-02
2003 FCA 136
Her Majesty the Queen (Appellant)
v.
Vasiliki Tsiaprailis (Respondent)
Indexed as: Canada v. Tsiaprailis (C.A.)
Court of Appeal, Strayer, Evans and Pelletier JJ.A.-- Toronto, November 28, 2002; Ottawa, March 17, 2003.
Income Tax -- Income Calculation -- Income from office or employment -- Disability insurance plan -- Crown appeal from T.C.C. decision lump sum paid taxpayer by insurer in settlement of action under disability insurance policy not taxable under Act, s. 6 (1)(f) -- Taxpayer's argument: settlement not payable on periodic basis as required by s. 6 (1)(f) -- Appeal allowed -- T.C.C. decision in Dumas holding such payment taxable under s. 6(1)(a) though not caught by 6(1)(f), preferred to T.C.C. decisions holding in taxpayer's favour -- Taxpayer had two types of claim against insurer: (1) past monthly payments not made; (2) claim to future benefits -- Two types to be treated differently for tax purposes -- Reliance upon family law case for proposition character of periodic payments not altered if not made on time -- Irrelevant that collection activity undertaken to enforce payment -- Allocation of global settlement matter of evidence, not legal principle -- Taxpayer unable to say recovery not flowing from insurer's policy obligations -- Outcome not dictated by contents of release executed by parties -- Courts look at nature of transaction -- Arrears portion of settlement taxable, unnecessary to consider tax treatment of portion of settlement for future entitlement.
This was an appeal by the Crown from a decision of Bowman A.C.J. of the Tax Court of Canada holding that no part of the proceeds of the settlement of a claim under a disability insurance policy should be included in taxable income in the year the settlement was paid to respondent.
Respondent had been employed by a private Ontario corporation as a press machine operator and, under a collective agreement, was entitled to long-term disability benefits under a policy of insurance. On November 10, 1984 she suffered physical and emotional injuries in an automobile accident resulting in permanent disability. But after paying benefits for nine years, the insurer cut her off, alleging respondent was no longer totally disabled. She sued the insurance company and settled out of court for a lump sum payment of $105,000. Respondent was assessed for income tax on the entire amount of the settlement, the Minister taking the position it was caught by Income Tax Act, paragraph 6(1)(f). Respondent's argument was that the settlement was not payable on a periodic basis, an essential element of paragraph 6(1)(f). The Judge below agreed, holding that "The lump sum payment arrived at after a law suit was commenced and negotiated as a compromise cannot on any basis of statutory interpretation be described as an `amount . . . payable on a periodic basis'". The Judge reasoned that a section of general application such as paragraph 6(1)(a) could not be relied upon to sweep into income an amount which did not fit within a provision aimed at amounts of that type, such as paragraph 6(1)(f).
Held (Evans J.A. dissenting), the appeal should be allowed.
Per Pelletier J.A. (Strayer J.A. concurring): The Tax Court of Canada has, in a number of cases, held that settlements of claims against disability insurers are not to be included in income as not payable on a periodic basis and accordingly fell outside paragraph 6(1)(f). But in Dumas, Mogan T.C.J. held that an amount paid to settle a disability insurance claim was to be included in income under paragraph 6(1)(a) although not caught by 6(1)(f), not being payable on a periodic basis.
Under the policy, respondent was entitled to a monthly benefit until age 65 while remaining totally disabled. When the insurer ceased payments respondent had two types of claim against it: (1) past monthly payments not made, and (2) a claim to future benefits. These gave rise to different remedies. As to future benefits, she would not have been entitled to a money judgment since an insured's eligibility arises each time a payment falls due. All a court could have done was to grant a declaration that, as at the date of judgment, the policy was valid and insured was totally disabled. Insurer would have an obligation to keep paying only so long as insured's condition of disability persists and other policy conditions were met. The right and corresponding obligation have a monetary value and it is open to an insured to surrender her rights in return for a payment.
Respondent received a single amount in satisfaction of both types of rights. But the two types of claim could be treated differently for tax purposes. Indeed, the agreed statement of facts reveals how the parties allocated the settlement amount between arrears and future payments. In R. v. Sills, a case involving lump sum amounts paid in satisfaction of arrears of maintenance payments, this Court held the amounts were taxable so long as the agreement provided for periodic payments. The payments did not change in character just because they were not made on time. Returning to the case at bar, paragraph 6(1)(f) makes reference to amounts "payable" on a periodic basis, not "paid" on such basis. The obligation to pay remains a periodic one. That collection activity has to be undertaken to compel payment does not change the nature of the payment in payee's hands.
The position taken by a majority of the Tax Court of Canada Judges, that a settlement of a disability insurance claim for a global amount is not taxable under Act, paragraph 6(1)(f) because (1) the payment itself was not made on a periodic basis, and (2) being a global settlement, it is not referable to an obligation to make periodic payments, could not be agreed with. The first point was answered by this Court's decision in Sills; the second by the judgment in Mohawk Oil Co. v. Canada, [1992] 2 F.C. 485 (C.A.). In that case, this Court dismissed an appeal against a reassessment whereby the Minister allocated a global settlement between income and capital accounts. That decision demonstrates that it is possible to disentangle the elements of a settlement where there is a sufficient evidentiary basis upon which to do so. The question of allocation is one of evidence, not legal principle. It is not open to respondent to bring action under the policy, recover an amount from insurer and then argue that the payment did not flow from insurer's policy obligations. Another approach to the disputed liability question is to enquire as to whether any release executed by the parties dictates the outcome. But a court would not consider itself bound by the characterization of a damages payment in release documentation. Courts will look at the nature of the transaction rather than at the terms of the release.
It had to be concluded that the payment to respondent included an amount covering arrears and that portion was taxable as it was in respect of amounts "payable on a periodic basis". The assessment being based on paragraphs 6(1)(a) and 6(1)(f), it was unnecessary to decide as to the tax treatment of the portion of the settlement paid with respect to future entitlement.
Per Evans J.A. (dissenting): The conclusion of Bowman A.C.J., that the lump sum was not caught by paragraph 6(1)(f), is consistent with the most obvious reading of the paragraph. A single payment made under a settlement by which the parties agree that insurer does not admit liability and that the money will be paid in a lump sum does not readily fit the words "payable . . . on a periodic basis . . . pursuant to . . . a disability insurance plan". As said by the Tax Court Judge, the Court was disinclined "to dream up imaginative ways of taxing disabled people" in order to hold in favour of the Crown.
The Sills case, relied upon by the majority herein, could be distinguished as it fails to help the Court decide if the lump sum payment in the instant case was made "pursuant to" the insurance contract or under the settlement of the disputed claim. The cases holding that the fact that money is paid under a settlement does not change the essential nature of the payment do not go as far as the Crown suggests the Court ought to go in this case. Until now, courts have only characterized the nature of the sum received by reference to its underlying source to determine its general nature. Parliament having, in paragraph 6(1)(f), precisely defined the circumstances whereunder a sum is taxable, it is not open to the Court to characterize a lump sum paid in settlement of a disputed claim as falling within the statutory description merely because the claim that the parties settled involved an allegation by insured that insurer had breached a policy obligation to make periodic payments.
Recent Supreme Court decisions favour an approach to tax imposition that gives effect to the legal nature of taxpayer's transactions--so long as they are not shams--rather than emphasizing the underlying economic or business realities. Here, it was expressly agreed that insurer did not admit liability under the contract of insurance. It is therefore difficult to conclude that, as a matter of law, that the payment was made under the insurance contract. The lump sum was paid pursuant to the settlement, not to the policy.
One consequence of the majority decision herein will be to reduce settlement in centimes and make it even more difficult than it already is to settle disability insurance claims legislation ought not be interpreted such as to deter the settlement of litigation.
statutes and regulations judicially
considered
Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, ss. 6(1)(a),(f), 110.2 (as enacted by S.C. 2000, c. 19, s. 17), 120.31 (as enacted idem, s. 30).
| Income Tax Act, S.C. 1970-71-72, c. 63, ss. 6(1)(a), 56(1)(n). |
cases judicially considered
followed:
R. v. Savage, [1983] 2 S.C.R. 428, [1983] CTC 393; (1983), 83 DTC 5409; Schwartz v. Canada, [1996] 1 S.C.R. 254; (1996), 133 D.L.R. (4th) 289, 17 C.C.E.L. (2d) 141; 10 C.C.P.B. 213; [1996] 1 C.T.C. 303; 96 DTC 6103; 193 N.R. 241; revg [1994] 2 F.C. 720; [1994] 2 C.T.C. 99; (1994), 2 C.C.P.B. 109; 94 DTC 6249; 167 N.R. 35 (C.A.).
applied:
Johnson Estate v. Canada, [2002] 2 C.T.C. 2725; (2002), 2002 DTC 1535 (T.C.C.); Dumas v. Canada (2000), 26 C.C.P.B. 218; [2001] 1 C.T.C. 2490; 2000 DTC 2603 (T.C.C.); R. v. Sills, [1985] 2 F.C. 200; [1985] 1 C.T.C. 49; (1984), 85 DTC 5096 (C.A.); Mohawk Oil Co. v. Canada, [1992] 2 F.C. 485; [1992] 1 C.T.C. 195; (1992), 92 DTC 6135; 140 N.R. 225 (C.A.).
considered:
London and Thames Haven Oil Wharves, Ltd. v. Attwooll (Inspector of Taxes), [1967] 2 All E.R. 124 (C.A.); R. v. Manley, [1985] 2 F.C. 208; [1985] 1 C.T.C. 186; (1985), 85 DTC 5150; 57 N.R. 362 (C.A.); Peel v. M.N.R. (1987), 87 DTC 268 (T.C.C.); Landry v. Canada, [1998] 2 C.T.C. 2712; (1998), 98 DTC 1416 (T.C.C.); Whitehouse v. Canada (1999), 23 C.C.P.B. 91; [2000] 1 C.T.C. 2714, 2000 DTC 1616 (T.C.C.).
referred to:
Andersen v. Great-West Life Assurance Co. (1987), 30 C.C.L.I. 85; 24 C.P.C. (2d) 113; [1988] I.L.R. 1-2317 (Ont. S.C.); Mercuri v. Imperial Life Assurance Co. of Canada (1990), 107 N.B.R. (2d) 320; [1990] I.L.R. 1-2660 (Q.B.); Short v. Canada, [1999] 4 C.T.C. 2085; (1999), 99 DTC 1146 (T.C.C.); T. Eaton Co. v. Canada, [1999] 3 F.C. 123; [1999] 2 C.T.C. 380; (1999), 99 DTC 5178; 239 N.R. 102 (C.A.); Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082; (2001), 204 D.L.R. (4th) 590; [2002] 1 C.T.C. 95; 2001 DTC 5505; 275 N.R. 90; Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298; (1998), 163 D.L.R. (4th) 385; 98 DTC 6505; 222 N.R. 58; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; (1999), 178 D.L.R. (4th) 26; [1999] 4 C.T.C. 313; 99 DTC 5669; 247 N.R. 19; Milliken v. Canada, [2002] 2 C.T.C. 2783; 2002 DTC 1510 (T.C.C.); Fry v. Canada (2001), 28 C.C.P.B. 231; 2001 DTC 846 (T.C.C.).
APPEAL by the Crown from a Tax Court of Canada decision ((2001), 2002 DTC 1563) holding a lump sum payment to taxpayer in settlement of a disability insurance claim was not subject to income tax. Appeal allowed.
appearances:
Daniel Bourgeois for appellant.
James H. Cooke for respondent.
solicitors of record:
Deputy Attorney General of Canada for appellant.
Miller Canfield, Windsor, for respondent.
The following are the reasons for judgment rendered in English by
[1]Pelletier J.A.: Vasiliki Tsiaprailis was injured in an accident and became eligible to receive disability benefits under a disability insurance policy provided by her employer. After paying disability benefits for approximately nine years, the insurer ceased making payments, alleging that Ms. Tsiaprailis was no longer totally disabled. She sued and eventually agreed to a settlement in the amount of $105,000. To her surprise, the Minister of National Revenue included the entire amount in her income in the year the settlement was paid to her. She appealed, and in a decision reported at 2002 DTC 1563, Associate Chief Judge Bowman of the Tax Court of Canada held that no part of the settlement was to be included in income. The Crown now appeals that decision.
[2]The matter was heard on an agreed statement of facts, the relevant portions of which are reproduced below:
2. At all material times, the Appellant was employed at Tamco Limited, a private Ontario corporation with its principal place of business located in Windsor, Ontario. She had been performing her duties as a press machine operator since February15, 1972.
3. Pursuant to a Collective Bargaining Agreement between Tamco Limited and The International, United Automobile, Aerospace and Agricultural Implement Workers of America and its Local 195 (the `Union'), the Appellant was entitled to long term disability benefits under Policy G12402 with Dominion Life Assurance Company. Manufacturers Life Insurance Company (`Manulife') subsequently assumed Dominion Life Assurance Company's obligation to the Appellant.
. . .
5. Under Policy G12402, long term disability benefits are 66 2/3% of monthly earnings, with a maximum of $1,100, minus Canada Pension Plan benefits. The long term disability benefits are payable monthly, up to the 65th birthday of the employee or until he or she ceases to be totally disabled.
6. On November10, 1984, the Appellant was involved in an automobile accident in the City of Windsor in which she sustained bodily injuries including emotional injuries associated with her bodily injuries, treatment and convalescence. The Appellant was permanently disabled as a result of the injuries sustained during the accident.
7. From May11, 1985 to May10, 1993, the Appellant received the long term disability benefits, minus her Canada Pension Plan benefits. In May of 1993, the Appellant's entitlement to long term disability benefits was $1,100 a month, which sum was reduced by her CPP benefit of $353.25, for a total sum paid by Manulife of $746.75 a month.
8. Manulife terminated the benefits and so advised the Appellant in July of 1993.
9. On March 30, 1994, the Appellant commenced civil proceedings against Manufacturers Life Insurance Company for a declaration that she was entitled to the continuance of Long Term Disability Benefits from and after May 10, 1993 pursuant to the Group Policy G12402 entered into between Tamco Limited and Manulife Agreement. A Statement of Defence was filed by Manulife.
. . .
11. In October 1996, the Appellant entered into a settlement agreement with Manulife and received a lump sum payment of $105,000 in lieu of continued benefits pursuant to the terms of settlement. The sum of $105,000 essentially meant Manulife was paying:
(a) the Appellant's entitlement to past benefits, plus interest;
(b) 75% of the present value of the Appellant's entitlement to future benefits under the policy;
(c) $6,455 for costs, GST and disbursement.
12. On October18, 1996, the Appellant signed a Direction and Authorization instructing her solicitors in respect of the sum of $105,000. The Appellant paid $18,068.97 in legal fees, plus disbursements and GST.
13. On October18, 1996, a Full and Final Release was executed by the Appellant.
14. An Order was issued by the Ontario Court (General Division) dismissing the action without costs.
[3]The issue in the litigation is the taxation of the amounts received by Ms. Tsiaprailis from Manufacturer's Life. The Minister assessed Ms. Tsiaprailis' on the basis that the amounts in question were to be included in income pursuant to paragraph 6(1)(f) of the Income Tax Act [R.S.C., 1985 (5th Supp.), c. 1] or, in the alternative paragraph 6(1)(a):
6. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from an office or employment such of the following amounts as are applicable:
(a) the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of an office or employment . . .
. . .
(f) the total of all amounts received by the taxpayer in the year that were payable to the taxpayer on a periodic basis in respect of the loss of all or any part of the taxpayer's income from an office or employment, pursuant to
. . .
(ii) a disability insurance plan, or
[4]Ms. Tsiaprailis asserts that these amounts are not to be included in income as they were not payable on a periodic basis, an essential element of paragraph 6(1)(f). Associate Chief Justice Bowman agreed with her, finding that the amount was not taxable because it was not payable on a periodic basis [at paragraph 18]:
Whether the Crown relies on paragraph 6(1)(f) or not, it has no application. The lump sum payment arrived at after a law suit was commenced and negotiated as a compromise cannot on any basis of statutory interpretation be described as an `amount . . . payable on a periodic basis.'
[5]He then went on to find that the Crown could not rely upon paragraph 6(1)(a) if its submissions with respect to paragraph 6(1)(f) were not accepted. He adopted the reasoning of the Supreme Court of Canada in R. v. Savage, [1983] 2 S.C.R. 428. In that case the taxpayer won a prize of $300 in an employment related context. Paragraph 56(1)(n) of the Income Tax Act [S.C. 1970-71-72, c. 63], as it read at the time, required that prizes for achievement with a value greater than $500 be included in income. The Minister argued that prizes of less than $500 could be included in income under paragraph 6(1)(a) even if they did not come within paragraph 56(1)(n). The Supreme Court rejected this argument on the basis that it effectively did away with the exemption contemplated in paragraph 56(1)(n). Associate Chief Justice Bowman held that a section of general application such as paragraph 6(1)(a) could not be used to sweep into income an amount which did not fit within a provision aimed at amounts of that type, such as paragraph 6(1)(f). I adopt the learned trial Judge's position on this issue.
[6]The judges of the Tax Court have generally been consistent in their treatment of amounts received in settlement of disability insurance claims. In many of these cases, the issue of inclusion in income under paragraph 6(1)(a) also arose, but for purposes of the following review, I will limit my comments to their treatment of paragraph 6(1)(f). In Peel v. M.N.R. (1987), 87 DTC 268 (T.C.C.), the Court held that a $90,000 payment to settle an action against a disability insurer was not to be included in income under paragraph 6(1)(f) because it was not a periodic payment.
[7]In Landry v. Canada, [1998] 2 C.T.C. 2712 (T.C.C.), Associate Chief Justice Bowman found that a lump sum payment of $30,000 which was accepted in settlement of a claim against a disability insurer was not to be included in income because it was not payable on a periodic basis and therefore did not fall within paragraph 6(1)(f). He had this to say about the nature of the settlement [at paragraph 9]:
The lump sum payment received by Mrs. Landry was not payable on a periodic basis and there is no allegation or assumption that the $25,000 represented simply the aggregate of periodic payments that she might have received over her lifetime. (cf. Marchand v. M.N.R., 87 DTC 630 (T.C.C.)).
[8]Judge Lamarre, in the case of Whitehouse v. Canada, [2000] 1 C.T.C. 2714 (T.C.C.), held that an amount received to settle a disability claim was not payable on a periodic basis and therefore was not to be included in income pursuant to paragraph 6(1)(f). There was no discussion of the nature of the payment itself. The same result was arrived at in Fry v. Canada (2001), 28 C.C.P.B. 231 (T.C.C.).
[9]In Johnson Estate v. Canada, [2002] 2 C.T.C. 2725 Judge Rip held that a lump sum payment made in settlement of accumulated arrears under a disability policy was to be included in income under paragraph 6(1)(f). In doing so, he commented on the nature of the settlement arrived at between the insured and the insurer [at paragraph 28]:
The payment in May 1995 by Mutual Life terminated the initial litigation. However, the payment was not the insurer's final or full liability under the Policy, as in Peel v. M.N.R., [ 87 DTC 268 (T.C.C.).] or Tsiaprailis v. The Queen [[2001] T.C.J. No.856 (Q.L.) per Bowman, A.C.J.] for example. The payment was simply the aggregate of arrears of amounts that were payable on a periodic basis under the Policy, plus interest and costs. The insurer paid what it ought to have paid under the Policy had it accepted Mrs. Johnson's application in March 1995, or earlier, and Mrs. Johnson received the arrears to which she was entitled under the Policy. Prior to the settlement, counsel for Mrs. Johnson and Mutual Life were "number crunching" to ensure that the lump sum amount aggregated the amounts she should have received had Mutual Life accepted her application when made, plus interest and costs of $1,500. Further, the Policy continued and Mrs. Johnson was to continue to receive monthly benefits. The insurer honoured the Policy and paid what it ought to have paid on a periodic basis. Mrs. Johnson relinquished no rights under the Policy to claim future benefits. Thus, under ordinary circumstances, the amounts received under the May Settlement ought to be included in Mrs. Johnson's income for 1995. [Emphasis added.]
[10]In Dumas v. Canada (2000), 26 C.C.P.B. 218 (T.C.C.), Judge Mogan held that an amount of $105,000 paid to settle a disability insurance claim was to be included in income. The learned Judge set out the problem as he saw it at paragraph 25 of his reasons:
If those disability benefits (arrears and future) had been paid on a periodic basis, they would have been included in the Appellant's income as received from year to year under paragraph 6(1)(f) of the Act. Those benefits were not paid on a periodic basis or paid at all. The Appellant sued GWL and recovered $105,000. The Appellant's problem in this appeal is to demonstrate that the character of the settlement amount is different from the character of the periodic payments (i.e. income) which would otherwise have been received.
Further along in his reasons, Judge Mogan decided that all or a part of an amount received in settlement of a claim can be characterized as income [at paragraph 25]:
The decisions of the Federal Court of Appeal in Manley and Mohawk Oil prove that all or a portion of an amount recovered as damages (as in Manley) or by way of settlement (as in Mohawk Oil) may be characterized as income for tax purposes. The character of an amount received as damages or to settle a claim will be influenced, if not wholly determined, by the nature of the claim made by the person receiving the amount.
[11]In the end, Judge Mogan concluded that the entire settlement amount was income in the hands of Ms. Dumas. However, he found that since it was not payable on a periodic basis, the payment did not come within paragraph 6(1)(f). But he did find that the payment was to be included in income by virtue of paragraph 6(1)(a).
[12]Before embarking upon an analysis of the tax consequences of the settlement, it is useful to examine the nature of the rights which Ms. Tsiaprailis had under the disability policy. The terms of the policy which are relevant to this appeal are reproduced below:
Totally Disabled
. . . due to illness or injury, completely unable to perform the normal daily duties as set out below
| For an Employee, the normal duties are deemed to be those of his or her own occupation for the Qualifying Period [182 days] and the next 24 months. After this, the normal duties are deemed to be those of any occupation for which the employee is or may become suited by education, training or experience. |
Long Term Disability Benefit
If a person becomes Totally Disabled while insured for this Benefit and remains Totally Disabled longer than the Qualifying Period, [the Insurer] will start paying a Monthly Benefit.
This Monthly Benefit will continue for up to the Maximum Benefit Period [up to the 65th birthday] while the person remains alive and Totally Disabled.
[13]The effect of these provisions is that a person is entitled to receive disability benefits so long as they are alive, totally disabled, and under the age of 65. If they cease to be disabled, their entitlement to disability benefits is also at an end. Claimants can cease to be disabled in a number of ways, not the least of which is the change in the definition of "normal daily duties" which occurs 24 months after the expiration of the qualifying period. The test is no longer the ability to do the duties of one's own occupation but rather is the ability to do the duties of any occupation for which one is suited by education, training and experience. This point is not relevant to this claim but merely demonstrates that total disability is not a static condition. Apart from a change in a claimant's physical condition, he or she might also cease to be disabled as a result of further treatment or training. The policy language is clear that the insurer is only required to pay benefits "while the person remains alive and Totally Disabled". Where an insurer puts the insured's disability into question, the onus of proving disability is on the insured (Andersen v. Great-West Life Assurance Co. (1987), 30 C.C.L.I. 85 (Ont. S.C.)).
[14]When the insurer ceased making payments to Ms. Tsiaprailis, the latter had two types of claims against the insurer. The first was with respect to the unpaid payments which came due in the period of time following the insurer's refusal to pay and the date of settlement. The second had to do with the right to receive benefits in the future. When Ms. Tsiaprailis launched her action, these two types of claims gave rise to different remedies.
[15]If the Court found that Ms. Tsiaprailis was totally disabled, then she would be entitled to a money judgment for all amounts which had become payable between the date of the insurer's breach of the contract and the date of judgment. Such a finding would establish that at the material times, she met all the conditions of the policy and therefore had established her right to demand payment from the insurer.
[16]However, in so far as future payments are concerned, Ms. Tsiaprailis would not be entitled to a money judgment for amounts which might become payable under the policy in the future because, as set out above, the question of the insured's eligibility arises each time a payment comes due. The only remedy available to a claimant is a declaration that, as of the date of judgment, the policy is valid and subsisting, and that the insured is totally disabled within the meaning of the policy. But that declaration does not bind the insurer to make the next payment which comes due if, for example, as a result of the change in the definition of totally disabled, the insured was no longer totally disabled. The declaratory relief simply establishes that the insured has a right to receive benefits and that the insurer continues to have the obligation to pay, so long as the state of disability persists (and the other conditions of the policy are met). See Andersen, supra and Mercuri v. Imperial Life Assurance Co. of Canada (1990), 107 N.B.R. (2d) 320 (Q.B.).
[17]This right to receive disability benefits so long as the state of total disability persists is a valuable right, just as the obligation to make the payments so long as the insured is eligible to receive them is a significant liability. The right and the corresponding obligation have a monetary value. An insured can agree to surrender his or her rights, thereby extinguishing the insurer's liability, in return for a payment. The fact that the parties choose to negotiate the value of that right/obligation by reference to the amounts which could become payable under the policy if the insured remained totally disabled and survived until age 65 does not mean that the settlement is a pre-payment of the insurer's obligations under the policy. We are not called upon to decide the nature of that right in this appeal but, in other circumstances, the disposition of a right to receive future amounts has been held to be a capital transaction. See Short v. Canada, [1999] 4 C.T.C. 2085 (T.C.C.).
[18]In this case, Ms. Tsiaprailis sued to enforce her rights under the disability insurance policy. She had two types of rights. She received a single amount in satisfaction of both types of rights. The jurisprudence of the Tax Court would suggest that the entire amount is either taxable as income in her hands or none of it is. But as Judge Mogan pointed out in Dumas, all or part of a payment can be treated as income in a taxpayer's hands. I can think of no reason why the two types of claims which Ms. Tsiaprailis was asserting in her claim cannot be treated distinctly for tax purposes. In fact, if one refers to paragraph 11 of the agreed statement of facts, one can see how the parties allocated the settlement amount between the arrears and Ms. Tsiaprailis' future entitlement. The significance of the allocation is the recognition by the parties to the settlement that there are past and future components to the settlement amount.
[19]The meaning of the phrase "payable on a periodic basis" was considered in R. v. Sills, [1985] 2 F.C. 200 (C.A.). The issue was whether amounts paid in satisfaction of arrears of maintenance were to be included in income. The payer was required by court order to pay Ms. Sills a monthly amount for maintenance for herself and her dependent children. Arrears accumulated as a result of missed payments. At various time, the payer made lump sum payments towards the arrears but never eliminated them. Ms. Sills argued that these lump sum payments in satisfaction of the arrears were not taxable in her hands because subsection 56(1)(b) of the Income Tax Act only provided for the inclusion in income of "alimony or other allowance payable on a periodic basis for the maintenance of the recipient thereof, children of the marriage, or both the recipient and children of the marriage". Mrs. Sills argued that since the lump sum payments were not payable on a periodic basis, they did not come within paragraph 56(1)(b) and were not subject to being included in her income. Heald J.A. had no difficulty disposing of this argument at page 205:
Where the Trial Judge erred, in my view, was in not having due regard to the use of the word "payable" in the paragraph. So long as the agreement provides that the monies are payable on a periodic basis, the requirement of the paragraph is met. The payments do not change in character merely because they are not made on time. The learned Tax Review Board member made the same error, in my view, when he said that the amounts to be included in income "must be received exactly according to the terms of the agreement".
[20]In my view, the logic of this position is unassailable. Paragraph 56(1)(b) of the Income Tax Act, as well as paragraph 6(1)(f) which is in issue here, refer to amounts which are "payable" on a periodic basis, as opposed to "paid" on a periodic basis. The fact that a payment is not made when due does not change the fact that the obligation to pay is a periodic one. Where a person has a right to receive a payment, the fact that collection activity must be undertaken to compel payment does not change the nature of that payment in the hands of the payee. (See London and Thames Haven Oil Wharves, Ltd. v. Attwooll (Inspector of Taxes), [1967] 2 All E.R. 124 (C.A.) as applied in R. v. Manley, [1985] 2 F.C. 208 (C.A.).)
[21]With this in mind, I return to the jurisprudence of the Tax Court on this issue. It seems to me that a fair characterization of the position taken by the majority of the judges of the Tax Court is that a settlement of all claims arising under a disability insurance policy in return for the payment of a global amount does not create liability for tax under paragraph 6(1)(f) of the Act because:
(a) the payment itself is not payable on a periodic basis; and
(b) being a global settlement, it is not referable to an obligation to make periodic payments.
[22]The first point is answered by the decision of this court in Sills, discussed above, which holds that payments are no less "payable on a periodic basis" for being aggregated and paid late. The response to the second point is found in the decision of this Court in Mohawk Oil Co. v. Canada, [1992] 2 F.C. 485 (C.A.) dismissing an appeal from a reassessment in which the Minister allocated a global settlement between income and capital accounts. In my view, this demonstrates that there is no bar to disentangling the elements of a settlement if there is a sufficient evidentiary basis upon which to do so. The same point arose in Schwartz v. Canada, [1996] 1 S.C.R. 254, where the Supreme Court set aside this Court's [[1994] 2 F.C. 720] characterization of the elements of a global settlement on the ground that the evidence did not support its conclusion. The clear implication is that the question of allocation was a matter of evidence and not a question of legal principle. In this case, there is no question as to the evidence since the breakdown of the settlement amount figures in the agreed statement of facts.
[23]Is this still true if the liability to make the payments is disputed? That question can be answered in two ways. The first is that the liability is only disputed by the insurer and it is not the taxation of the insurer which is in issue. In my view, Ms. Tsiaprailis cannot assert the insurer's liability under the policy in her action, recover an amount from the insurer in that action, and then argue that the payment does not flow from the obligations of the insurer under the policy.
[24]The second approach to the question of disputed liability and the effect of the settlement is to refer to the cases where the court has inquired into the nature of a payment received as damages, to see if the terms of any release executed by the parties dictated the result of the inquiry. In Schwartz, supra, the settlement between the taxpayer included a release which described the major portion of the sum being paid to him as damages. The terms of the release are not given but, on the theory that if something turned on its terms, they would have been reported, one can presume that the release contained the usual unexceptional terms as to denial of liability and a full release of any liability of any sort. In examining the nature of the payment to Schwartz, the Supreme Court referred to the letters which passed between the parties in the course of negotiations and the testimony of Mr. Schwartz as to his view of the payment. The importance of this is that the Court did not consider itself bound by the characterization of the payment as damages in the release documents. In Mohawk Oil Co., supra, the parties executed a release whose terms are not disclosed in the report of the decision but once again, the Court's inquiry into the nature of the payments received did not turn on the terms of the release but rather on the nature of the transaction. In my view, the terms of a release executed between parties to a dispute have not been taken as limiting any inquiry into the nature of the payments made.
[25]Consequently, I am of the view that the payment to Ms. Tsiaprailis included an amount with respect to the accumulated arrears. I find that this amount is taxable in Ms. Tsiaprailis' hands pursuant to paragraph 6(1)(f) because, even though it was paid as a lump sum under the compulsion of litigation, it was in respect of amounts "payable on a periodic basis".
[26]Given the issue in the appeal which is before us, it is not necessary to decide the tax treatment of the amounts paid with respect to future entitlement since the assessment is based upon inclusion in income under paragraphs 6(1)(a) and 6(1)(f). I would therefore allow the appeal and return the matter to the Minister for reassessment in accordance with these reasons. In the circumstances, I think it is appropriate that each party bear their own costs.
Strayer J.A.: I agree.
* * *
The following are the reasons for judgment rendered in English by
[27]Evans J.A. (dissenting): I have had the benefit of reading the reasons of my colleague Pelletier J.A. I agree that the Crown's argument on paragraph 6(1)(a) of the Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, must fail. This case is indistinguishable from Schwartz v. Canada, [1996] 1 S.C.R 254. However, unlike my colleague I am of the view that no part of the lump sum payment of $105,000 made to Ms. Tsiaprailis by Manulife in 1996 is taxable under paragraph 6(1)(f). Accordingly, I would dismiss the appeal.
[28]Pelletier J.A. is of the view that the portion of this sum that is attributable to future payments by the insurer is not caught by paragraph 6(1)(f). He reasons that, since payments under the policy were not due at the time that the payment was made and, indeed, might never have become due, the portion of the lump sum attributable to future payments cannot be said to have been paid pursuant to the contract of insurance. However, in so far as the lump sum represents payments already due, the payment was made to replace moneys payable on a periodic basis pursuant to the policy. To that extent, Pelletier J.A. concludes, the Minister was correct to treat the lump sum as income under paragraph 6(1)(f). It is with this conclusion that I respectfully disagree.
[29]The critical question is whether the lump sum payment of $105,000, less $18,069 for legal expenses, is properly characterized as "payable to the taxpayer on a periodic basis . . . pursuant to . . . a disability insurance plan" under paragraph 6(1)(f). The conclusion of Bowman A.C.J. that the lump sum was not caught by paragraph 6(1)(f) is clearly consistent with the most obvious reading of the paragraph. A single payment made under a settlement contract in which the parties agree that the insurer does not admit liability and that the money shall be paid in a lump sum does not readily fit the words "payable . . . on a periodic basis . . . pursuant to . . . a disability insurance plan." Accordingly, Bowman A.C.J. concluded (at paragraph 25) that, in these circumstances, the Court would have "to dream up imaginative ways of taxing disabled people" in order to find for the Crown, an exercise in which he declined to engage.
[30]As Pelletier J.A. acknowledges, the Tax Court has generally, although not invariably, taken the position that lump sum payments made pursuant to settlements of disputed disability insurance claims do not satisfy the conditions of taxability prescribed by paragraph 6(1)(f). However, my colleague finds two grounds of support for the proposition that the portion of the settlement payment representing the value of the past unpaid benefits is taxable under the paragraph.
[31]First, he relies on R. v. Sills, [1985] 2 F.C. 200 (C.A.), as authority for the proposition that whether money is "payable on a periodic basis" is determined by the terms of the legal instrument containing the duty to pay and not by the manner in which the money owing is in fact paid. I agree that this is what Sills decides. However, in my respectful view, it does not assist the Crown in this case.
[32]In Sills, lump sum payments were made towards the arrears of payments that the taxpayer was required by a court order to make on a periodic basis. That is, the payments were made to discharge a liability to make periodic payments. In the present case, however, the payment was made to Ms. Tsiaprailis pursuant to the settlement of a law suit, not the original disability benefits insurance contract. While the insurance contract provided that disability benefits were payable on a periodic basis, the settlement contract contained no such provision. Sills does not help us to decide if the lump sum payment was made "pursuant to" the disability insurance contact, or the contract to settle the disputed claim.
[33]Second, Pelletier J.A. relies on R. v. Manley, [1985] 2 F.C. 208 (C.A.), to deal with this last point. This case is cited as authority for the proposition that the fact that money is paid under a settlement does not change the essential nature of the payment. The argument is that, since the lump sum was paid to Ms. Tsiaprailis under an agreement to settle a disputed claim that the insurer had failed to make periodic payments as required by the contract to pay disability benefits, the "arrears" part of the payment should be treated in the same way that it would have been if the insurer had paid the benefits monthly in accordance with the contract of insurance.
[34]In my view, however, the cases in which this approach has been taken do not go as far as the Crown would have us go in this case. To date, the courts have only characterized the nature of the sum received by reference to its underlying source in order to determine its general nature.
[35]Thus, in London and Thames Haven Oil Wharves, Ltd. v. Attwooll (Inspector of Taxes), [1967] 2 All E.R. 124 (C.A.), it was held that the underlying source of an award of damages was relevant to determining whether the sum awarded should be treated as profits for tax purposes. The Court held that the amount included in the damages for profits lost as a result of the defendant's negligently damaging the plaintiff's jetty was taxable as profit earned from trade. Similarly, this Court has also looked behind awards of damages or settlements to determine whether to characterize a payment as a capital gain or business income: see, for example, R. v. Manley; Mohawk Oil Co. v. Canada, [1992] 2 F.C. 485 (C.A.); T. Eaton Co. v. Canada, [1999] 3 F.C. 123 (C.A.).
[36]In paragraph 6(1)(f), however, Parliament has precisely defined the circumstances under which a sum is taxable: that is, when it is "payable . . . on a periodic basis . . . pursuant to . . . a disability insurance plan". In my opinion, it is not open to the Court to characterize a lump sum paid in settlement of a disputed claim as falling within this description merely because the claim that the parties settled involved an allegation by the insured person that the insurer had breached its obligation under the policy to make periodic payments.
[37]The particularity and complexity of the definitions in subsection 6(1) of income from an office or employment are a warning to courts not to "dream up imaginative ways" of bringing within its scope payments that would appear clearly to fall outside the wording of paragraph 6(1)(f). As the Supreme Court of Canada said in Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R 1082, at paragraph 53, "this Court has repeatedly stated that in matters of tax law, a court should always be reluctant to engage in judicial innovation and rule making."
[38]Further, recent decisions of the Supreme Court of Canada seem generally to favour an approach to the imposition of tax that gives effect to the legal nature of the transactions entered into by the taxpayer, provided that they are not shams, rather than one that emphasizes the underlying economic or business realities and disregards the legal forms used by the taxpayer: Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622.
[39]In the present appeal, the settlement expressly states that the parties agree that the insurer is not admitting that it was liable to Ms. Tsiaprailis under the contract of insurance. It is therefore difficult to conclude that, as a matter of law, the payment was made pursuant to the contract of insurance. Further, since the settlement provided for a lump sum payment, the money received in payment of the settlement debt was not "payable on a periodic basis".
[40]The settlement replaces whatever legal rights the parties had under the insurance contract. Thus, for example, the insurer could not resist a claim by Ms. Tsiaprailis for payment of the amount promised in the settlement on the ground that she was no longer disabled. Hence, since the lump sum received by Ms. Tsiaprailis was paid in discharge of the insurer's liability under the settlement, it was surely paid pursuant to the settlement, and not pursuant to the disability insurance policy. If the insurer had been liable to pay pursuant to the policy, the liability was terminated by the settlement.
[41]In my opinion, it would be inconsistent with the general thrust of the Supreme Court's jurisprudence to impose tax by looking behind the legal nature of the contract under which the payment was made to the underlying dispute. While the tension between form over substance and substance over form can never be definitively resolved, it seems to me that the Supreme Court has indicated it will be the exceptional case in which the Court should look beyond the legal arrangements made by the taxpayer, provided that they are not shams, something that was certainly not suggested in this case.
[42]The text of paragraph 6(1)(f), the principle that tax liability is generally imposed on the basis of the parties' transactions, and the absence of case law compelling a different conclusion in this case, are, in my opinion, sufficient to dispose of this appeal. However, I would also observe that the consequences of my colleague's view that paragraph 6(1)(f) applies to the "arrears" portion of the sum received by Ms. Tsiaprailis lend no support to the proposition that Parliament should be taken to have intended to subject it to taxation.
[43]First, the likely result of including a lump sum payment in Ms. Tsiaprailis' 1996 income is that she will pay income tax at a higher marginal rate than if she had received the same amount by way of disability insurance benefits on a monthly basis over the previous three years. Counsel put it succinctly: the Minister alleges that the amount of $105,000 was payable periodically, but proposes to tax it as a lump sum. However, the retroactive averaging provisions contained in sections 110.2 [as enacted by S.C. 2000, c. 19, s. 17] and 120.31 [as enacted idem, s. 30] of the Income Tax Act may provide some relief: see, however, Milliken v. Canada, [2002] 2 C.T.C. 2783 (T.C.C.), on the complexities and limited utility of these provisions.
[44]A case where a "substantive" analysis results in the imposition of additional tax on persons of limited means who have been, and may still be, unable to work as the result of a disability is not, in my respectful opinion, an appropriate occasion for departing from what is now the dominant approach to the determination of liability to taxation.
[45]Second, to subject any part of the settlement payment to tax under paragraph 6(1)(f) is likely to reduce incentives to settle and to make it even more difficult than it already is to settle disability insurance claims. Courts should be reluctant to interpret legislation in a way that is apt to deter the settlement of litigation.
[46]Third, to bring lump sum settlement payments within paragraph 6(1)(f) may lead to an undesirable degree of arbitrariness in the imposition of taxation. Settlements are generally concluded on the basis of a total settlement figure and, in light of the existing case law, parties would not have thought it important to consider how much of this amount should be attributable to "arrears" and how much to future payments.
[47]In addition, unlike the settlement in this case, settlements may not even specify how the lump sum is allocated between past and future payments. Pelletier J.A. says that the taxpayer must establish the quantum of his or her income and, if the Minister is not satisfied that a proper attribution has been made between "arrears" and future payments, the Minister can make a reasonable attribution and, on appeal, the taxpayer may attempt to refute the Minister's assumption. However, this leaves considerable discretion in the hands of the Minister and adds to the uncertainties surrounding the administration of income tax legislation.
[48]Finally, however, I must acknowledge that considerations of horizontal tax equity seem to militate in favour of taxing the lump sum in the hands of Ms. Tsiaprailis, since those to whom disability insurance benefits are paid on a periodic basis pay income tax on them. However, it is not always easy to determine whether taxpayers are similarly situated.
[49]For instance, even after the settlement, Ms. Tsiaprailis was not necessarily in the same situation as someone who had been receiving monthly payments pursuant to a disability insurance policy. The refusal of an insurer to pay benefits may cause the insured person great anxiety or force them into debt, especially, of course, if they have only limited means at their disposal. The payment of interest on the "arrears" will not necessarily compensate for losses of these kinds, although they may be factored implicitly into the final settlement figure.
[50]In my opinion, the resolution of the apparent inequity on which the Crown relies in support of the view that paragraph 6(1)(f) includes lump sums paid pursuant to settlements of disputes claims under disability insurance contracts is better left to Parliament. In a scheme as complex as the Income Tax Act, fairness may be too elusive and multifaceted a concept to justify a court's adopting an interpretation or application of particular provisions of the Act that does not sit comfortably with the language that Parliament has selected to convey its meaning and ignores the legal nature of the transactions entered into by the parties.
[51]For these reasons, I would dismiss the appeal with costs.