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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation] Are court awards for wrongful refusal to reinstate an employee taxable and on what basis? The amounts awarded include compensation, interest and reimbursement of part of the legal expenses.
Position: The compensation award is a taxable retiring allowance pursuant to subparagraph 56(1)(a)(ii) of the Act. The amount awarded or reimbursed for legal expenses incurred to recover or establish an entitlement to a retiring allowance must be added to income pursuant to paragraph 56(1)(l.1).
Pre-judgment interest granted by a pre-2004 order is not taxable. However, post-judgment interest is taxable interest income under paragraph 12(1)(c).
Reasons: The compensatory award is an amount received in respect of the taxpayer's loss of employment.
The reimbursement of legal costs follows the wording of section 56(1)(l.1).
The administrative position (which has been changed for orders or out-of-court settlements dated on or after January 1, 2004) was that pre-judgment interest relating to wrongful dismissal awards was not taxable. For out-of-court orders or settlements dated on or after January 1, 2004, it will be taxable.
June 28, 2004
Mr. XXXXXXXXXX Headquarters
XXXXXXXXXX Tax Services Office Sylvie Labarre, CA
(613) 957-8981
2004-007376
Compensation received by XXXXXXXXXX
This is further to your fax of April 29, 2004, in which you requested our opinion on the tax treatment of amounts paid to XXXXXXXXXX (the "taxpayer") by XXXXXXXXXX (the "corporation") as a result of a decision of the Trial Division of the Federal Court of Canada.
Facts
The taxpayer was employed as XXXXXXXXXX by the corporation. He was dismissed from his position on XXXXXXXXXX. The taxpayer filed a wrongful dismissal claim which was found to be partially substantiated by the arbitrator on XXXXXXXXXX. The arbitrator annulled the taxpayer's dismissal and ordered the corporation to reinstate the taxpayer to his duties and to pay him the wages he was deprived of between XXXXXXXXXX and XXXXXXXXXX. The arbitrator made the calculations for this period and added interest up to the date of payment on XXXXXXXXXX.
In XXXXXXXXXX, the corporation refused to reinstate the taxpayer because XXXXXXXXXX. Following the refusal of reinstatement, the taxpayer wanted to enforce the arbitrator's decision and obtain equivalent enforcement. He went to court. On XXXXXXXXXX, the Court found that the corporation never wanted to reinstate the taxpayer and that the refusal to reinstate him was based on unjustified grounds. The Court therefore decided that a compensatory indemnity should be paid by the corporation in the amount of $XXXXXXXXXX (i.e. $XXXXXXXXXX per month from XXXXXXXXXX until XXXXXXXXXX) with interest at the rate of XXXXXXXXXX% from XXXXXXXXXX. In addition, the Court awarded $XXXXXXXXXX to reimburse a portion of the taxpayer's legal fees.
Questions
You wish to know if the taxpayer should include in income the $XXXXXXXXXX compensation, interest, and the amount awarded as reimbursement of the taxpayer's legal fees, and on what basis. You also wish to know if the corporation issued the appropriate slip by issuing the taxpayer a T4 slip.
We do not comment on the tax treatment of the amounts received on XXXXXXXXXX as a result of the arbitral award of XXXXXXXXXX as it is not the subject of this request.
The term "retiring allowance" is defined in subsection 248(1) of the Income Tax Act (the "Act"). That definition provides that the term "retiring allowance" includes an amount received in respect of a loss of an office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal.
As noted in Interpretation Bulletin IT-337R4, in this context, the words "in respect of" have been held by the Courts to imply a connection between the loss of employment and the subsequent receipt, where the primary purpose of the receipt was compensation for the loss of employment. In order to determine whether there is a connection for the purposes of a retiring allowance, the Courts have formulated the following two questions:
1. But for the loss of employment would the amount have been received? and,
2. Was the purpose of the payment to compensate a loss of employment?
Under this Bulletin, a loss of office or employment usually refers to the elimination or expiration of a particular office or employment, for example, the abolition of a job or position for economic reasons or as the consequence of an employer's withdrawal from a particular business. However, a loss of office or employment may also refer to the loss of an income source of an employee who is released from an office or employment whether unilaterally or not.
In this situation, we are of the view that the $XXXXXXXXXX awarded to the taxpayer to compensate for the wrongful refusal to reinstate is in respect of the taxpayer's loss of employment. Therefore, the $XXXXXXXXXX is taxable as a retiring allowance pursuant to subparagraph 56(1)(a)(ii). That amount should have been reported on a T4A slip.
In addition, in this situation, the taxpayer has incurred judicial or extra-judicial costs to recover or establish an entitlement to a retiring allowance in respect of employment, and an amount of $XXXXXXXXXX was awarded to the taxpayer by the Court and reimbursed by the corporation in respect thereof. In such a case, this reimbursement is not included in the definition of retiring allowance in subsection 248(1) and consequently will not be included in the taxpayer's income by virtue of subparagraph 56(1)(a)(ii). However, the taxpayer will be required to include the $XXXXXXXXXX so repaid in computing his income pursuant to paragraph 56(1)(l.1). The corporation is not required to issue an information slip for the $XXXXXXXXXX.
The taxpayer will be able to deduct, pursuant to paragraph 60(o.1), an amount in respect of legal expenses to recover or establish an entitlement to the retiring allowance. The deduction of those expenses is subject to the limit allowed under that paragraph. Paragraph 23 of Interpretation Bulletin IT-337R4 explains the limit applicable to the deduction of those costs.
Furthermore, the Court awarded the taxpayer interest at the rate of XXXXXXXXXX% for the period beginning on XXXXXXXXXX. The interest paid to the taxpayer could therefore include pre-judgment interest and post-judgment interest. Pre-judgment interest is interest that is qualified as interest by the Courts or by an out-of-court settlement and is payable for the period between the event giving rise to the dispute and the date of the judgment or settlement. Post-judgment interest is interest that is payable for the period after the date of the judgment.
For out-of-court orders or settlements dated prior to January 1, 2004, there was an administrative position regarding the tax treatment of pre-judgment interest relating to wrongful dismissal awards. According to that position, pre-judgment interest on such amounts was not taxable. That position does not apply to out-of-court orders or settlements dated on or after January 1, 2004. For more information, please refer to Income Tax Technical News No. 30 dated May 21, 2004 under the heading "Pre-judgment interest".
In this situation, the order is dated XXXXXXXXXX. Therefore, the interest of XXXXXXXXXX% that is payable for the period from XXXXXXXXXX to the date of the order is not taxable. However, if there is post-judgment interest in this situation (i.e., interest calculated for the period from XXXXXXXXXX to the time of payment), it is interest income in the hands of the taxpayer and must be included in the taxpayer's income pursuant to paragraph 12(1)(c), even though the corporation did not issue the T5 information slip that it should have issued.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that these comments are of assistance. Should you require further information on the content of this document, please do not hesitate to contact us.
Ghislaine Landry, CGA
for the Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
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