Should collateral benefits be deducted gross or net of income tax?

On May 20, 2020, Justice Emery released his decision in  Farrugia v. Ahmadi et al 2020 ONSC 3149,  which  inter alia  concluded that deduction of long-term disability benefits and Canadian Pension Plan (CPP) disability payments from damages awarded for income loss under section 267.8(1) of the  Insurance Act, R.S.O. 1990,  must be made on a gross basis, before deduction of taxes. He stated that he came to this conclusion after considering:

• The general direction given by the court in Cadieux v. Cloutier, 2018 ONCA 903 143 O.R. (3d)
• Application of the specific principles on how tax should be treated in Nemchin v. Green, 2019 ONSC 6243

In Nemchin, Justice Corthorn held, in the case of an assignment of future taxable LTD benefits, that:

• “The taxation of collateral benefits is a matter between the state and Ms. Nemchin and does not affect the credit to which the defendant is entitled with respect to Ms. Nemchin’s rights to payments for LTD benefits.”
• “It is also incumbent upon the plaintiff to top up the amounts paid by Sun Life. It remains open to the parties to reach an agreement as to how to facilitate the top up.”

Prior to Nemchin, there was no case law supporting the deduction of gross collateral benefits. Two significant earlier cases, Bapoo v. Co-operators General Insurance, (1997-12-12) ONCA c25188 and  Anand v. Belanger  [2010] O.J. No. 1835 ,  that dealt with the issue of gross versus net decided precisely the opposite, supported by elaborate arguments of principle.

Examining the Act , s. 267.8(1) states that in an MVA tort action a plaintiff’s entitlement to income loss shall be reduced  inter alia  by “All payments in respect of the incident that the plaintiff has received or that were available before the trial of the action for income loss or loss of earning capacity under the laws of any jurisdiction or under an income continuation benefit plan.”

Similarly, s.267.8(9) requires  inter alia  that  “All payments in respect of the incident that the plaintiff receives after the trial of the action for income loss or loss of earning capacity under the laws of any jurisdiction or under an income continuation benefit plan”  are to be held in trust for the benefit of the defendant, unless an assignment of such payments is ordered per s.267.8(12).

We note that no specific qualification as to gross or net for such payments is made under the Act (unlike the equivalent provisions in the SABS  [Statutory Accident Benefits Schedules, O.Reg. 403/96 – Accidents On Or After November 1, 1996  and O. Reg. 34/10 Accidents On Or After September 1, 2010.], which was amended effective Sept. 1, 2010, from net to gross). Payments are, however, qualified in the Act by the words “received” and “receives.”

S.267.5 of the Act states that before trial, liability for damages in tort MVA actions are limited to 80% of the net income loss for accidents before Sept. 1, 2010, and 70% of the gross income loss thereafter. This amendment was made presumably to avoid the difficulty and imprecision of calculating applicable income taxes, with the difference of 10% assumed to be an approximate average of such taxes. Arguably, the fact that there was no equivalent levelling of the playing field with a similar 10% adjustment—say to 90% of gross benefits—indicates a legislative intent that collateral benefits be deducted on a net basis.

The general principle behind the deduction of collateral benefits is to ensure that the insured is not reimbursed for his or her income losses more than once. After deduction, however, the insured should equally not be placed in a worse position than had he or she not received such collateral benefits.

Given that tort income loss awards are not taxable, plaintiffs that receive taxable collateral benefits would be worse off in aggregate if their collateral benefits are deducted from their tort award entitlements on a before-tax basis than had they not received such collateral benefits, to the extent of the taxes payable on such benefits, as demonstrated in the simple example below:

In Bapoo, an IRB matter, Justice Laskin (with Justice Labrosse concurring) provided actual amounts that similarly illustrate this principle in an IRB context, and wrote: “This dictionary definition provides a plausible meaning for the word ‘received’ in the context of s.12(4)(b). Applying this meaning, Bapoo ‘received’ only the net disability payments because, as commonly occurs, the disability carrier… withheld the income tax payable and remitted it to Revenue Canada.”

“Section 12(4) of the Schedule was intended to avoid overcompensation; it was not intended to promote under compensation. Section 12(4) is an equality provision, treating recipients and non-recipients of collateral benefits equally. The interpretation advanced by Co-Operators turns s.12(4) into an inequality provision. Moreover, because the car insurer is the residual payer, the interpretation of s.12(4) advanced by Co-Operators provides a disincentive to insureds to obtain collateral insurance benefits. These results of permitting gross deductions fly in the face of the purpose of s.12(4) of the Schedule. I agree with arbitrator Mackintosh in Edgar v. Wellington Insurance Company, O.I.C. File No. A-005441, when she wrote, ‘I do not accept that it was the intention of the Legislature to penalize insureds who, through their own foresight or opportunity obtain collateral insurance benefits.’”

“The interpretation of a statutory provision should not only comply with the legislative text and promote the legislative purpose, it should yield a reasonable and just outcome. For the reasons I have already stated, permitting the car insurer to deduct gross disability income payments does not yield a reasonable and just outcome.”

In  Anand,  a tort case relating to an MVA that occurred prior to Sept. 1, 2010, the relevant issue at hand was the interpretation placed on the wording  “ received by ”  in determining the deductibility of benefits received on a gross or net basis (net of legal fees and disbursements in that case). Justice Stinson reasoned that the words  “ received by” meant actual receipts, and held that only net proceeds after deduction of legal fees and direct taxes thereon (in that matter) qualify as “payments received” by a plaintiff.

Specifically, Justice Stinson concluded that “To follow the defendant’s approach would be to place an injured plaintiff who has recourse to IRBs or LTD coverage in a worse position than someone who does not. Such a result would be illogical.”

Returning to  Farrugia,  Justice Emery dealt with:

• Bapoo by stating that although it was his initial impression that it would apply, that case turned on a section in the SABS that was not at issue in  Farrugia,  namely that of s.12(4) of the SABS and the meaning of “received,” concluding that “The issue of adjusting ongoing IRBs by deducting amounts payable from other sources in Bapoo was not the issue before this court. The reasoning and result in Bapoo should therefore be confined to the context of applying s.12(4)(b).” Even Laskin J.A. recognized in paragraph 13 that “in another context,” the word “received” could be interpreted more broadly to include amounts withheld for income tax.
• Anand and other cases that followed  Anand (Siddiqui v. Siddiqui, 2015 ONSC 6260  and  Green v. State Farm Mutual Automobile Insurance Co., [2009] O.J. No. 2713.),  by writing that  “The dispute about whether a statutory benefit should be deductible with or without deducting legal fees was put to rest by the Court of Appeal in Cadieux, where the Court held conclusively that s.267.8(1), (4) and (6) shall be reduced by the amount of accident benefits on a gross basis”  and “While the deductibility of legal fees was not an issue before me, the subtext of the approach in Cadieux provides direction of a general nature to this court.”

Justice Emery recognised the views expressed in both  Demers v. B.R. Davidson Mining & Development Ltd., 2011 ONSC 2046  and  A.B. and Waite v. Leroux, 2018 ONSC 2151,  that collateral benefits should be deducted net of taxes. However, although conceding,  “While there is no bright line,”  he considered the facts in  A.B. and Waite,  dealing in part with equitable apportionment of a lump sum settlement of future LTD benefits with an unknown tax liability, as distinguishable from those in  Nemchin,  where the court was addressing the issue of credit for income tax for periodic payments under an LTD plan. He also questioned if the references in  Nemchin  to the cases of  The Queen v. Jennings, 1966 CanLii (SCC)  and  Cooper v. Miller, 1994 CanLii 120 (SCC),  had been cited to Justice MacLeod in considering the submissions in A. B. and Waite.

Justice Emery, therefore, preferred the reasoning of Justice Corthorn in  Nemchin  and her reliance on  Jennings  and Cooper:  “After making an order for an assignment of future LTD benefits payable to the plaintiff…withholding tax at source was a mechanism through which the LTD carrier met its obligation to remit tax to the government. Her honour found this fact irrelevant to the rights of the plaintiff to receive payment for LTD benefits, whether or not income tax is deducted at source. She concluded that the defendant, in that case, was entitled to a credit for the gross amount of the payments to which the plaintiff would be entitled under the plan.”

In Nemchin, the case of  Jennings  was referenced in explaining why damages for loss of income are assessed on a gross basis, ignoring income tax implications: “The net sum representing what the plaintiff would have received after deduction of tax is not adequate compensation for loss of the ability to deal freely with the gross sum. Not only is the plaintiff deprived of his chance of dealing freely with his income as he thinks fit and so reducing his liability to tax, but third parties who might otherwise have benefited from such arrangements as the plaintiff might be disposed to make are unable to do so.”

Furthermore, in  Cooper,  Justice Cory wrote, “The recovering of tax damages for lost wages is a matter between the state and the individual, and does not affect the damages due to the plaintiff from the defendant. By analogy, the taxation of collateral benefits is a matter between the state and Ms. Nemchin and does not affect the credit to which the defendant is entitled with respect to Ms. Nemchin’s rights to payments for LTD benefits.”

Finally, in Nemchin, Justice Corthorn wrote, “With a defendant entitled to a credit for the full amount of the payments for LTD benefits to which a plaintiff has the right, the parties to an action are in the same position regardless of the tax status of LTD benefits paid.”

Notwithstanding the merits of Justice Emery’s arguments, we raise the following observations and questions:

• The Act does not specify if collateral benefit deductions are to be made at gross or net, but does employ the term “received.” Had it been the intent of the legislation that deductions be made at gross, an equivalent adjustment from 100% to 90% would arguably have been made effective Sept. 1, 2010, when the pre-trial liability threshold was reduced from 80% to 70% of income losses. No such adjustment was necessary if deductions were intended to be made on a net basis.
• The decision in  Bapoo  was rejected as it turns on the meaning of “received” in the SABS, which, according to Justice Emory was “not at issue” in Farrugia. Yet s.267.8 of the Act employs the same wording in relation to collateral benefits at issue in Farrugia.
• As opposed to a narrow reliance on factual and circumstantial differences between  Farrugia  and the  Bapoo, Anand  and  A.B. and Waite  cases, we question if the underlying principles set out in the  Bapoo  and  Anand  decisions have been adequately considered in this decision, or the inequitable consequence of under compensation flowing from such interpretation, as we have demonstrated.
• We question the basis of the assertion in  Nemchin  that with deduction of the full (gross) amount of LTD benefits, the parties to an action are in the same position regardless of the tax status of the LTD benefits. The plaintiff is clearly under-compensated in the case of taxable LTD benefits, as evidenced by the fact that he or she is responsible for a top-up payment equal to the tax liability.
• Furthermore, this decision has the unfortunate effect of incentivizing plaintiffs to forego claiming taxable collateral benefits in order to avoid the non-recoverable taxes incurred (especially in the case of assigning future benefits), a situation that would clearly be anathema for the tort insurer. Can this be correct?
• Whereas the argument that withholding tax at source is irrelevant to the rights of the plaintiff to receive payment for the full (gross) amount of taxable LTD benefits, does it necessarily follow, as assumed in Nemchin, that the same amount must be credited to the defendant under s.267.8 of the Act?
• Finally, there is nothing specific in the  Cadieux  decision justifying deducting taxable LTD benefits on a gross basis. As regards the general direction provided by the court in  Cadieux,  the court stated ,  “The words of the statute are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of the enacting legislative body.”

While a lot has been written about the issues of overcompensation and double recovery, this decision serves to undercompensate the plaintiff. In discussing the  Farrugia  decision, a client asked the question, “Would other courts, including the Court of Appeal, should a case arrive there, really give a different meaning to the word ‘received’ in such similar contexts, or are they so similar that the decision is likely to be overturned?” In his decision, Justice Emery acknowledged the existence of conflicting decisions and conceded that the debate about whether collateral benefits are to be deducted gross or net of income tax under s.267.8(1) has not yet been resolved.