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: Is a payment for general damages upon termination subject to income tax and withholding?
Position: In this case likely yes.
Reasons: It appears that the general damages amount received relates to termination of employment. As such, the general damages payment would be considered a retiring allowance and included in income under subparagraph 56(1)(a)(ii) of the Act. Withholding is required under 153(1)(c) of the Act. However, if it is determined that a portion of the general damages payment relates to settlement of the non-termination grievances, this portion of the payment will be taxable under paragraph 6(1)(a) of the Act and subject to withholding. If it is determined that a portion of the general damages can be traced to events or actions unrelated to or separate from the loss of employment, this portion of the payment will be treated as non-taxable.
XXXXXXXXXX
2011-042865
P. Waugh
July 26, 2012
Dear XXXXXXXXXX:
Re: General Damages
We are writing in response to your letter of November 14, 2011, concerning the taxation of general damages awarded to an individual during arbitration of several grievances.
In the situation you described, an individual was terminated by his or her employer XXXXXXXXXX. An original termination settlement was reached to award the individual a termination payment consisting of “in lieu of notice”, severance and vacation pay. At the time of termination, the individual had several grievances outstanding with the employer. An additional grievance was filed for termination without just cause. At arbitration, the termination settlement was revised to include an additional amount for general damages and it was agreed that the individual would withdraw all existing grievances. The arbitration award states that the payment for general damages is to be paid to the individual without income tax withholdings. You have asked for clarification whether income tax should be withheld from this payment.
Our Comments
The determination of whether a particular amount received by an employee upon or after termination of employment constitutes employment income, a retiring allowance, non-taxable damages, or a combination thereof, can only be made after a thorough review of all of the circumstances relevant to the particular situation. The words used in a settlement agreement to label a payment may not always reflect the actual character or reason for the payment. Also, where payments are made to settle a grievance without the grievance being fully addressed, the underlying grievance will be considered in determining the purpose of the payment. In addition, if there is any indication that there may be more than one purpose for a payment, a reasonable attempt must be made to allocate the payment between each purpose if the income tax consequences will vary.
Subparagraph 56(1)(a)(ii) of the Income Tax Act (the “Act”) requires a taxpayer to include in computing income for a taxation year the amount of a retiring allowance received by the taxpayer in the year. The definition of “retiring allowance” in subsection 248(1) of the Act 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.”
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, etc. Only where an award of damages can be traced to events or actions unrelated to or separate from the loss of employment will damages not be considered a retiring allowance.
Damages received in connection with a loss of employment clearly fall within the definition of a retiring allowance and consequently are taxable by virtue of subparagraph 56(1)(a)(ii) of the Act and subject to income tax withholding under paragraph 153(1)(c) of the Act. If an amount is not a retiring allowance but still related to an office or employment, it may be taxable as employment income under paragraph 6(1)(a) of the Act.
Paragraph 6(1)(a) of the Act generally includes in a taxpayer’s income from an office or employment “the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of an office or employment”, except any benefit specifically excluded by subparagraphs 6(1)(a)(i) to (v), none of which apply here. It is well established that the phrase “in respect of, in the course of, or by virtue of an office or employment” means that there need only be a small connection between a benefit and the employment in order to trigger the operation of paragraph 6(1)(a). In a number of situations where damages have been received as the result of grievances filed against an employer (e.g. grievance for violation of collective agreement), the courts have found such amounts to be taxable under paragraph 6(1)(a) of the Act and subject to income tax withholding.
As noted in paragraph 12 of IT-337R4, Retiring Allowances, where general damages are received in respect of personal injuries sustained before or after the loss of employment (for example, in situations of harassment during employment or defamation after dismissal), or where a loss of employment involves a human rights violation and is settled out of court, general damages may be viewed as unrelated to the loss of employment and therefore non-taxable. In order to claim that damages received upon loss of employment are for personal injuries unrelated to the loss of employment, it must be clearly demonstrated that the damages received relate to events or actions separate from the loss of employment.
Based on the information provided, it appears that the general damages payment relates to the individual’s loss of employment. As such, the general damages payment would be considered a retiring allowance which is included in income under paragraph 56(1)(a)(ii) of the Act and subject to income tax withholding under paragraph 153(1)(c) of the Act.
For more information on retiring allowances and settlements, please refer to IT-337R4 and Interpretation Bulletin IT-365R2, Damages, Settlements and Similar Receipts.
We trust these comments will be of assistance.
Nerill Thomas-Wilkinson, CA
Manager
for Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2012
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2012
Email this Content