AN EMPLOYMENT LAWYER'S GUIDE TOINCOME TAX IMPLICATIONS IN WRONGFUL

DISMISSAL CASES

These materials were prepared by Susan Barber of McDougall Gauley law firm Regina, Saskatchewan·for the Saskatchewan Legal Education Society Inc. seminar, Current Issues in Employment Law;September 2002.

The intention of this paper is to provide a brief overview of some of the income tax

considerations which frequently arise in negotiating and concluding severance packages for

dismissed employees. Although the case law and tax rulings relative to the treatment and

characterization of various aspects of damage awards are numerous, this paper will focus on

those which arise on a day-to-day basis for employment practitioners. In most cases the more

complicated issues that arise should be reviewed by an accountant or a tax lawyer.

) I. INTRODUCTION

2

Ij

II. TAX TREATMENT OF PAYMENTS RECEIVEDBY A DISMISSED EMPLOYEE

In most cases, an amount received by a former employee which arises out of or in consequence of

termination of employment will either be considered to be a retiring allowance as defined in

section 248(1) of the Income Tax Act, R.S.C. 1985, c.l, as amended (the "Act") or income from

employment under subsection 5(1) or 6(1) of the Act. The significance of the distinction is that a

retiring allowance can be transferred to a registered pension plan or a registered retirement

savings plan and thus be deducted under paragraph 60 G.l) of the Act whereas income from

employment cannot be similarly transferred.

(a) Income from an Office or Employment

The relevant sections of the Act in this regard are sections 5(1) and 6(1) of the Act which provide

as follows:

5(1) ... a taxpayer's income for a taxation year from an office or employment is thesalary, wages and other remuneration, including gratuities, received by thetaxpayer in the year.

6(1) There shall be included in computing the income of a tax payer for a taxation yearas income from an office or employment...

(a) the value of board, lodging and other benefits of any kind whatever received or.enjoyed by the taxpayer in the year in respect of, in the course of , or by virtue ofan office or employment, except .. ,

3

Canada Customs and Revenue Agency ("CeRA"), according to Interpretation Bulletin 337R31,

considers the following items to be included as income for a taxation year from an office or

employment:

i) a payment received upon or after retirement or in respect of a loss of employment

pursuant to the terms of an employment contract with a former employer (unless the

payment can reasonably be regarded as being in recognition of long service or as

compensation for loss of office, in which case it will be a retiring allowance).

ii) Receipt of a low salary or no salary before retirement in return for a so-called retiring

allowance upon or after retirement from an office or employment. Such an amount is

more likely to be regarded as deferred compensation, taxable as income from an office or

employment when received.

iii) Salary and wages for accrued vacation pay.

iv) Payments in lieu of earnings for the period of a reasonable notice of termination by virtue

of the terms of the taxpayer's employment (explicit or implied). This is because payment

in lieu of earnings for a period of a reasonable notice of termination is considered to be

included in the terms of the taxpayer's employment contract.

v) Amounts received out of or under an employee benefit plan or a salary deferral

arrangement;

vi) Special damages, such as those received for lost (unearned) wages or employee benefits,

if the employee retains his or her employment or is reinstated.

vii) A payment in respect of a non-competition covenant (generally included under paragraph

6(3)(c) of the Act).

It should be noted that amounts paid for counselling services in respect of the re-employment or

retirement of the taxpayer are excluded from the definition of income by subsection 6(l)(a)(iv) of

the Act.

1 CCRA Interpretation Bulletin IT-337R3 - Retiring Allowance, January 30, 1998

)/

4

(b) The Retiring Allowance

"Retiring Allowance" is defined by section 248(1) of the Act as follows:"retiring allowance" means an amount (other than a superannuation or pensionbenefit, an amount received as a consequence of the death of an employee or abenefit described in subparagraph 6(l)(a)(iv)) received

(a) on or after retirement of a taxpayer from an office or employment inrecognition of the taxpayer's long service, or(b) in respect of a loss of an office or employment of a taxpayer, whether ornot received as, on account or in lieu of payment of, damages or pursuant to anorder or judgment of a competent tribunal,

by the taxpayer or, after the taxpayer's death, by a dependent or a relation of the taxpayeror by the legal representative of the taxpayer.

A retiring allowance includes termination or severance pay that is either awarded by a court or

paid by private settlement. Retiring allowances are taxable pursuant to subsection 56(1)(a)(ii)2

and are subject to source withholding pursuant to subsection 153(l)(b).3

The component parts of the definition of a 'retiring allowance' have been considered by the Tax

Court of Canada as follows:

1. "Retirement" from an Office or Employment or "Loss" of an Office or Employment

The first portion of the definition of a retiring allowance applies to an amount paid on retirement

in recognition of long service.

256(1) Amounts to be included in income for year - Without restricting the generality of section 3, there shall beincluded in computing the income of a taxpayer for a taxation year,

(a) any amount received by the taxpayer in the year as, on account or in lieu of payment of, or insatisfaction of,(ii) a retiring allowance, other than an amount received out of or under an employee benefitplan, a retirement compensation arrangement or a salary deferral arrangement.

3 153(1) Withholding - Every person paying at any time in a taxation year(b) .a retiring allowanceshall deduct or withhold from the payment the amount determined in accordance with prescribed rules andshall, at the prescribed time, remit that amount to the Receiver General on account of the payee's tax for theyear under this Part or Part XI.3, as the case may be, and, where at that prescribed time the person is aprescribed person, the remittance shall be made to the account of the Receiver General at a designatedfinancial institution.

5

Whether an individual has retired is a question of fact to be considered based on all of the

circumstances. CCRA takes the position that continued participation in a former employer's

health plan for a restricted period of time would not, in itself, mean that employment has not

terminated, particularly if the employer's plan specifically permits former employees to be

covered. If, however, pension benefits continue to accrue to that same individual, the

employment relationship is assumed to continue since such benefits only accrue to employees.4

The fact that the employer does not require an individual to report to work is not, by itself,

determinative of whether the individual has retired. An individual who has- been given a leave of

absence for educational purposes, for example, is still an employee.

fu determining "long service" reference is had to the total number of years in an employee's

career with a particular employer or with affiliated employers.

Generally speaking, a payment for a loss of office or employment refers to the elimination or

expiration of a particular office or employment such as the abolition of a job or shutting down of

a business. A loss of office or employment might also refer to an early retirement program which

is designed to eliminate a number of positions. CCRA has determined, however, that retirement

or loss of an office or employment does not include the followings:

• transfer from one office or position to another with the same employer (or an affiliate), in a

different capacity (including one with diminished responsibilities);

• termination of employment with an employer followed by re-employment with the employer

on a full or part-time basis or employment with an affiliate of the employer, either of which is

made pursuant to an arrangement prior to the termination of employment; or

• termination of employment where salary and benefits continue to accrue until a later date (in

which case, retirement or loss of employment will be considered to take place at the later

date.

4 IT 337R3, supra, note 1, paragraph 4

)

6

In R. v. Fostey, [1999] 99 DTC 1004 (Tax CC), Mr. Fostey was terminated from his position as

Chief Executive Officer when his employer, Company A, sold the business goodwill to Company

B. However, the sale agreement provided that Company B would hire Mr. Fostey for a 40­

month personal employment contract and that he would receive a retiring allowance of

$30,000.00 on the cessation of his employment.

The Court held that the original employment had ceased and, as such, the payment was a proper

retiring allowance. The Court considered the fact that after the sale, Mr. Fostey's corporation

surrendered its customs brokerage license and became inactive. After the sale, Mr. Fostey had no

contact with clients or with importers and no financial responsibility. Nor did he perform any

external representation or research roles and, most importantly, he was not the control behind the

customs brokerage business. It was clear that Mr. Fostey's new role was mainly clerical and thus

sufficiently distinguished from his original position as CEO. The original employment or office

had thus been 'lost' and the retiring allowance was properly characterized as such within the

meaning of subsection 248(1) of the Act. The Court concluded that Mr. Fostey retired from his

position as Chief Executive Officer and, when he ceased his employment, he received a retiring

allowance in respect of his many long years of service.

2. "Office or employment"

The definition of "office or employment" in the context of elected or volunteer positions was

considered in R. v. Gordon, [1999] 1 CTC 2327 (Tax CC). Mr. Gordon, a former alderman for

the City of Burnaby, received a complimentary golf pass in recognition of his service. The

Court confirmed that he did not hold an 'office or employment' as an independent elected

representative of the citizens and, as such, the value of the pass should not be included as

income. The Court stated:

I find that the Appellant's volunteer services do not meet the definitions of "office.or employment." He was not a servant or employee. He generously donated histime to benefit his community. There was no evidence that he was an individualholding a position in the service of some other person... ·

5 Ibid, paragraph 3

7

3. Received "in respect or' the Loss of an Office or Employment

This phrase has been widely considered in the context of settlement or damage awards for

terminated employees. The touchstone Supreme Court case, R. v. Norwegijick, [1983] 83 DTC

5041 (SCC), directed a very broad approach and stated as follows:

The words "in respect of' are, in my opinion, words of the widest possible scope.They import such meanings as "in relation to", "with reference to" or "inconnection with". The phrase "in respect of' is probably the widest of anyexpression intended to convey some connection between two ~elated subjectmatters.

In R. v. Saardi, [1999] 99 DTC 767 (Tax CC), the taxpayer sued his American employer for both

unpaid wages and moving expenses. The parties were able to reach a settlement for $50,000.00

approximately 3 years after the commencement of legal proceedings. The taxpayer did not

include that settlement amount in his taxable income. In a subsequent assessment, CCRA treated

the $50,000.00 as a taxable retiring allowance and assessed a penalty. The taxpayer appealed on

the grounds that the settlement proceeds were reimbursement of costs and expenses incurred

during or prior to employment in the United States.

The Court found that there was an "insufficient connection" between the settlement payment and

the loss of employment. In particular, the court suggested that the payment arose primarily

from the lawsuit and was thus "extraneous" to the loss of employment apd could not be

characterized as the payment of a retiring allowance.

The Court also refused to accept the argument of the Minister that the $50,000.00 payment

represented remuneration caught by subsection 5(1) of the Act. The amount that was initially

claimed for unpaid wages represented 90% of the total claim and the balance of 10% was

claimed as damages. The taxpayer accepted $50,000.00 out of a claim of $366,000.00, being

approximately 10% of the total claim. The Court found that the parties to the out-of-court

settlement were at liberty to settle their litigation by mutual agreement and to characterize the

transaction in such a way as to minimize the tax payable. The Court found that 10% of the

8

amount claimed in the lawsuit was in respect of damages and that the taxpayer agreed to accept

compensation for that portion only. The Court accepted that the amount of $50,000.00 was paid

to compensate the personal loss suffered by the taxpayer in agreeing to move to the United States

and was not a payment of unpaid wages.

In R. v. Fournier, [1999] 4 CTC 2247 (Tax CC), a female employee resigned and accepted a

settlement payment following sexual and physical harassment by co-workers. The payment was

intended to serve the purposes of reimbursing, retraining, re-educating and re-establishing the

taxpayer in return for her agreeing to apply for long-term disability -and to withdraw all

grievances and complaints. As a consequence, her employment was terminated and recorded as

a resignation.

In computing her income for the tax year in question, the taxpayer included income from the

employer in the amount of approximately $55,000.00, a retirement allowance from her employer

in the amount of approximately $5,000.00 and employment benefits from a wage loss plan in the

) amount of approximately $15,000.00. She also claimed an amount of $42,500.00 as a deduction

in computing her taxable income. The Minister refused the deduction on the basis that the

amount was a retiring allowance to be included in income.

The Court found that the amounts received by the taxpayer from her employer were not received

"in respect of a loss of...employment...on account of or in lieu of payment of, damages." The

employer did not make any payment, nor did the taxpayer receive any payment in respect of a

loss of employment. The payments were made due to the fact that co-workers were harassing the

taxpayer and that the taxpayer had a valid claim for damages against the employer due to the

actions of its employees. The Court found, similarly, that her agreement to resign was simply a

way for the employer to get rid of an employee. She did not receive any payment in

consideration of, or on account of, her agreeing to leave the employment of the employer and did

not receive these amounts as damages for any stress, medical or other injuries she sustained as a

result of the termination of her employment.

)

9

The case of loUvet v. Canada, [2000] TCJ No. 48 (Tax Ct of Canada) presents an opposite

approach to Fournier. In that case the taxpayer was terminated without cause and her grievance

for the employer's verbal abuse was settled for a cash sum of $10,000.00. She signed a Release

discharging the employer from future claims connected with the termination.

The Employer issued a T4A slip indicating that the $10,000.00 payment was for "damages

settlement". No income tax was withheld at source and the taxpayer did not include that amount

in her income tax return. The Minister of National Revenue assessed the taxpayer and added the

amount of $10,000.00 to her income for the tax year in question on the basis it was income from

a retiring allowance.

The taxpayer appealed, arguing that the settlement was never intended to form a severance or

retiring allowance, that the sole purpose was to prevent her further legal action, and that the

amount was significantly more than the one month severance pay she would have ordinarily

received.

The Court found that the release signed by the taxpayer was clear in indicating that the

$10,000.00 amount was received in respect of the loss of employment. The Court found a

sufficient nexis between the money and the employment and determined that, had there been no

loss of employment, there would have been no grievance, no settlement, no award and, therefore,

no payment. Even though both parties intended to characterized the payment as damages. it did

not change the fact that the taxpayer received that amount as a consequence of the loss of her

employment. The Court also rejected the suggestion by the taxpayer that the settlement amount

was received as damages in compensation for a human rights violation. The Release specifically

provided that there was no admission of liability on the part of the employer and, accordingly, the

Court found it impossible to attribute a reasonable amount in respect of general damages caused

by a human rights violation.

)

)

10

(c) Characterization of Damages and Human Rights Awards

CCRA takes the position that amounts paid by way of general damages - i.e. damages for loss of

self-respect, humiliation, mental anguish, hurt feelings, etc., or pursuant to an order or judgment

of a competent tribunal may be a retiring allowance if the payment arises from a loss of office or

employment of a taxpayer. However, if a human rights tribunal awards a taxpayer an amount for

general damages, the amount is normally not required to be included in income. When a loss of

employment involves a human rights violation and is settled out of court, a reasonable amount in

respect of general damages can be excluded from income. 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.

In Young v. MNR 86 DTC 1567 (TCC), the taxpayer was dismissed from employment and sued

his employer for wrongful dismissal. In addition to the damages for wrongful dismissal the

Court awarded damages for mental distress and exemplary damages. The Minister treated the

entire damage award as a retiring allowance. The taxpayer appealed.

The Tax Court of Canada dismissed the appeal on the basis that the amounts paid by way of

exemplary damages and for mental distress were not shown to be outside of the parameters of

subsection 248(1) of the Act. It is interesting to note, however, that the Court was careful to

point out that if there had been some direct evidence or testimony as to the origin of the amounts

in issue, the decision might have been otherwise. The Court suggested that the position of the

Minister in assessing the taxpayer could have been more clearly demonstrated and that the case

"raised some questions" regarding matters of evidence before the Court.

In 1990, the Tax Court of Canada again considered the issue of taxation on damage awards in

Louis - Philippe Bedard v. MNR 91 DTC 573. In that case the taxpayer was dismissed from his

employment and the reasons for his dismissal made their way to radio and television news

headlines. A settlement was reached between the employer and the taxpayer in which the

taxpayer received 6 months salary together with a $32,000.00 payment which was stated to be

"by way of compensation for damage suffered". The Minister included that amount in the

11

taxpayer's income for the taxation year in which it was received as a retiring allowance. The

taxpayer appealed.

The Tax Court of Canada determined that the law makers did not, in adopting the definition of

"retiring allowance", intend it to include damages for defamation that might be suffered by the

occasional victim of a dismissal. The Court held that while an amount granted to an employee

after his dismissal may include damages for defamation, it is clear that any such part of the

compensation granted belongs to an entirely different order of compensation that is manifestly

not covered by the definition of "retiring allowance".

The Court agreed, based on testimony of the taxpayer, that the compensatory amount was granted

partly to make up for the defamation of which he was the victim and partly to compensate for the

financial damage suffered by him· and his family after he lost his job. The court somewhat

arbitrarily considered the extent of the blow to his reputation and found that only one-half of the

$32,000.00 should be included in income. The other half, as found by the court, constituted

damages for defamation, not classed as income from a retiring allowance.

The Court, in passing, opined that the judge in the Young case did not rule out the possibility that

amounts granted as compensation for mental distress might not be regarded as a retiring

allowance. The Court simply found that the evidence was insufficient to show how the amount

received had been granted as compensation for a type of damage other than that resulting from

the loss of employment.

In Niles v. MNR 91 DTC 806 (TCC), decided in 1991, the taxpayer settled a complaint filed with

the Ontario Human Rights Commission by receiving $5,000.00 from his employer. The Minister

included the amount in the taxpayer's income in the year in which it was received. The taxpayer

appealed.

The Court found that the payment in question was not compensation ordered for breach of the

Human Rights Code but, rather, payment of a settlement reached between the employer and the)

)

)

12

employee. The Court characterized the payment, not as an award or damages but as settlement of

a complaint. Although the method of calculating the settlement was based on the taxpayer's

hourly rate of pay and the number of weeks between his lay-off and the time of commencing his

re-training, that, in itself, was not necessarily the sole method of determining the nature of the

payment. The Court held that all of the factors taken together pointed to the payment being one

made as a result of loss of employment. In dismissing the appeal, the Court concluded as

follows:

There is no doubt but that the settlement payment was made because of theemployee's loss of employment. It makes no matter why he was laid off whetherfor breach of contract or because of an alleged discrimination. He received theamount to settle his claim against the employer for loss of employment. Therewas no finding of discrimination, nor was there an award which might havealtered the character of the payment. The settlement was based on lost wages anddetermined in that fashion.

In Stolte v. Canada [1996] T.C.J. No. 215, the Court considered the matter of compensation for

mental distress and whether a payment by way of compensation for such distress was taxable.

A claim by the taxpayer against her former employer was settled by the taxpayer receiving five

weeks severance plus two months salary as a compensation for pain and suffering. The position

of the taxpayer was that the sum of approximately $6,000.00 (two months salary) was not

received "in respect of a loss of an office or employment" but was paid and received to

compensate her for the physical and mental damages which she suffered from the ill-treatment to

which she was subjected at the hands of managers and supervisors of her employer during

approximately 1 Yz year prior to her ceasing to be employed by the company.

The Court reviewed the facts and found that the amount in dispute was for damages and not for

the loss of employment. The damages were for the mental and physical injuries that the

taxpayer sustained by reason of the "insensitive, arrogant and wholly unacceptable treatment"

that she suffered at the hands of her employer prior to the termination of her employment.

13

III. INCOME INCLUSION AND TRANSFERS TO A REGISTERED RETIREMENTSAVINGS PLAN OR REGISTERED PENSION PLAN

As noted at the outset of this paper, retiring allowances are taxable and included in computing

the income of a taxpayer under subparagraph 56(l)(a)(ii) of the Act. However, section 600.1) of

the Act allows a deduction for all or part of a retiring allowance which is included in computing

the taxpayer's income under subparagraph 56(l)(a)(ii) and transferred to a registered pension

plan or a registered retirement saving plan under which the taxpayer is the annuitant, provided

that the transfer is made in the year or within 60 days after the end of the year. The deduction,

generally speaking, is limited to the aggregate of:

(a) $2,000.00 times the number of years before 1996 during which the employee was

employed by the employer or a related employer; and

(b) $1,500.00 times the number of years prior to 1989 in respect of which employer

contributions to a pension plan or a deferred profit sharing plan of the employer or

a person related to the employer had vested in the employee.

According to a CCRA advanced tax ruling6, a year will qualify for inclusion in the calculation

even if the employee worked for the employer for as little as one day in that year. The Act does

not stipulate that the employment must be continuous. Nor does the Act exclude part-time

employment and, accordingly, such periods may be included in the formula.

IV. OTHER RELEVANT CONSIDERATIONS

a) Deductions at Source

The employer who pays a retiring allowance is required to report the amount paid on form T4A

Supplementary and, pursuant to subsection 153(l)(c)7 of the Act is required to withhold tax in

such amount as is prescribed by the regulations.

6 CCRA ATR48 Transfer of Retiring Allowance to an RRSP, April 6, 19927 153(1) Every person paying at any time in a taxation year

(c) a retiring allowance, shall deduct or withhold therefrom such amount as is determined in accordance withprescribed rules ...

14

) According to the regulations and, specifically, regulation 103(4), the withholding rates for

retiring allowances are as follows8:

• If the payment does not exceed $5,000.00, 10%;

• If the payment exceeds $5,000.00 but does not exceed $15,000.00,20%; and

• If the payment exceeds $15,000.00, 30%.

It used to be the case that if the retiring allowance or any part of it was paid directly to a

registered pension plan or a registered retirement savings plan, the employee had to obtain a

waiver of withholding tax in respect of amounts that would qualify for deduction by completing

Form TD2, Tax Deduction Waiver for a Direct Transfer of an Eligible Retiring Allowance.

According to CCRA Income Tax Technical News Bulletin #199, Form TD2 is no longer

required for a direct transfer.

For the purposes of the Employment Insurance Act, a retiring allowance does not constitute

insurable earnings and no withholdings are required in respect of a retiring allowance. 10 There

may, however, be an issue as to repayment if E.I. benefits are received by an employee after the

date of termination but before payment of the retiring allowance.

For purposes of CPP, section 12 of the Canada Pension Plan Act defines "contributory salary

and wages of a person for a year" as his or her "income for the year from pensionable

employment computed in accordance with the Income Tax Act". Because a retiring allowance is

included under section 56 of the Act and not as employment income under section 5, a retiring

allowance is not within section 12 of the CPP Act and no withholdings for CPP are required.

8 The federal rates are 7%, 13% and 20% respectively but, when combined with the provincial rates, bump up to thelevel set out.9 CCRA Income Tax - Technical News No. 19, June 16,2000.

)

15

b) Taxation of Pre-Judgment and Post-Judgment Interest

The position of CCRA is that post-judgment interest on an award of damages for wrongful

dismissal, calculated from the date of the settlement or judgment, is required to be included in

income under paragraph 12(1)(c) of the Income Tax Act. However, source deductions are not

required to be withheld from such amounts. I I

Conversely, pre-judgement or pre-settlement interest received in respect of an award for damages

for personal injury, death or wrongful dismissal may be excluded from income and, accordingly,

there are no withholding or reporting requirements imposed on the payer in respect of such

amounts. 12

c) Deductibility of Legal Fees

Under paragraph 60 (0.1) of the Income Tax Act, a deduction is allowed for legal expenses which

are paid by a taxpayer in order to collect or establish a right to a pension benefit or a retiring

allowance (including a right to damages for wrongful dismissal).

Conversely, any reimbursement or award of legal expenses for the same purposes must be

included in the taxpayer's income under paragraph 56(1)(1.1).

The amount that is allowed by way of deduction in the year is limited to the aggregate of the

amount of the retiring allowance included in income in the year or a previous year and in respect

of which the legal expenses were paid, and the amount of any award or reimbursement of legal

expenses included in income pursuant to paragraph 56(1)(1.1) for the year or a preceding year,

less any portion of the retiring allowance that has been transferred to a registered pension plan or

a registered retirement saving plan pursuant to paragraph 600.1).13

10 Moreau v. Canada (Minister ofNational Revenue - M.N.R.), [2000] T.C.J. No. 28011 Round Table, November 13, 1998 reference: 5612 Window on Canadian Tax, CCH Canadian, paragraph 1095.13 CCRA Interpretation Bulletin IT-99R5 Legal and Accounting Fees, December 11, 1998, paragraph 26.

)

16

Eligible legal fees that are not deductible because they exceed the income as calculated above can

be carried forward and deducted in the next seven years, but only to the extent that further related

income arises and to the extent that the amounts in question were not previously deductible.

The best way to understand the deductibility of legal fees is by way of example, two of which are

set out in IT99R5 and IT337R3:

1. In 1995 and again in 1996, Mr. X incurred legal fees of $3,000.00 and $6,000.00

respectively to establish a right to a retiring allowance.

2. In 1996, Mr. X received from his employer a retiring allowance of $15,000.00 and

a payment towards legal fees of $7,500.00. Mr. X transferred the $15,000.00 to

his RRSP.

3. In 1997 and 1998, Mr. X received a further retiring allowance from the same

employer of $10,000.00 and $5,000.00 respectively. He transferred the first

$10,000.00 to his RRSP in 1997 and an additional $2,500.00 to his RRSP

in1998.

According to Canada Customs and Revenue Agency, the legal fees incurred in 1995 cannot be

deducted because Mr. X did not receive either a retiring allowance or a reimbursement of fees in

that year.

In 1996, Mr. X has to include the $7,500.00 reimbursement in his income. While he has incurred

legal fees of $9,000.00 ($3,000.00 in 1995 and $6,000.00 in 1996) his deduction is limited to

$7,500.00 which remains after taking the aggregate of the retiring allowance and reimbursement

of fees ($15,000.00 and $7,500.00) less the amount transferred to the RRSP ($15,000.00).

The remaining legal fees that were not deducted in 1996 ($2,500.00) can be carried forward for

up to seven years as long as Mr. X receives a further retiring allowance or reimbursement of legal

fees which relates to the legal fees incurred in 1995 and 1996. No deduction would be allowed in

17

1997 because the entire amount was transferred to an RRSP. In 1998, however, the remaining

$2,500.00 in fees could be deducted because only $2,500.00 of the $5,000.00 received in that

year was transferred to an RRSP. Accordingly, the amount transferred by an employee to a

RRSP or a RPP can affect the deductibility of legal fees and the employee will want to try, to the

extent possible, to have sufficient "room" to allow the deduction. In many cases, however, the

disadvantage associated with non-deductibility of fees will be more than offset by the benefit

received from the transfer.

According to CCRA Tech Interp 973161514, there is no statutory requirement for an employer to

withhold tax in respect of legal fees reimbursed to an employee, nor to report such amount on an

information slip. The Department position is that reimbursement of legal fees as contemplated

by 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 1OO(1) of the Regulations.

By virtue of subsection 8(1)(b). of the Act, an employee is allowed a deduction in computing

income from an office or employment for legal expenses paid in the year to collect or to establish

a right to salary or wages (as distinct from a retiring allowance or pension benefit) owed by an

employee or former employer. Subsection 6(1)(j) requires a taxpayer to include in income any

such amounts received by way of an award or reimbursement for which a corresponding

deduction is available. 15

Note that the deduction is allowed only in respect of an amount "owed" by an employer or

former employer. If the taxpayer is unsuccessful in court or otherwise fails to establish that some

amount it owed, no deduction for legal expenses is allowed. However, failure to collect an

amount established as owed does not preclude a deduction. 16

14 From Carswell Tax Partner Main © 2002 Thomson Canada Limited 2002, Release 4, Tech Interp 9731615 ­Reimbursement of Legal Fees, February 19, 1998.IS IT-99R5, supra, note 13, paragraphs 22 and 23.16 Ibid, paragraph 23.

)

18

Unlike the position respecting legal fees described in subsection 56(1(11.1) of the Act, CCRA

takes the position that amounts included in income under paragraph 6(1)0) are payments

described in subsection 53(1) of the Act. As such, the employer would technically be required to

make the appropriate withholdings and prepare the appropriate information slip in respect of any

such payments. However, to the extent the fees are otherwise deductible under subsection

(8)(1)(j) of the Act and the reimbursement of those fees has not been taken into account in

determining the amount of deduction under that subsection, the Department is generally prepared

to waive the withholding requirement. The appropriate information slip must still be prepared. I?

d) Periodic Payment

It may be in the best interests of an employee to consider deferring the receipt of a retiring

allowance until the next taxation year or splitting the allowance between taxation years in order

to avoid having all of the income received at once and triggering a higher marginal tax rate.

From the employer's perspective, deductibility is governed by subsection 78(4) of the Act which

provides that if the expense (Le. the retiring allowance, salary, wages or other remuneration) is

not paid within 180 days of the end of the taxation year in which it was incurred, the amount

owing is deemed not have been an expense incurred in the year and is not deductible. However,

if the amount owing is actually paid after that time, it is deductible in the taxation year it is paid

as the amount is deemed to be an expense incurred in that year. Interestingly enough, under these

circumstances, it is possible that the employer might get the deduction in.one year and the

employee might defer the payment receipt until the next year.

v. CONCLUSION

This paper is not a treatise on tax treatment of wrongful dismissal awards and should not be

relied on as such. It is intended to provide a practical, straightforward and basic overview of

some of the issues that can arise more frequently in settlement and structuring of wrongful

17 Tech Interp 9731615, Supra, Note 14.

)

)

19

dismissal awards. Any unusual "twists" or concerns should be raised with a tax lawyer or an

accountant.

)