18 October 1989 Ministerial Correspondence 58444 F - Wittholding of Tax - Wrongful Dismissal Payment

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.

October 18, 1989

Dear Sirs:

Re:  Paragraph 153(1)(c) of the Income Tax Act (the "Act")

This is in reply to your letter of July 26, 1989, wherein you requested our confirmation of your understanding of the requirements relating to the withholding of tax pursuant to paragraph 153(1)(c) of the Act in the following situation.

An employee receives a settlement from his former employer with respect to a wrongful dismissal action.  The total settlement is divided as to his legal fees, damages for wrongful dismissal and pre-judgement interest on the damages.  It is your opinion that when the former employer makes the settlement payment he is required to withhold tax only on that portion of the settlement that relates to damages.  In your opinion, the portion that relates to his legal fees and pre-judgement interest is not included in the definition of the term "retiring allowance" as that term is defined in subsection 248(1) of the Act and, accordingly, no withholding of tax is required pursuant to paragraph 153(1)(c) of the Act on those amounts.

The Department takes the position that reimbursements for necessary legal expenses in wrongful dismissal cases will not be included in a taxpayer's income as' part of the retiring allowance, to the extent that they were actually incurred by the taxpayer.  Therefore, withholding tax will not be required on the payment of such reimbursements.

To benefit from this treatment, the terms of the settlement or court order must state that the award includes a specified sum in respect of the taxpayer's out-of-pocket legal expenses.  Reimbursement of legal fees are usually received by the taxpayer; however, the tax treatment would be the same where the former employer pays the taxpayer's lawyer directly.

We advise that Bill C-28, which received first reading in the House of Commons on June 20, 1989, has proposed changes to the Act with respect to this issue.

New paragraph 56(1)(i.1) of the Act would require a taxpayer to include in computing income amounts received as an award or reimbursement of legal expenses paid to collect or establish a right to a retiring allowance or benefits under a pension fund or plan in respect of employment.  Paragraph 56(1)(i.1) would be applicable to amounts received after 1985 other than amounts received in relation to legal expenses paid before 1986.

New paragraph 60(o.1) of the Act would provide for the deductibility of eligible legal expenses paid after 1985 to collect or establish a right to a retiring allowance or pension benefits. Eligible legal expenses would be deductible in a taxation year to the extent they do not exceed the retiring allowance or pension benefits to which such expenses relate.  The income against which eligible legal expenses may be deducted may be reduced by virtue of a transfer to a registered retirement savings plan or register pension plan pursuant to paragraph 60(3) or (3.1) of the Act.  The non-deductible portion of such expenses would be eligible for carry forward and deduction in any of the seven subsequent taxation years, to the extent further related income arises. New paragraph 60(o.1) of the Act would be applicable to the 1986 and subsequent taxation years.

We have taken the position that "pre-judgement interest" received would be excluded from income and, as such, withholding tax is not required on the payment of such amounts.

We trust our comments will be of assistance to you.

Yours truly,

for Director Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch