7 August 2014 External T.I. 2014-0521901E5 - Damages in settlement of grievances

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 a settlement amount received is taxable.

Position: Question of fact.

Reasons: See response below.

XXXXXXXXXX
2014-052190
S.Trop

August 7, 2014

Dear XXXXXXXXXX:

Re: Income tax status of a payment in settlement of grievances

We are writing in response to your letter of January 23, 2014, concerning the tax treatment of a payment to an employee in settlement of grievances.

In the situation described, the employer abolished the employee's position, but the employee remained employed by the same employer and was assigned different duties. The union filed grievances in regards to the abolition of the employee's position, alleging, notably, that the change in the employee's working conditions constituted discrimination, and was illegal. While the grievances were being treated, the employer introduced an early retirement program. The employee was eligible for this program and retired. The employee received a retirement allowance amount as well as a payment made in settlement of the grievances. You have asked whether the settlement amount received by the employee is taxable.

Our Comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (the "Act') and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, Advance Income Tax Rulings. Generally, compensation received by an employee from the employee's employer or former employer on account of damages may be a retiring allowance, employment income, non-taxable damages, or a combination thereof. Such a determination is a question of fact, which requires a thorough review of all of the facts relevant to the particular situation.

Retiring Allowance

Subparagraph 56(1)(a)(ii) of 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." 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. Two questions set out by the Courts to determine whether a connection exists for purposes of a retiring allowance are as follows:

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?

Only if the answer to the first question is no and the answer to the second question is yes, will the amount received be considered a retiring allowance.

Employment Income

If an amount is not a retiring allowance but received in respect of, in the course of, or by virtue of an office or employment, it may be taxable as employment income under paragraph 6(1)(a) of the Act. 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) of the Act. Paragraph 10 of Interpretation Bulletin IT-337R4, Retiring Allowances, states that "[s]pecial damages, such as those received for lost (unearned) wages or employee benefits, are taxable as employment income if the employee retains his or her employment or is reinstated." The Courts have consistently viewed damages received as the result of grievances filed by virtue of a contract of employment (e.g., grievance for violation of a collective agreement) to be taxable as employment income.

Non-Taxable Damages

As noted in paragraph 12 of IT-337R4, 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.

Summary

The taxation of settlement payments for income tax purposes is generally based on the nature and purpose of the settlement payment, which is question of fact. In most cases, the parties to the settlement agreement are in the best position to make this determination. You, the parties, have stated that the payment was for moral damages and unrelated to the loss of employment. As noted above, where it can be clearly demonstrated that the damages were unrelated to the loss of employment, the amount would likely be considered damages for personal injury and not taxable.

We trust these comments will be of assistance to you.

Yours truly,

Nerill Thomas-Wilkinson, CPA, CA
Manager
Business and Employment Income Section
Business and Employment Division
Income Tax Rulings Directorate