Principal Issues: [TaxInterpretations translation] What is the tax treatment of certain amounts paid in settlement of union grievances?
Position: General comments.
Reasons: Question of fact.
XXXXXXXXXX I. Landry, M. Fisc. 2011-043113
February 29, 2012
Dear Madam,
Subject: Amounts paid in settlement of a grievance
This is in response to your email of November 1, 2011 in which you inquired as to the tax treatment of amounts paid by XXXXXXXXXX (the "Employer") in settlement of a union grievance.
Unless otherwise indicated, all statutory references below are to the provisions of the Income Tax Act, R.S.C. 1985 (5th Supplement), c.1, as amended (the “Act”).
The Facts
You briefly described a particular situation, specifically:
1. An employee of an Employer was terminated in XXXXXXXXXX. Thereafter, the employee has not had other sources of income.
2. That employee submitted on XXXXXXXXXX a grievance against the Employer for wrongful dismissal by applying for reinstatement of employment in the same or equivalent position and with full compensation for lost wages and injury and the reimbursement of professional expenses and fees incurred respecting the grievance.
3. The Employer proposes to pay the employee a lump sum of approximately $XXXXXXXXXX so that the latter can make a contribution to a registered pension plan in order to buy back past years of service going from XXXXXXXXXX to XXXXXXXXXX. No breakdown of that amount has been provided.
4. As a result of those past service contributions, the employee could retire without penalty in XXXXXXXXXX. XXXXXXXXXX.
5. In addition, the Employer proposes to pay the employee an amount equal to the contributions of $XXXXXXXXXX required by the pension fund for the period.
6. XXXXXXXXXX.
Our Comments
The determination of the nature of an award is a question of fact that requires a review and analysis of all the facts, circumstances and documents specific to each situation. Consequently, given that your email only briefly described the facts of your situation, it is impossible for us to make a final determination in the context of this request. We can however make the following general comments.
Introduction
An amount received by an employee or former employee as a result of the termination of employment or at the time of retirement is considered to be income from that employment that is taxable by virtue of subsection 5(1), or as income taxable as a retiring allowance under subparagraph 56(1)(a)(ii), or to be non-taxable, or a combination of those components.
The determination of the nature of such an award is, however, a question of fact which requires a review of all facts and documents specific to each case. Generally, the determination of the nature of an award is made by the employer according to the characteristics of each situation. We are of the view that in this type of situation it is usually the employer who has all the relevant information in order to properly carry out that determination. If an award entails various payments with differing natures, the employer must apportion the award to determine the nature of each payment.
The general position of the Canada Revenue Agency on this subject is set out in Interpretation Bulletin IT-337R4, Retiring Allowances (Consolidated), which we invite you to consult on our Internet site at the following address: http : //www.cra-arc.gc.ca/E/pub/tp/it337r4-consolid/it337r4-consolid-e.pdf).
Salary and other employment income
Section 5 specifies that a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year. A taxpayer's employment income includes any salary, wages, bonus, vacation pay, tips, fees, and other payments received during the year for services rendered during the year as an employee or in the course of employment.
As stated in paragraph 13 of Interpretation Bulletin IT-337R4, 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 is generally viewed as remuneration from the former office or employment by virtue of subsection 5(1). However, in circumstances where the payment can also reasonably be regarded as being in recognition of long service or as compensation for loss of the position (see also paragraph 6) it is considered to be a retiring allowance.
For example, compensation for damages received in respect of wages or other unpaid benefits (such as vacation) is generally considered taxable employment income under subsection 5(1). Similarly, in the case of retroactive reinstatement of an employee, compensation for taxable damages will be considered employment income and not a retiring allowance.
In addition, as stated in Interpretation Bulletin No. IT-337R4 paragraph 17, benefits are not considered retiring allowances if an employer treats the instalments as income from employment for the purposes of computing Employment Insurance premiums and benefits, Canada Pension Plan or Quebec Pension Plan accruals or eligible years of service under a registered pension plan.
Retiring allowance
Paragraph 2 of Interpretation Bulletin IT-337R4 explains, as follows, what is a "retiring allowance":
2. "Retiring allowance" is defined in subsection 248(1) to mean an amount received
(a) on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer's long service, or
(b) in respect of a loss of 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,
by the taxpayer or, after the taxpayer's death, by a dependant or a relation of the taxpayer or by the legal representative of the taxpayer.
As stated in paragraph 5 of Interpretation Bulletin IT-337R4, a retiring allowance includes an amount received in respect of a loss of office or employment. In this context, the words "in respect of" have been held by the Courts to imply a connection between the loss of employment and the subsequent receipt, where the primary purpose of the receipt was compensation for the loss of employment. Two questions formulated by the Courts in determining whether such a connection exists are:
1 – But for the loss of employment would the amount have been received?
2 – Was the purpose of the payment to compensate for a loss of employment?
Generally, an award of damages received for wrongful dismissal is a retiring allowance if the employee is not reinstated retroactively. That allowance may be paid in respect of lost wages, renunciation of reinstatement and in lieu of notice or as other benefits including expenses incurred in seeking new employment, where there is a connection between the loss of employment and those payments.
Consequently, where there is a connection between loss of employment and compensation for damages, that allowance will generally be considered a retiring allowance. That is so for both special damages and general damages such as those paid for loss of self-esteem, humiliation, mental anguish or hurt feelings.
An amount received as a retiring allowance shall be included in computing the taxpayer's income in the taxation year in which it is received pursuant to subparagraph 56(1)(a)(ii) and may give rise to a deduction under paragraph 60(j.1)
Non-taxable amounts
Certain amounts paid to an employee or former employee may be exempt from tax. In that respect, paragraph 12 of the same Bulletin states:
Where personal injuries have been sustained before or after the loss of employment (for example, in situations of harassment during employment, or defamation after dismissal), the general damages received in respect of these injuries may be viewed as unrelated to the loss of employment and therefore non-taxable. In order to claim that damages received upon loss of employment are for personal injuries unrelated to the loss of employment, it must be clearly demonstrated that the damages relate to events or actions separate from the loss of employment. In making such a determination, the amount of severance that the employee would reasonably be entitled to will be taken into consideration.
Consequently, pursuant to paragraph 12 of IT-337R4, general damages received by an employee to compensate the employee for events occurring during the employee’s employment will generally be considered unrelated to the loss of employment and therefore not to be taxable. Since such actions or events are distinct from the loss of employment, the damages are instead intended to compensate the employee for personal injury sustained before the loss of employment rather than to compensate the employee for the loss of employment.
Similarly, damages awarded as a result of a human rights violation may be considered unrelated to the loss of employment, although often loss of employment results from a complaint of human rights violation. An amount that a human rights tribunal awards to a taxpayer as general damages does not normally have to be included in income.
Legal and out-of-court costs
Where an amount is received by a taxpayer as damages or as a reimbursement of legal expenses incurred by the taxpayer to collect or establish a right to a retiring allowance, that amount is included in the taxpayer's income under paragraph 56(1)(l.1). However, paragraph 60(o.1) allows the deduction of eligible legal expenses incurred by a taxpayer to collect or establish a right to a retiring allowance (including a right to damages for wrongful dismissal). We refer you to paragraph 23 of Interpretation Bulletin IT-337R4 for more details on this subject.
Deduction of a contribution to a registered retirement savings plan (RRSP) or a registered pension plan (RPP) from a retirement allowance
Paragraph 60(j.1) permits the deduction in computing a taxpayer's income of all or a portion of a retiring allowance that is included in the taxpayer's income under subparagraph 56(1)(a)(ii) that is transferred to an RPP or an RRSP of which the taxpayer is the annuitant. Paragraph 60(j.1) does not apply if the amount received is not a retiring allowance but is income from an office or employment.
The deduction under paragraph 60(j.1) is equal to the lesser of three amounts. Paragraphs 19 to 22 of Interpretation Bulletin IT-337R4 explain in detail how to calculate those three amounts. Here is a summary of how to calculate them.
The first amount, determined under subparagraph 60(j.1)(i), is the amount of the retiring allowance included in the taxpayer's income for the year by virtue of subparagraph 56(1)(a)(ii).
The second amount is determined under subparagraph 60(j.1)(ii). Subject to clauses 60(j.1)(ii)(C), (C.1) and (D), this amount is $2,000 multiplied by the number of years before 1996 during which the retiree was employed by the employer or by a "person related to the employer" under clause 60(j.1)(ii)(A). An additional amount of $1,500 may be added to that amount by virtue of clause 60(j.1)(ii)(B) for each year before 1989 in respect of which no employer contributions made, inter alia, under a pension plan had vested in the retiree at the time of the payment.
The question of whether a contribution has vested in a retiree is a question of fact. A contribution would not have vested if, at the time the retirement allowance is paid, the employee is not entitled to a pension, or a commuted lump sum, which includes contributions to the employer's pension plan. Where an employee buys back years of past service, we consider that employer contributions vest for each buy-back year. Consequently, an employee is not entitled to the additional $1,500 in clause 60(j.1)(ii)(B) for those years. Thus, in determining the limit established under subparagraph 60(j.1)(ii), the amount will be limited to $2,000 for each year before 1996 the services for which have been bought back in whole or in part. The additional $1,500 remains available for each year before1989 that the individual has not bought back in whole or in part.
Years of service with a former employer related to the current employer are taken into account in calculating the amount of a retiring allowance that may be transferred to an RRSP or RPP by virtue of paragraph 60(j.1). It is a question of fact whether a person is related to the employer. Paragraph 60(j.1)(v) provides that a "person related to the employer" includes a previous employer of the retiree whose service therewith is recognized in determining the retiree’s pension benefits. Where the employer's pension plan takes into account part of the years of service with a previous employer (for example, because of buying back the years of service), all years of service with the former employer may be included in the total number of years to be considered for the purposes of computing the amount eligible for a deduction by virtue of paragraph 60(j.1).
Furthermore, in determining the number of years of employment of the retiree, an incomplete year counts for one year.
The third amount that limits the deduction under paragraph 60(j.1) is determined under subparagraph 60(j.1)(iii) where the retiring allowance is paid into an RPP or an RRSP by the taxpayer in the year or within 60 days after the end of the year. That limit is the total of the amounts paid by the taxpayer during the year or within 60 days after the end of the year, first, pursuant to clause 60(j.1)(iii)(A), as a contribution to or under an RPP, other than the portion of that contribution that is deductible by virtue of paragraph 60(j) or 8(1)(m) in computing the taxpayer’s income for the year and, second, pursuant to clause 60(j.1) (iii) (B), as a premium under an RRSP under which the taxpayer is an annuitant, other than the portion of that premium designated for the purposes of paragraph 60(j) or 60(l). The deduction is permitted to the extent that the amount was not deducted in computing the taxpayer's income for a preceding year.
Deduction of an RPP contribution from employment income
Contributions to a registered pension plan may also be deductible from employment income by virtue of paragraph 8(1)(m). That deduction is the amount that the taxpayer may deduct under subsection 147.2(4) in computing the taxpayer’s income for the year for contributions to registered pension plans. Pursuant to clause 60(j.1)(iii)(A), contributions to a registered pension plan deducted from employment income under paragraph 8(1)(m) may not, however, give rise to a deduction by under paragraph 60(j.1).
Where an individual contributes to an RPP for services before 1990, the individual may claim a deduction in computing income under paragraph 147.2(4)(b) or (c), as the case may be. Paragraph 147.2(4)(b) refers to the services of a non-contributor and paragraph 147.2(4)(c) refers to the services of a contributor. Consequently, in determining whether a deduction is permitted by virtue of paragraph 147.2(4)(b) or (c), it must be determined whether or not the contribution is for a year for which the individual was contributing to an RPP.
For more information, please refer to Interpretation Bulletin IT-167R6, Registered Pension Plans - Employee's Contributions, available on our website at the following address: http: //www.cra -arc.gc.ca/E/pub/tp/it167r6/it167r6-e.html. We recommend that you refer specifically to paragraphs 4 to 8 and paragraph 17 of that Interpretation Bulletin regarding the maximum deduction a taxpayer may claim under paragraph 147.2(4)(b) or (c).
Best regards,
Michel Lambert, CA, M. Fisc.
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and
Regulatory Affairs Branch