29 January 2007 External T.I. 2006-0195221E5 - Damages for wrongful dismissal

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.

Principal Issues: Whether any part of damages paid to a taxpayer for wrongful dismissal can be considered non-taxable.

Position: Question of fact; however, most of the damages would likely constitute retiring allowances.

Reasons: Only where an award of damages relate to events or actions unrelated to or separate form the loss of employment will damages be treated as non-taxable.

XXXXXXXXXX 								2006-019522
J. Gibbons, CGA
January 29, 2007

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (the "Taxpayer")

This is in response to your facsimile dated July 10, 2006, concerning the income tax treatment of payments to be made to the Taxpayer pursuant to a judgment (the "Judgment") of the Ontario Superior Court of Justice (the "Court") relating to the wrongful dismissal of the Taxpayer by the XXXXXXXXXX (the "Former Employer").

Facts

• The Taxpayer was hired by a predecessor of the Former Employer in XXXXXXXXXX and in XXXXXXXXXX was assigned by the Former Employer to the position of XXXXXXXXXX, the position from which he was eventually dismissed.
• XXXXXXXXXX.
• The Court concluded that the conclusions of the Former Employer concerning the Taxpayer's XXXXXXXXXX were false and that there were no grounds for the Taxpayer's dismissal. The Court also found that the manner in which the Taxpayer was dismissed was wrongful and malicious.
• The Court ordered the Former Employer to pay the following damages:

Intangible damages flowing from the wrongful actions of the Former Employer resulting in humiliation, embarrassment, loss of self-esteem, and loss of enjoyment of social activities

$XXXXXXXXXX
Intangible damages flowing from the wrongful actions of the Former Employer resulting in damage to the Taxpayer's physical and mental health

$XXXXXXXXXX
Damages for failure to provide notice of termination
$XXXXXXXXXX
Damages for the misconduct of the Former Employer that prevented the Taxpayer from finding alternative employment beyond the 15 month notice period

$XXXXXXXXXX
Damage for the misconduct of the Former Employer that resulted in the Taxpayer earning less income from a subsequent employer

$XXXXXXXXXX
Punitive damages
$XXXXXXXXXX
Damages for defamation relating to a memo from the Former Employer to Human Resource Development Canada concerning the Taxpayer's dismissal

$XXXXXXXXXX

Special damages for expenses incurred in seeking new employment, i.e., postage, paper, ink, ads, etc.

$XXXXXXXXXX
Prejudgment interest
To be calculated

• The Taxpayer's lawyers contend that only the damages received for failure to provide notice of termination are taxable.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following general comments.

A "retiring allowance" is defined in subsection 248(1) of the Income Tax Act to include "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." The courts have generally taken the view that a retiring allowance includes any compensation on account of damages for a loss of employment, including special damages, as well as general damages received for loss of self-respect, humiliation, mental anguish, hurt feelings, etc. Also, where the payment of damages arising from the loss of office or employment includes an amount in respect of the period of reasonable notice, this latter amount is also considered a retiring allowance. Only where an award of damages can be traced to events or actions unrelated to or separate from the loss of employment will damages be treated as non-taxable. These principles are outlined in Interpretation Bulletin IT-337R4, Retiring Allowances.

As a general rule, where the actions or events causing personal injuries occurred before or after a loss of employment, the damages received in respect of those injuries may be viewed as unrelated to the loss of employment and thus non-taxable. For instance, this would apply in situations of harassment occurring during employment or defamation after dismissal. In trying to ascertain the appropriate treatment of an award of damages where some of all such amounts may relate to a loss of office or employment, the courts have taken the view that consideration should be given to whether the damages would have been received if it were not for the loss of office or employment. If not, the damages are considered to have been received in respect the loss of office or employment and, accordingly, taxed as a retiring allowance.

Based on the foregoing, is our view that only the damages received by the Taxpayer for defamation would likely be non-taxable, based on our understanding that this portion of the award is in respect of defamation that occurred subsequent to the dismissal. In regard to other damages, we considered it doubtful whether they would have been awarded to the Taxpayer were it not for the loss of his employment. Nonetheless, if, after a thorough analysis of all of the facts and circumstances, it were established that some of the damages do in fact relate to events occurring either before or after employment, such portions of the damages would be also non-taxable.

A person paying a retiring allowance is required to report the amount of the retiring allowance on a T4A slip. In this regard, the amount of a retiring allowance that is eligible to be transferred to the recipient's RPP or RRSP pursuant to paragraph 60(1)(j.1) of the Act must be recorded in Box 26 of the T4A slip with the balance to be reported in Box 27 of the T4A. This information is contained in RC4157 - Deducting Income Tax on Pension and Other Income, and Filing the T4A Slip and Summary Form, which, along with the other publications referred to herein, can be found on the Canada Revenue Agency's website located at www.cra.gc.ca.

Please note also that the pre-judgment interest is considered taxable interest income and is required to be reported on a T5 slip.

We trust that the above information is helpful.

Yours truly,

Randy Hewlett
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch