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.
Principal Issues: What is the amount of the income inclusion for severance paid to former employees where the payment is made by the employer issuing shares?
Position: The fair market value of the shares at the time of receipt is included in income as either a retiring allowance or a section 7 benefit.
Reasons: The income inclusion under both paragraph 7(1)(a) and subparagraph 56(1)(a)(ii) is based on the amount received.
XXXXXXXXXX
2020-084892
K. Podor
February 1, 2021
Dear XXXXXXXXXX:
Re: Settlement of severance by share issuance
This is in reply to your email correspondence of May 14, 2020, in which you asked us for our comments regarding the amount that would be required to be included in the income of two former employees where shares were issued by the employer in settlement of a severance obligation.
In addition, you also asked us to confirm whether the amount to be included in income would include additional shares that were subsequently released from escrow and transferred by the employer to one of the former employees. Under the terms of the settlement agreement, the additional shares were only to be released in the event of, and as proportionate compensation for, any decrease in the share price during the four-month period that the original shares were subject to a holding period under securities law.
We apologize for the delay in our response.
Our comments
This technical interpretation provides general comments about the provisions of the Income Tax Act (Canada) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R10, Advance Income Tax Rulings and Technical Interpretations.
In general, an amount received by an individual arising out of, or in consequence of, termination of their employment may be characterized as income from employment or a retiring allowance depending on the specific circumstances. Where the employer pays the amount by issuing shares, it could also be a benefit under section 7 depending on the terms of the agreement to issue the shares. Ultimately, this is a question of fact that can only be determined after a thorough review of the facts, including the settlement agreement. Regardless, the income tax consequences for the individual are generally the same; the amount is included in income at the time of receipt.
Where an employer issues shares to a former employee as compensation for a loss of employment of the individual (including a settlement claim for damages for wrongful dismissal), the amount would be a retiring allowance. The fair market value of the shares at the time the shares are received by the former employee would be included in their income under subparagraph 56(1)(a)(ii) for the year of receipt. The determination of fair market value is a question of fact.
However, where the shares are issued as compensation for the prior employment relationship and not in respect of the loss of the employment, section 7 would apply. In this situation, the fair market value of the shares at the time the shares are received by the former employee would be included in their income from employment by virtue of paragraph 7(1)(a) for the year.
In the case of shares held in escrow under circumstances described above, the former employee would generally not be considered to have received the shares until such time as they are released from escrow and transferred to the former employee. As a result, the additional amount to be included in the former employee’s income in respect of those shares would be based on the fair market value of the shares at that time. The character of the income would be the same as that determined for the initial shares.
For information on how to report retiring allowances and employment income, see RC4120, Employers' Guide - Filing the T4 Slip and Summary.
We trust these comments will be of assistance.
Yours truly,
Kimberly Duval, CPA, CA
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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