We will review the Supreme Court of Canada decision that explained why adjustments on awards are made as it relates to interest and income tax that may accrue on awards and why “tax gross up” comes into play.
This is a simple explanation extracted from the case law:
- earnings on the capital awarded are subject to income tax;
- an amount called tax gross-up is awarded to ensure that the amount will not be eroded by the tax liability.
A referenced case Palmquist v. Ziegler, 2010 ABQB 337 (CanLII) offers this discussion and leads us to the SCC decision Townsend v. Kroppmans, 2004 SCC 10:
When assessing an award under the Fatal Accidents Act, R.S.A. 2000, c. W‑15 (“FAA”), an assumption is made that the award is invested and earns interest. For this reason, the award is “discounted” to take the interest to be earned into account. However, because that interest income will also attract income tax, an additional adjustment called a “tax gross up” must also be made. The tax gross‑up is awarded to ensure that the compensation paid will not be eroded by the tax liability: Townsend v. Kroppmans, 2004 SCC 10 at para. 6.
Paragraph 6 in the Townsend decision states the following:
The same underlying rationale guides the attribution of management fees and tax gross-up. The law aims at ensuring that the value of the amounts awarded to victims is maintained over time. In tort law, victims of personal injuries are awarded management fees when their ability to manage the amount they receive is impaired as a result of the tortious conduct. The purpose of this segment of the award is to ensure that amounts related to future needs are not exhausted prematurely due to the inability of the victims to manage their affairs. Depending on the needs of the victims, more or less extensive help is required. The assessment is made on a case-by-case basis: Mandzuk v. Insurance Corporation of British Columbia, 1988 CanLII 16 (SCC), [1988] 2 S.C.R. 650. In the same vein, since the earnings on the capital awarded are subject to income tax, an amount called tax gross-up is awarded to ensure that the amount will not be eroded by the tax liability.
The Palmquist case also refers to paragraphs 19 and 21 from the SCC decision Townsend. It states:
In Townsend, the Supreme Court of Canada confirmed at paras. 19 and 21, that the assumptions that a plaintiff will invest the full amount of the award and that the interest on the award will be taxed, are notional assumptions and not predictions about what will actually happen to the award:
Future costs and loss of future earnings are amounts that are estimated because, by definition, they are not yet incurred or earned. Although this hypothesis may seek to simulate reality, it remains notional. Courts can only provide the victim with an adequate amount to cover the loss caused by the defendant. There is no assurance that the amount will cover the actual costs of care that become incurred nor is the defendant guaranteed that he or she is not disbursing more than the strict minimum that becomes necessary to cover the victim’s loss. In assessing damages, courts do not take into consideration what victims actually do with the award. The fact that the respondent here had to wait for almost five years before management fees were assessed creates an atypical situation, but these exceptional circumstances should not justify a departure of the usual rules. Notional amounts cannot be mixed with actual amounts when assessing future damages.
…
This final and most important principle is that the plaintiff has property of the award. The plaintiff is free to do whatever he or she wants with the sum of money awarded: Andrews, supra, at pp. 246‑47. On this issue, I am in complete agreement with the reasons delivered by Finch C.J.B.C. in the Court of Appeal. He held that it is not relevant to inquire into how the plaintiff chooses to spend the amounts recovered for the assessment of damages for management fees and tax gross‑up. Consequently, management fees and tax gross‑up are to be assessed based on the first assessment of damages and not according to the amount available for investment as eventually found at some indeterminate future date. In other words, the appropriate basis for calculation is the one determined at trial, without considering what happens thereafter. It is improper for a trial judge to consider what the plaintiff does with awarded damages.
The summary of the Supreme Court of Canada decision is also helpful in understanding “tax gross up” and is copied here:
Torts — Damages — Determination of award — Whether rate of return should be taken into account in assessing award — Whether tax gross-up and management fees should be calculated on award established at trial or on figure determined at later date — Law and Equity Act, R.S.B.C. 1996, c. 253, s. 56 — Law and Equity Regulation, B.C. Reg. 352/81.
After assessing damages against the appellants in the respondent’s action arising out of a motor vehicle accident, the trial judge issued supplementary reasons to deal with the tax gross-up and management fees. By then, the respondent had already received partial payment and spent part of it purchasing a house and paying legal fees. The trial judge deducted the capital expenditure and the legal fees in calculating management fees and the tax gross-up. He also reduced the fee award by 50 percent to account for a predicted increased return, assumed to result from the investment counselling for which the management fee award was granted. In British Columbia, the discount rates are fixed by the Law and Equity Regulation and a four-level classification for calculating management fees is regularly applied by the courts. The Court of Appeal unanimously held that the evidence did not support the reduction of the award for management fees and that management fees and the tax gross-up were to be calculated in relation to the full amount of damages awarded, without deducting the respondent’s legal fees and the capital investment.
Held: The appeal should be dismissed.
The higher rate of return on the award attributed to investment counselling should not result in a reduction of the award. The statutory discount rates do not take investment costs into consideration and apply in all cases. Moreover, the fee classification was formulated on the basis that victims do not benefit from advice costs being already built into the statutory discount rate. Indeed, deducting the difference between the potential rate of return and the statutory rate from the award would defeat the whole purpose of the deeming provisions, which is to render irrelevant any evidence on actual or potential rates of return or inflation. The effect of the statutory rate and the classification cannot be avoided by claiming a reduction in the fees award. The legislature made a policy choice which the courts must respect.
The cost of the respondent’s legal fees and house should not be deducted from the amount upon which management fees and tax gross-up are calculated. This conclusion is supported by three principles involved in assessing damages. First, since damages are assessed, not calculated, the notional amount assessed for future damages cannot be mixed with actual amounts. Second, the principle of finality would be undermined if the award were to be adjusted for changing circumstances. Finally, the plaintiff has property of the award and how he or she chooses to use it is irrelevant.
Cases Cited
Applied: Andrews v. Grand & Toy Alberta Ltd., 1978 CanLII 1 (SCC), [1978] 2 S.C.R. 229; referred to: Mandzuk v. Insurance Corporation of British Columbia, 1988 CanLII 16 (SCC), [1988] 2 S.C.R. 650; Arnold v. Teno, 1978 CanLII 2 (SCC), [1978] 2 S.C.R. 287; Walker v. The King, 1939 CanLII 2 (SCC), [1939] S.C.R. 214.
Statutes and Regulations Cited
Law and Equity Act, R.S.B.C. 1996, c. 253, s. 56 [ad. 1981, c. 10, s. 30].
Law and Equity Regulation, B.C. Reg. 352/81.
Rules of Court, B.C. Reg. 221/90, r. 37(23).
Authors Cited
British Columbia. Law Reform Commission. Report on Standardized Assumptions for Calculating Income Tax Gross-up and Management Fees in Assessing Damages. Vancouver: The Commission, 1994.
APPEAL from a judgment of the British Columbia Court of Appeal (2002), 2 B.C.L.R. (4th) 10, 171 B.C.A.C. 11, 280 W.A.C. 11, 12 C.C.L.T. (3d) 88, [2002] B.C.J. No. 1287 (QL), 2002 BCCA 365, allowing an appeal from a decision of the British Columbia Supreme Court, [1998] B.C.J. No. 2447 (QL), and its supplementary reasons regarding damage awards for management fees and tax gross-up, [2000] B.C.J. No. 1352 (QL), 2000 BCSC 964. Appeal dismissed.
Patrick G. Foy, Q.C., and Robert J. C. Deane, for the appellants.
Joseph J. Arvay, Q.C., and Aaron A. G. Gordon, for the respondent.
The judgment of the Court was delivered by
1 DESCHAMPS J. — This appeal deals with issues which are often raised in large personal injury cases. It concerns management fees and tax gross-up awarded to a victim in a tort case. More specifically, first, should the award take into account the rate of return by the victim and, second, should the tax gross-up and management fees be calculated on the estimated amount established at the time of the trial or on some other figure likely to become known at a later date. This Court dismissed the appeal at the conclusion of the hearing, with reasons to follow.
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