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.
Toronto District Office
FROM- Small business and General Division A. Jane (613) 957-2126
L. Shepherd Office Examination
XXXX
This is in reply to your memorandum of May 8, 1986 and attachments regarding the income tax treatment of certain amounts awarded as damages under a judgment for breach of two employment contracts. The amounts awarded are based on commission that would have been earned had the two above-named taxpayers received proper notice of termination of their contracts of employment. You advise that although the taxpayers received the amounts (damages and accrued interest) under the judgment in 1984, they have not reported any amounts on their 1984 returns in this connection except for interest earned on these amounts after they received payment. In your view the damages appear to be for lost commissions, however, a quotation from page 30 of the judgment reads "... the respondents are entitled to compensation on the basis of a claim for damages for wrongful dismissal". You ask for our view as to how these amounts should be treated for income tax purposes.
As indicated in Interpretation Bulletin IT-365R (the "Bulletin"), the question of whether or not a taxpayer is in receipt of taxable income can be determined only by an examination of all the facts pertinent to the particular situation. The facts described below were ascertained from the judgment of the Court of Appeal.
The two taxpayers were long-term employees of Bell Canada. In 1976 and 1977 they were assigned to a division, "Phone Power", of a joint venture of Bell and other telephone companies to work as a selling team in respect of new long distance access programs. The contract of employment between the taxpayer and Phone Power (for which Bell was liable) called for a base salary and a commission of 10% on the increased revenue received by Bell as a result of sales effected by them with no upper limit on the amount of commissions that could be earned. The taxpayers became involved in negotiating some very large sales. However, before all commissions from these sales were fully earned, Bell unilaterally caused the contracts of employment to be changed by reassigning the taxpayers to other work and by reducing their commission rates. It would appear these changes occurred on November 8 and 1978 for the two taxpayers respectively and as a result they sued for their commissions.
At trial, the court found that Bell made the contractual changes to defeat the taxpayer's rights to their commissions. The trial judge awarded damages for breach of contract based on all commissions that would have been earned if the terms of employment had not been changed. On appeal to the Court of Appeal, it was held that the damages should have been limited to such commissions as the taxpayers would have earned during a period of reasonable notice of dismissal.
In the Court of Appeal's view, the contract of employment was considered terminated. At page 29 of the judgment the Court states, "The company having broken the contract, the plaintiff was not entitled to consider it as still subsisting".. However, the contract of employment was for an indefinite period and at common law there is an implied term that termination of an employment contract requires reasonable notice. Taking into account all of the circumstances, a reasonable period of notice was found to be 18 months. As stated by the court at page 26 "... a reasonable length of notice of termination in the circumstances of this case must be such as would reasonably enable the respondents to complete the sale of any programs which had been initiated by them prior to the purported termination of their employment in the capacities in which they had been hired in 1978 by Phone Power. For these reasons the Court held that the damages should be assessed on the basis of commissions on sales that probably would have been effected within the period of reasonable notice. Sales that would not have been effected until a later time should be excluded.
Special Release dated May 25, 1984, to IT-365R says that as a rule, taxable amounts include payments in lieu of earnings for the period of a reasonable notice, or any other payments made by virtue of the terms of the taxpayer's employment (explicit or implied). The damages awarded in this case were based on an implied term of the contract of employment and were assessed as commissions that would have been earned during a period of reasonable notice of termination.
According to paragraph 2 of the Special Release to the Bulletin, if the termination occurred after November 16, 1976 and before November 13, 1981, payments in lieu of earnings for the period of reasonable notice should be included in computing income as a termination payment under subparagraph 56(1)(a)(viii) and as defined in subsection 248(1) of the Income Tax Act as these two provisions read at that time. This would apply to the termination of Mr. Docherty who, it would appear, was terminated on November 27, 1978. Subparagraph 56(1)(a)(viii) and the definition in subsection 248(1) were added to the Act in respect of terminations of an office or employment after November 16, 1978. With respect to terminations occurring before that date, the jurisprudence indicates that amounts paid in lieu of reasonable notice are not taxable. Thus, in our opinion, damages awarded to Mr. Prozak in respect of termination of his employment on November 8, 1978 are not taxable.
We note that the court decision includes an award of pre-judgment interest on the damages awarded ($304,900 for Docherty and $306,100 for Prozak) at 11.5% per annum. In our view, this award of interest is not to be considered as taxable due to the policy set forth in the enclosed press release relating to pre-judgment interest awarded in 1984.
We return herewith the income tax returns for 1984 for both taxpayers.
Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch
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