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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Tax implications of wrongful dismissal awards
Position: General comments given explaining our policy.
Reasons: A specific situation was not presented. Tax implications depend upon whether damages can be characterized as a retiring allowance, or salary; and whether any portion of damages relates to a human rights violation. Post-judgment interest would be taxed as interest income. Effective for 2004, pre-judgment interest would likewise be considered interest. Withholding is required on salary, and retiring allowance. No withholding is required on interest.
2003-002146
XXXXXXXXXX Wayne Antle, CGA
(613) 957-2102
September 29, 2003
Dear XXXXXXXXXX:
Re: Technical Interpretation Request: Wrongful Dismissal Awards
This is further to your letter of May 27, 2003, concerning the tax treatment of wrongful dismissal awards, including amounts awarded for punitive damages, aggravated damages, mitigation expenses, interest, and legal costs. We will outline our general position on each of these components below.
Damages
Generally, compensation received by an individual from the individual's former employer on account of damages related to a loss of employment is either employment income or a retiring allowance. Whether an amount received by an employee, upon or after termination of employment, is income from employment, and therefore included in income pursuant to subsection 5(1) of the Income Tax Act (the "Act"), or a retiring allowance that is included in income pursuant to subparagraph 56(1)(a)(ii) of the Act, is a question of fact that can only be determined after a review of the employment contract, other agreements and all of the other circumstances relevant to a particular situation.
Retiring Allowance
"Retiring Allowance" is defined in subsection 248(1) of the Act to include "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". Therefore, in all likelihood, punitive damages and aggravated damages would be taxed as a retiring allowance if the payments arise from an employee's loss of employment.
However, as noted in paragraph 9 of Interpretation Bulletin IT-337R3 Retiring Allowances, where the portion of the award or settlement amount that is in respect of damages can be shown to be related to a violation of the prevailing human rights legislation, then that portion will not be considered a retiring allowance, and will not be included in the employee's income. In order to determine whether some of the damages awarded for loss of employment relate to a human rights violation, there must first be clear evidence that an employee has lost his employment due to a contravention of existing human rights legislation. After establishing that a loss of employment is related to a human rights violation, then it is necessary to determine what portion of the damages reasonably relate to such a violation. The determination of what is reasonable is influenced by the maximum amount that can be awarded under the applicable human rights legislation, and the evidence presented in the case.
Income from Employment
A payment received on or after retirement or loss of employment by reason of a contractual arrangement with a former employer is generally viewed as remuneration from the former office or employment, either in the normal sense, or by virtue of the extended meaning given under subsection 6(3) of the Act. Subsection 6(3) essentially provides that an amount received pursuant to an agreement made immediately before, during or immediately after a period of employment is considered to be remuneration for services rendered during the period of employment unless it can be established that it is not reasonable to consider the payment as being received under the employment contract, for entering the contract of employment, or for a covenant with respect to what the payee is or is not to do before or after his or her employment terminates. As noted in paragraph 4(c) of Interpretation Bulletin IT-196R2 Payments by Employer to Employee, subsection 6(3) would apply to "a payment received on the termination of employment, where the contract of employment either expressly or implicitly provides that the payee is entitled to receive such payment on account of, in lieu of payment of, or in satisfaction of the employer's obligation to pay his salary, wages, commissions, etc., remaining under the contract of employment or for a period coincident with a reasonable period of notice of the termination of his employment".
The Canada Customs and Revenue Agency ("CCRA") has developed a position related to the payment of an amount where there is some doubt with respect to its nature and has expressed this position in paragraph 7 of Interpretation Bulletin IT-337R3. Essentially, a payment made upon or after a termination of employment or in respect of a loss of employment will generally be treated as income from employment if it was paid pursuant to the terms of an employment contract. However, where it is also reasonable to regard the amount as the payment of an amount in respect of the loss of employment, it will be considered a retiring allowance.
Mitigation Expenses
We are unable to provide general comments on an award related to mitigation expenses. A review of the specific terms of the wrongful dismissal award or settlement would be required.
Interest
An award or settlement for wrongful dismissal may provide for the payment of pre-judgment and post-judgment interest. Pre-judgment interest refers to an amount, classified as interest by the courts or under the terms of a settlement agreement, that is interest payable for the time between the emergence of the cause of action and the date of the award or settlement. Post-judgment interest refers to interest payable for the period between the date of the award or settlement and the payment of the damages.
Post-judgment interest would be included in income pursuant to paragraph 12(1)(c) of the Act as interest income. In addition, as announced at the 2003 Canadian Tax Foundation Round Table discussions, effective for 2004 and subsequent years, pre-judgment interest on wrongful dismissal awards will likewise be taxed as interest income.
Reimbursement of Legal Costs
Paragraph 56(1)(l.1) of the Act requires 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. Reimbursements or awards for legal fees in connection with the collection or establishing a right to income from employment are included in income from an office or employment by virtue of paragraph 6(1)(j) of the Act.
Withholding and Reporting Requirements
Subsection 153(1) of the Act requires tax to be withheld from the payment of both employment income, and a retiring allowance. Please refer to the 2003 Employers Guide to Payroll Deductions for information on calculating the amount to be withheld. However, there is no requirement to withhold tax from either the interest component of the payment, or the reimbursement of legal fees incurred in respect of the retiring allowance.
For reporting purposes, the income from employment (including the reimbursement of related legal fees) would be included on a T4 slip, the retiring allowance on a T4A slip, and the interest income on a T5 slip. While there is no requirement to report the reimbursement of legal fees included in income under paragraph 56(1)(l.1) of the Act, if an employer wishes to report these amounts on a T4A, we would suggest that Box 28 (Other income) be used with "00" in Box 38 (Footnote codes) and a brief explanation in the Footnotes area.
The publications referenced above are available on our website at www.ccra.gc.ca.
We trust that our comments will be of assistance.
Yours truly
John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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