Principal Issues: A) The question is whether a retroactive salary adjustment payment could benefit from the rules for averaging a retroactive payment under sections 110.2 and 120.31 of the Income Tax Act.
B) You also wish to know on which slips the interest paid should appear.
Position: A) No; B) Interest paid on a retroactive salary payment is reported on T5 slips.
Reasons: In our view, employees will not be able to benefit from the treatment provided for in section 110.2 because the conditions are not satisfied. The payment of the amounts in this case is not a "qualifying amount" for the purposes of subsection 110.2(2) because it is not received pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding. These agreements reached entitling the parties to the retroactive salary adjustments are the result of a determination by the parties of the need to review the salary structure and of negotiations. This resulted in agreements between the employer and representatives of the various pay equity committees.
XXXXXXXXXX 2010-038185 Anne Dagenais Advocate, M. Fisc. B.A.A. March 3, 2011
Dear Madam,
Subject: Retroactive salary adjustments
This is in response to your letter of September 21, 2010, in which you requested our opinion on the tax treatment of amounts paid by an employer to its employees.
Specifically, you described the following hypothetical situation:
A few years ago, under the Québec Pay Equity Act, an employer set up several pay equity committees composed of employee and employer representatives. The conclusions were that no salary adjustment was required under the Québec Pay Equity Act. However, it was agreed to review the salary structure for certain job classes and to apply the same criteria as those provided for in the Quebec Pay Equity Act to the adjustments thus calculated. This facilitated the withdrawal of complaints that had been filed by the unions with the Pay Equity Commission.
Consequently, agreements have been reached between the employer and the various pay equity committees for the payment of retroactive salary adjustments for the period from November 21, 2001 to December 31, 2010. Those amounts will be paid in 2011 and will bear interest at the legal rate of 5%.
You wish to know if employees who receive a retroactive salary adjustment will be able to benefit from the rules for averaging a retroactive payment provided for in sections 110.2 and 120.31 of the Income Tax Act (the "Act"). You also wish to know on which slips they should show the interest paid.
Unless otherwise specified, all legislative references in this document are to the provisions of the Act.
Our Comments
It appears to us that the situation described in your letter and summarized above could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and a transaction or transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for its opinion. However, we are able to provide you with the following general comments that may be useful to you.
Sections 110.2 and 120.31 provide a mechanism for averaging lump sum payments. The definitions in section 110.2 also apply to section 120.31.
Subsection 110.2(2) provides that there may be deducted in computing the taxable income of an individual (other than a trust) for a particular taxation year the total of all amounts each of which is a specified portion of a qualifying amount received by the individual in the particular year, if that total is $3,000 or more. A hypothetical tax is calculated pursuant to section 120.31 on the amount deducted under subsection 110.2(2).
To qualify, payments must meet the definition of "qualifying amount" in subsection 110.2(1). That definition requires inter alia that the amount be received pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding.
In our view, the amounts paid in this case do not satisfy the definition of "qualifying amount" in subsection 110.2(1) because they are not received pursuant to an order or judgment of a competent tribunal, an arbitration award or a contract by which the payor and the individual terminate a legal proceeding.
The agreements reached giving entitlement to these retroactive salary are the result of a finding by the parties that there was a need to review the salary structure for certain job classes. That resulted in agreements between the employer and representatives of the various pay equity committees. As a result, employees will not be eligible for the treatment provided under sections 110.2 and 110.31 because the conditions in subsection 110.2(2) are not satisfied. Form T1198 does not have to be completed in this case.
Furthermore, interest paid on a payment as a retroactive salary adjustment is reported on T5 slips for the year it is received to allow employees to be better informed of the amounts they have received, since they must be included in computing their taxable income.
These comments do not constitute an advance income tax ruling and do not bind the CRA with respect to a particular factual situation.
We hope that the above comments will be of assistance and will answer your questions.
Best regards,
François Bordeleau, Advocate
Manager
Business and Partnerships Section
Income Tax Rulings Directorate.