8 July 1999 Internal T.I. 9902987 - BREACH OF EMPLOYMENT CONTRACT (SCHWARTZ)

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:

XXXXXXXXXX

The taxpayer claimed damages and, in XXXXXXXXXX, received the sum of $XXXXXXXXXX. The issue is whether or not it is taxable.

Position: The amount is not considered to be taxable.

Reasons. The facts of this case are considered to be essentially identical with those in Schwartz (96 DTC 6103). Also see "Memo To File" in the subject file.

								July 8, 1999

	XXXXXXXXXX Tax Setvices Office		HEADQUARTERS
	Problem Resolution					M. Eisner
(613) 957-2138
								990298

Settlement - Pre-Employment Breach of Contract

This is in reply to your facsimile of February 3, 1999 concerning the tax treatment of an amount received by XXXXXXXXXX (the "Plaintiff') in respect of a breach of an employment contract which was entered into by the Plaintiff with the XXXXXXXXXX. We also acknowledge your submission made to us on March 31, 1999.

The circumstances of the situation are as follows:

XXXXXXXXXX

Taxpayer's Position

In correspondence, the Plaintiff has indicated that the entire settlement should be non-taxable as a result of the decision of the Supreme Court of Canada (the "SCC") in Schwartz V. The Queen, 96DTC 6103.

Our Comments

As you are aware, this Directorate previously issued a letter to the Plaintiff dated April 29, 1998 (File #980460) in respect of the above issue. In that letter, it was indicated that a definitive response could not be provided because all documentation concerning the final settlement had not been provided and that, should the portion of damages relating to loss of wages be clearly identified, this situation may be distinguishable from the Schwartz case. The latter comment was based partly on the Department's comments expressed in Appeal's Branch Decision 93-13R (copy attached).

In the Schwartz case, the taxpayer was offered an employment position that was to commence at a later date with a specified salary and stock options. Before the taxpayer commenced to be employed, the offer was withdrawn and, after negotiations, the employer agreed to pay the taxpayer $400,000 representing $360,000 in damages and $40,000 for costs. The issues before the SCC were whether the amount of $360,000 was taxable as income from an unenumerated source under paragraph 3(a) of the Income Tax Act (the "Act") as income from the employment contract or, in the alternative, as a retiring allowance under subparagraph 56(1)(a)(ii) of the Act.

First, the SCC concluded that the Federal Court of Appeal should not have overturned the Tax Court's factual determination of the allocation of the payments. In addition, the SCC stated in order to find that some of the amount received by Mr. Schwartz was taxable under S. 3(a) as income from the employment contract, one must be able to identify what portion of the $360,000 was paid to Mr. Schwartz in compensation for amounts that he would have been entitled to receive under the contract of employment. The SCC considered that the payment was, in part, for loss of the contract and, in part, for personal injury such as embarrassment, anxiety and inconvenience, but there was no evidence to determine what portion related to each of the two parts. Thus, absent a proper determination of that factual situation, the SCC considered that the damages received by Mr. Schwartz could not, in whole or in part, be found to be taxable under paragraph 3(a) of the Act as income from the employment contract.

Upon review of the additional information provided to us, we are of the opinion that the facts of this case can not be adequately distinguished from the facts in the Schwartz case and, accordingly, the entire amount of the damages are non-taxable. We note that the Settlement is silent on the issue of the composition of the Funds. We also note that XXXXXXXXXX of the Amended Statement of Claim filed with the Ontario Court (General Division) does not describe the composition of the "general damages" and "special damages". Accordingly, even though the distribution of the Funds among the various claimants was based on a percentage (XXXXXXXXXX%) of each plaintiffs initial claim, this is not, in our opinion, sufficient evidence of the allocation of damages to allow the Department to distinguish these facts from those in the Schwartz case.

In addition to the reasons stated above, we would also suggest that even if the allocation of the damages was clear and specific, the better view would be to treat the entire damages as non-taxable. In this regard, the SCC in Schwartz went on to address, albeit in what was arguably obiter dictum, the issue of where amounts were, in fact, paid for loss of the employment contract (i.e., the allocation was clear and specific), whether those damages in lieu of lost wages could be considered to be income from an unenumerated source (income from a source pursuant to paragraph 3(a) of the Act). In this regard, the SCC noted that, previously, damages for wrongful dismissal were neither income from employment nor retiring allowances. The Act was amended to define such damages as a "termination payment" to be partially included in income under section 56 of the Act. Another amendment repealed the definition of "termination payment" and included these amounts in the definition of "retiring allowance" in subsection 248(1) of the Act. The SCC concluded that since Parliament had dealt with similar payments (damages for wrongful dismissal) and amended the Act to include them in income, but did not amend the Act to include damages such as those that were involved in the Schwartz case, no part of the amount of $360,000 was required to be included in income pursuant to paragraph 3(a) of the Act as income from an unenumerated source.

Summary

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we would suggest that the better view would be to treat all damages (i.e., damages in lieu of lost wages as well as personal injury) for loss of intended employment as non-taxable. We would point out, however, that if a tax services office were to come across an offensive scenario where transactions were structured and contracts of employment breached to purposely fall within the circumstances of the Schwartz case, we would want to review the situation again.

If you require further technical assistance, we would be pleased to provide our views. We apologize for the delay in responding.

For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the legislation Access Database (LAD) on the Department's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (613) 957-0682. The severed copy will be sent to you for delivery to the client.

Jim Wilson
Section Chief
Business, Property & Employment Section II
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch