Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Whether damages received in 2003 in respect of a loss of employment, which occurred on XXXXXXXXXX , would be subject to tax.
Position: Not taxable
Reasons: The Act did not contain any provisions dealing with the taxation of damages received in respect of terminations of employment occurring before November 16, 1978. Existing jurisprudence at the time held that such damages were not taxable.
2003-003753
XXXXXXXXXX Wayne Antle, CGA
(613) 957-2102
November 26, 2003
Dear XXXXXXXXXX:
Re: Damages for Termination of Employment
This is further to your letter of September 5, 2003, concerning whether the XXXXXXXXXX (the "Employer") is required to withhold income tax from damages paid to XXXXXXXXXX ("Mr. X") with respect to the termination of his employment on XXXXXXXXXX.
Mr. X was a tenured professor at the Employer when differences arose between himself and members of the Faculty of XXXXXXXXXX. As a result of these differences, Mr. X and the Employer entered into a settlement agreement in XXXXXXXXXX (the "XXXXXXXXXX Agreement") whereby Mr. X agreed to take early retirement effective XXXXXXXXXX. In XXXXXXXXXX, Mr. X alleged that the Employer failed to honour its obligations under the XXXXXXXXXX Agreement and commenced legal action. This action was settled and another settlement agreement was entered into in XXXXXXXXXX (the "XXXXXXXXXX Agreement").
Under the XXXXXXXXXX Agreement, Mr. X's performance was to be assessed for one year and, if his work were found not to be up to the standard of a full tenured professor, he would continue to be bound to take early retirement effective XXXXXXXXXX. Mr. X claimed that the assessment process required under the XXXXXXXXXX Agreement was not conducted fairly. The court agreed with Mr. X, ruling that he should not have been forced to take early retirement (as required by the XXXXXXXXXX Agreement) and, therefore, should have been entitled to continue as a tenured professor for XXXXXXXXXX years until his normal retirement date. The court also found that the measure of his damages was the value of the salary and benefits he would have earned up to XXXXXXXXXX, had he not been denied the right to continue under the fixed term contract provided by his tenure. The damages were reduced by an amount to account for Mr. X's failure to mitigate his loss from breach of the contract.
Mr. X was ultimately awarded damages in the amount of $XXXXXXXXXX, plus costs. The Employer was concerned that the damages may have been subject to withholding requirements. Consequently, when the damages were paid to Mr. X's lawyer in XXXXXXXXXX, the Employer withheld $XXXXXXXXXX to remit to the Canada Customs and Revenue Agency ("CCRA"). Mr. X's lawyer felt that there should be no withholding, and agreed to hold the withheld amount in trust pending a decision from the CCRA. This amount has since grown to over $XXXXXXXXXX with accumulated interest. You feel that the Employer was not required to withhold income tax from the damages and, therefore, the amount withheld can be released to Mr. X's estate.
The particular situation outlined in your letter relates to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments, which may be of assistance.
Under current tax law, damages received with respect to a loss of employment generally fall within the definition of "retiring allowance" in subsection 248(1) of the Income Tax Act (the "Act") and must be included in income pursuant to subparagraph 56(1)(a)(ii) of the Act. The definition of "retiring allowance" was amended in 1981 to include damages with respect to terminations that occurred after November 12, 1981. Since the termination occurred prior to this date, the damages would not constitute a retiring allowance.
Prior to November 12, 1981, a portion of certain amounts received as damages in respect of a loss of employment were included in income as a "termination payment". A termination payment was defined generally as the amounts received in respect of a termination of an office or employment (whether or not paid pursuant to an order of a competent tribunal), to a maximum of 50% of the taxpayer's income from that office or employment for the preceding 12 months. However, the definition of "termination payment" was added to the Act in 1978 applicable to amounts received in respect of a termination of employment occurring after November 16, 1978. Since the termination occurred before this date, it would not be considered a "termination payment".
For terminations occurring prior to November 16, 1978, there were no specific provisions in the Act to deal with the taxation of damages received with respect to a loss of employment. Consequently, the issue of the taxation of such damages was the subject of a number of court cases. The leading cases in this area were HMQ v. Atkins (76 DTC 6258) and HMQ v. Pollock (84 DTC 6370), both heard by the Federal Court of Appeal. In these cases, the court found that damages received due to the breach of an employment contract were not taxable, either as employment income, or as a retiring allowance (as that term was defined at the time).
Based on the existing tax law at the time of the termination of employment, and the jurisprudence, it is our view that the damages paid to Mr. X would not be subject to income tax. Accordingly, the Employer would not be required to withhold income tax from the damages paid.
It should be noted, however, that the interest earned on the withheld amount retained in the lawyer's trust account would be subject to income tax. Please refer to paragraph 10 of Interpretation Bulletin IT-129R Lawyer's Trust Accounts and Disbursements for more information in this regard. This document can be obtained from our website at www.ccra.gc.ca.
We trust that our comments will be of assistance.
Yours truly
John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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