Principal Issues: [TaxInterpretations translation]
Is an amount paid by an employer to an employee in an out-of-court settlement taxable and if so, on what basis?
Position:
Yes, according to the information obtained, the amount is taxable as a retiring allowance.
Reasons:
The definition of "retiring allowance" in subsection 248(1) of the Act includes an amount received by an employee following the loss of employment.
October 19, 2004
XXXXXXXXXX Headquarters Tax Services Office Danielle Bouffard XXXXXXXXXX (613) 957-8953
2004-008571
Damages received as a result of an out-of-court settlement
This is in response to your fax of July 14, 2004 in which you requested our opinion on the above subject. We apologize for the delay in responding to your request.
Situation
Our understanding of the facts is as follows:
1. The taxpayer has lodged three grievances with the union representing her.
2. The first grievance filed in XXXXXXXXXX challenged her employer's decision not to pay her salary insurance for the period from XXXXXXXXXX. A second grievance filed in XXXXXXXXXX challenged a suspension of XXXXXXXXXX days of work and claimed lost earnings. The third grievance, also in XXXXXXXXXX, related to psychological harassment by her employer.
3. The taxpayer and the union had also brought proceedings before the Commission des lésions professionnelles and filed a complaint with the Commission de la santé et de la sécurité du travail du Québec ("CSST").
4. On XXXXXXXXXX, the taxpayer signed a document entitled "Settlement & Transaction" (the "Settlement") involving the employer, the union and the taxpayer (the latter being referred to for the purposes of this document as "the Employee"). The main points of the Settlement were:
- The Employee resigned from her position; all employment ties between the Employee and the Employer were severed as of the signing of the Settlement, i.e. on XXXXXXXXXX.
- The Employee and the Union withdrew the three grievances as well as the other challenges or complaints with the Commission des lésions professionnelles and the CSST.
- The Employer agreed to pay the Employee the sum of $XXXXXXXXXX and release the sum of $XXXXXXXXXX representing the balance of wage-loss insurance that the Employee received in excess. The Wage Earner agreed to reimburse the CSST the sum of $XXXXXXXXXX for benefits received during the first XXXXXXXXXX days of work stoppage.
5. On XXXXXXXXXX, the taxpayer received a cheque in the amount of $XXXXXXXXXX, which was the amount of $XXXXXXXXXX net of deductions at source.
Question
Should the amount received by the taxpayer be added to her income, and on what basis?
Our Comments
In general, compensation paid to an individual by the individual’s employer or former employer as damages may be a retiring allowance, employment income, tax-free damages or a combination of these.
The term "retiring allowance" is defined in subsection 248(1) of the Income Tax Act (the "Act"). That definition provides that the term "retiring allowance" includes an amount received in respect of a taxpayer's loss of an office or employment, whether or not received as damages or pursuant to an order or judgment of a competent tribunal.
As noted in paragraph 5 of Interpretation Bulletin IT-337R4, Retiring Allowance, 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 set out by the Courts to determine whether a connection exists for purposes of a retiring allowance are as follows:
1 – But for the loss of employment would the amount have been received? and,
2 – Was the purpose of the payment to compensate a loss of employment?
Under this Bulletin, termination of employment for any reason is considered retirement or loss of employment. In addition, loss of office or employment may relate to the loss of a source of income by an employee who is relieved, unilaterally or otherwise, of an office or employment.
In the context of this request, the Settlement signed by the taxpayer states that the taxpayer has resigned from her position and that the union and the taxpayer withdraw the three grievances and other complaints. Taking these two specific points into account, the employer agrees to pay $XXXXXXXXXX and releases $XXXXXXXXXX of wage loss insurance that the taxpayer received in excess. It is therefore reasonable to conclude that the taxpayer received some or all of the money from her employer in respect of her loss of employment (her resignation was one of the terms of the settlement).
However, based solely on the information provided in your request, particularly the content of the Regulations, it is difficult for us to determine whether part of the amount paid by the employer on XXXXXXXXXX may relate, inter alia, to unpaid wages (loss of earnings following a suspension) which would be added in calculating the taxpayer's income pursuant to section 5; to compensate the taxpayer for the harassment that the taxpayer alleges to have experienced during the period of employment; or to a combination of these elements
As stated in paragraph 12 of IT-337R4:
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. (our emphasis)
In the absence of further information demonstrating that the amount paid by the employer was intended to compensate the taxpayer for items such as wages that should have been paid to her during her period of employment and/or damages relating to the harassment complaint made during the period prior to her loss of employment, it is our view that the definition of "retiring allowance" in subsection 248(1) covers both the $XXXXXXXXXX received by the taxpayer and the wage loss replacement insurance receipt of $XXXXXXXXXX which must be included in the taxpayer's income pursuant to subparagraph 56(1)(a)(ii). It should be noted that the $XXXXXXXXXX of wage-loss insurance could give rise to a deduction from the taxpayer's income from office and employment as a reimbursement of remuneration pursuant to paragraph 8(1)(n) if the amount had otherwise been previously included in the taxpayer's income from office and employment.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency'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 your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client 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 Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope you find these comments of assistance. Should you require any additional information regarding the content of this document, please do not hesitate to contact us.
Ghislaine Landry, CGA
for the Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch