16 August 1996 External T.I. 9618015 - WRONGFUL DISMISSAL SETTLEMENT

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

whether damages for wrongful dismissal, loss of reputation, aggravated damages, punitive damages and mental distress are a retiring allowance

Position: represents a retiring allowance

Reasons:

the reference to "damages" in the definition of a retiring allowance may incorporate more than damages for wrongful dismissal and thus may include other forms of damages

									961801
XXXXXXXXXX							D. Zion

Attention: XXXXXXXXXX

August 16, 1996

Dear Sirs:

Re: Wrongful Dismissal

This is in reply to your correspondence of May 17, 1996, wherein you request that we provide you with a ruling concerning the tax treatment and withholding requirements applicable to amounts awarded from the out-of-court settlement of a wrongful dismissal action.

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only when the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R2. Where the particular transactions are completed, the enquiry should be addressed to the relevant Tax Services Office. While we are unable to provide you with a ruling in this instance, we can however, give you our general comments in response to the issues you have raised.

As explained in paragraph 2 of Interpretation Bulletin IT- 337R2, a "retiring allowance" is defined in subsection 248(1) to mean an amount "... received on or after retirement of a taxpayer from an office or employment in recognition of one's long service or in respect of a loss of office or employment, 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". Retiring allowances do not include interest awarded in respect of the award, any unpaid employment income or any amount awarded in respect of expenses incurred to obtain the retiring allowance.

The taxation of damages was at issue in Young v. MNR (86 DTC 1567). In brief, Mr. Young sued his former employer for wrongful dismissal. In addition to damages for wrongful dismissal, the court awarded the taxpayer damages for mental distress and exemplary damages. The entire amount was treated as a retiring allowance and the taxpayer appealed to the Tax Court of Canada, contending that the damages for mental distress and the exemplary damages were damages in tort rather than damages for breach of the contract of employment. It was decided that the entire damage award was "in respect of a loss of an office or employment" and it therefore fell within the definition of retiring allowance.

As mentioned, generally, payments made by an employer to an employee in connection with a loss or termination of employment, whether or not received as damages or pursuant to an order of a competent tribunal, would be characterized as a retiring allowance. However, where the portion of the award or settlement amount that is in respect of damages can be satisfactorily shown to be related to violations of the prevailing human rights legislation, then that portion, within limits, will not be subject to tax. Whether such violations are involved and whether the amount of damages reasonably relate to those violations will always be a question of fact. To the extent that the settlement amount reflects court awards under comparable circumstances the amount received would be considered as not subject to tax. Any excess would, however, be characterized as a retiring allowance for tax purposes.

The reporting and withholding requirements pertaining to the payment of a retiring allowance are described on pages 6-16, 7-5 and 7-6 of the "Employers' Guide to Payroll Deductions - Basic Information" (we have enclosed copies of the relevant pages of this Guide). In general, the lump sum withholding rates are used to determine the amount of income tax to be withheld and the retiring allowance is reported in box 26 of the T4A supplementary.

The reimbursement of legal costs are not considered part of a retiring allowance but are taxable under paragraph 56(1)(l.1) of the Act. Legal expenses related to the collection of, or establishment of, the right to a retiring allowance are deductible to the extent permitted under paragraph 60(o.1) of the Act. No withholding is required in respect of an amount so reimbursed. Amounts paid directly to the attorneys in respect of legal costs in circumstances where the settlement award is not subject to tax would not attribute to the employee as a taxable amount and no withholding would be required from the amounts paid by the employer.

Interest awards in respect of the settlement of employment contracts are included in income as income from employment where they are computed with respect to amounts of unpaid remuneration and are in respect of periods prior to the rendering of the judgement. Interest earned after the date of judgement must be included in income as ordinary interest. The Department's position in respect of prejudgment or presettlement interest paid on an award or settlement for wrongful dismissal is currently under review. Interest payable in respect of any other type of retiring allowance would be taxable as interest as stated in paragraph 12 of Interpretation Bulletin IT-396R "Interest Income."

We trust our comments will be of assistance to you.

Yours truly,

J.A. Szeszycki
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

enclosure