What’s a “retiring allowance”…and what’s not
You’d think termination pay, severance packages, and other compensation for getting the so-called golden handshake from your employer would be a fairly simple thing from a tax standpoint. Wrong. The Canada Revenue Agency (CRA) calls some of these payments “retiring allowances,” even though they might have nothing at all to do with “retirement,” and wants its share of tax from them. Last time, I looked at what these “allowances” are in the CRA’s view, and what can be done to cut the tax payable. This time, I want to probe a bit further and see what the CRA’s take is on various other payments made in respect of termination of employment, particularly in the area of legal damages payable.
In a Round Table way back in 1993, the CRA expressed the view that “termination pay” under the Ontario Employment Standards Act does not qualify as a “retiring allowance.” This is because the legislation imposes a minimum number of weeks of notice prior to termination, dependent on the years of employment.
During the notice period, the employee is entitled to receive regular wages. Because of this, the CRA’s position is that if the employee is terminated without written notice, the employee is entitled to termination pay equal to regular wages payable over the same number of weeks for which notice was required. What does this mean? Essentially, the termination pay is treated as a continuation of regular salary payments, in spite of the termination of employment. (Presumably, there would be similar problems in other provinces).
Yet, a different interpretation was given to “severance pay,” under which an Ontario employee may be entitled to payments by virtue of large employers discontinuing businesses, where 50 or more employees have been laid off within a six-month period. This does qualify as a retiring allowance.
The CRA’s administrative positions is that an amount paid on account of damages for emotional distress per a court order may be a retiring allowance if the payment arises from a loss of office or employment. If you’re hoping that the word “may” opens the door for you to take the position that such damages are not retiring allowance, but may in fact be tax-free payments, think again. The CRA stated in a ruling that damages received as compensation for mental distress as a result of the loss of employment “would be taxed as a retiring allowance” (unless the damages relate to human rights violations).
CRA has stated that pre-judgment interest on either a retiring allowance or a tax-free award is considered to be tax-free. But in yet another ruling, it expressed the view that interest paid on an award for wrongful dismissal for the period after the date of settlement is taxable as interest. On top of that, it does not form part of a retiring allowance and therefore cannot be rolled into an RRSP.
So, pre-judgment interest appears to get the best possible treatment – it can be completely tax-free (if related to a retiring allowance or a damage payment which is not income from employment). Post-judgment interest gets the worst – it’s fully taxable and can’t even be rolled into an RRSP.
Other case law
Besides CRA pronouncements, there have been a couple of interesting court cases in the area that have held that not all damage payments received by a terminated employee fall within the definition of retiring allowance. A case in point is Bedard v. M.N.R, where it was held that an amount paid to compensate an employee for defamation fell outside the definition of a retiring allowance. Some practitioners have also argued that that exemplary damages and damages for mental distress awarded in a wrongful dismissal action are, arguably at least, non-taxable – i.e., in spite of another case.
A number of other CRA rulings have dealt with other typical scenarios. For instance, compensation for termination due to a work-related injury was held to be a retiring allowance under the particular situation. Or, a payment received as a result of a layoff under the terms of a labour agreement will usually qualify as a retiring allowance. And unused sick-leave credits paid on termination qualify as a retiring allowance, but accumulated vacation pay does not.
Previously published in The Fund Library on October 24, 2019 by tax and estate planning lawyer, Samantha Prasad. Portions of this article first appeared in The TaxLetter, © 2019 by MPL Communications Ltd. Used with permission.