CRA indicates that an employee indemnity, in a settlement agreement with the employer, regarding the employer’s failure to withhold, likely is not a reportable transaction

The settlement agreement between an employer and a terminated employee protected the employer against any claim in respect of failure to withhold income tax, CPP or EI. Was this a reportable transaction on the basis of being an avoidance transaction with a contractual protection hallmark?

Regarding that hallmark, CRA indicated that “[g]enerally, the person having contractual protection is the person that would be entitled to compensation in the event of a failure of the transaction to achieve a tax benefit” and that where an employer is protected by an indemnity clause like this “the contractual protection hallmark is unlikely to be triggered in most instances.” Presumably, this comment could reflect that the only tax “benefit” to the employer that is being protected by the indemnity is not bearing a 10% penalty under s. 227(8)(a) (assuming that the employee was resident.)

Regarding whether there was also an avoidance transaction, it noted that this is a “fact-driven determination” but went on to state:

Presumably, the main purpose of an employment settlement is to resolve a dispute between an employer and employee. In our view, the fact that damages are paid as a result of a settlement should not systematically lead to the conclusion that “one of the main purposes” of the settlement is to obtain a tax benefit. In situations where the parties negotiated in good faith and reached a principled settlement that provides for a proper characterization of the damages, it is unlikely that such settlement would qualify as an “avoidance transaction”.

However, it further indicated that a settlement could be reportable. For example, “the absence of legal or factual basis to the payment of non-taxable damages could lead to a determination that the settlement is an ‘avoidance transaction’.”

Neal Armstrong. Summaries of 7 June 2024 External T.I. 2024-1006831E5 under s. 237.3(1) - contractual protection - (a)(i)(A), - avoidance transaction.