8 October 1996 Income Tax Severed Letter 9627015 - Loss of employment, mental distress, damages

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:

taxability & withholding requirements for an award of damages relating to loss of employment & torts

POSITION:

amounts received in respect of a loss of employment, whether or not received as damages, are included in income under 56(1)(a)(ii) as a retiring allowance as defined in ss 248(1) of the Act. In a wrongful dismissal action that also involves a violation or alleged violation of human rights, an award for general damages may also be granted in respect of mental anguish or similar suffering arising from such violation or alleged violation of the employee's human rights. Reimbursement of legal fees (or award in respect of legal fees) included in income under 56(1)(l.1) but no withholding required. If client's legal representative is entitled to a part of the award which is characterized and paid as "damages" by the payor then such amount is included under 56(1)(a)(ii) and not 56(1)(l.1) as the amount is not "received ...as an award or a reimbursement in respect of legal expenses..." notwithstanding that additional legal fees may have to be paid from the award under the terms of a separate agreement between the client and his or her legal representative.

REASONS:

962701 XXXXXXXXXX Sandra Short

Attention: XXXXXXXXXX

October 8, 1996

Dear Sirs:

Re: Settlement for Loss of Employment, Mental Distress, Other

This is in reply to your letters of July 18 and September 18, 1996, which asks whether an out-of-court settlement amount should be characterized as a retiring allowance or as damages paid in tort.

You have asked that we consider the situation of an employee who has claimed contractual damages for wrongful dismissal and, in the alternative, damages for the torts of negligent misrepresentation and mental distress. The Minutes of Settlement provide that the parties to the settlement "understand and agree that these Minutes of Settlement represent a compromise of a doubtful and disputed claim, and that the settlement of this claim does not constitute any admission of liability on the part of the Defendant to the Plaintiff and that such liability is specifically denied." Given this statement, the amount awarded cannot be tied to any particular claim for damages although a specified portion of the lump sum award is to cover legal costs and disbursements.

As discussed in our telephone conversation of September 30 (XXXXXXXXXX/Short), if you wish to be advised of the tax consequences of a specific proposed transaction, an advance income tax ruling request must be made in the manner set out in Information Circular 70-6R2 and the Special Release attached thereto, dated September 30, 1992. We are prepared, however, to offer you the following general comments.

Amounts received in respect of a loss of employment, whether or not received as damages, are included in income under subparagraph 56(1)(a)(ii) of the Income Tax Act as a retiring allowance, as this term is defined in subsection 248(1) of the Act.

The taxation of damages was at issue in Young V MNR [ [1986] 2 C.T.C. 475] (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.

Generally, and as stated above, 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, are characterized as a retiring allowance. For example, damages received as compensation for mental distress suffered by an employee as a result of the loss of employment would be taxed as a retiring allowance. The Department acknowledges that general damages relating to human rights violations can be considered unrelated to the actual loss of employment despite the fact that the loss of employment is often a direct consequence of the human rights complaint. To the extent that damages which are awarded by a human rights tribunal, or are a settlement in lieu thereof, do not relate to the loss of employment but relate solely to damages arising from a human rights violation, such damages are not required to be included in income.

The reimbursement of legal costs do not form part of a retiring allowance but such amounts are taxable under paragraph 56(1)(l.1) of the Act. Paragraph 56(1)(1.l) requires the inclusion in income of "amounts received by the taxpayer in the year as an award or a reimbursement in respect of legal expenses...." The reimbursement of legal fees described in paragraph 56(1)(l.1) of the Act is not a payment described in subsection 153(1) of the Act nor is it an amount included in the definition of "remuneration" as found in subsection 100(1) of the Regulations. As a result, there is no statutory requirement for an employer to withhold tax from such amounts or to report such amounts on an information slip.

If there is a Contingency Fee Agreement in place such that the client is required to pay his or her legal representative a percentage of any gross amount recovered as "damages" in addition to any disbursements or other legal charges, then the amount required to be paid by the client under the terms of the Contingency Agreement is not an "award or reimbursement in respect of legal expenses" as referred to in paragraph 56(1)(l.1), notwithstanding that the client is required to pay an amount of legal fees from the damage award. It is our opinion that the gross amount awarded as "damages" is required to be included in income under paragraph 56(1)(a)(ii), to the extent such damages relate to the loss of employment.

Legal expenses related to the collection of, establishment of, or the right to a retiring allowance are deductible to the extent permitted under paragraph 60(o.1) of the Act. In this regard, see paragraphs 21-23 inclusive of Interpretation Bulletin IT-99R4.

The Department's position on prejudgment or presettlement interest paid on an award or settlement for wrongful dismissal is currently under review. Interest payable on any other type of retiring allowance is 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,

Jack Szeszycki for Director Business and Publications Division Income Tax Rulings and Interpretations Directorate Policy and Legislation Branch