Principal Issues: Whether an amount allocated for mental distress on a settlement of damages, following a loss of employment, is non-taxable or a retiring allowance.
Position: Likely a retiring allowance.
Reasons: In order to qualify as non-taxable damages, the taxpayer must be able to demonstrate that the damages relate to events or actions separate from the loss of employment. In this case, the damages appear to relate only to the loss of employment.
November 2, 2006
Client Services HEADQUARTERS Regina TSO J. Gibbons, CGA (819) 458-3538 Attention: Joan Ervin 2006-020497
XXXXXXXXXX (the "Taxpayer")
This is in response to your facsimile dated September 20, 2006, concerning the income tax treatment of a settlement for damages (the "Settlement") between the Taxpayer and his former employer (the "Former Employer") in the amount of $XXXXXXXXXX relating to the Taxpayer's loss of employment (the "Loss of Employment") with the Former Employer. In particular, you are seeking our assistance concerning the Taxpayer's request for a waiver in respect of $XXXXXXXXXX of the $XXXXXXXXXX, which he claims is tax-exempt. According to the documents sent along with your facsimile, including copies of the Taxpayers statement of claim (the "Statement of Claim") and the minutes of Settlement (the "Minutes of Settlements") relating to the Taxpayer's claim against the Former Employer, the relevant facts are as follows:
Facts
- The Loss of Employment occurred in XXXXXXXXXX, approximately one year after the Taxpayer was hired by the Former Employer.
- Following the Loss of Employment, the Taxpayer commenced a claim against the Former Employer in XXXXXXXXXX, claiming damages for loss of pay in lieu of notice, loss of benefits and emotional distress.
- In the Minutes of Settlement, the Former Employer agreed to pay the Taxpayer the following amounts:
- Payment in lieu of notice of termination of employment contract - $XXXXXXXXXX
- Damages for emotional distress - $XXXXXXXXXX
Total $XXXXXXXXXX
Our Views
A "retiring allowance" is defined in subsection 248(1) of the Income Tax Act to include "an amount...received...in respect of a loss of an 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." On the basis of the Supreme Court of Canada's in Nowegijick, 83 DTC 5041, which opined that the words "in respect of" are "... of the widest possible scope," we have taken the position that a retiring allowance can encompass all types of payments arising from an employee's loss of employment. In this regard, paragraph 11 of Interpretation Bulletin IT-337R4, Retiring Allowances, states that where an individual receives compensation on account of damages for a loss of employment, the amount received will be taxed as a retiring allowance. This applies to both special damages, as well as general damages received for loss of self-respect, humiliation, mental anguish, hurt feelings, etc.
As noted in paragraph 12 of IT-337R4, only where general damages are received in respect of personal injuries sustained before or after the loss of employment (for example, in situations of harassment during employment or defamation after dismissal), or where a loss of employment involves a human rights violation and is settled out of court, will general damages 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 received relate to events or actions separate from the loss of employment. In the case of damages received for a human rights violation, only a reasonable amount, determined by reference to the maximum amount that would be awarded under the particular human rights legislation and the evidence presented in the case, would qualify as non-taxable.
As is generally the case, the Minutes of Settlement set out the terms of Settlement in very generic terms, stating only that $XXXXXXXXXX is awarded for "damages for emotional distress." However, the Statement of Claim and a letter from the Taxpayer's legal representative unequivocally link the $XXXXXXXXXX damage settlement to the loss of employment. As indicated above, unless a taxpayer can clearly demonstrate that damages received from a former employer relate to events or actions separate from the loss of employment, the damages will be considered a retiring allowance. Accordingly, it is our view that the $XXXXXXXXXX amount designated as "damages for emotional distress" in the Minutes of Settlement, along with the other $XXXXXXXXXX damage award included therein, constitute a taxable retiring allowance.
For your information a copy of this memorandum will be severed using the criteria in the Access to Information Act and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the Taxpayer. Should the Taxpayer request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
If we can be of any further assistance, please feel free to contact the author at the above-noted number.
Randy Hewlett
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch