Principal Issues: [TaxInterpretations translation]
Are amounts paid as part of an out-of-court settlement considered a retiring allowance?
Position:
Depends on the employment contract.
Reason:
E9813575, F9714785 and E2000-0028167
November 16, 2000
Laval Tax Services Office Headquarters
Financial Industries Division
Attention: Hélène St-Jacques
L. J. Roy, CGA2000-003506
Out-of-court settlement
This is further to your memo of June 22, 2000, in which you asked for our opinion on amounts paid to a former employee following an out-of-court settlement.
Our understanding of the facts of the situation you have referred to us is as follows.
FACTS
1. The employee was laid off on XXXXXXXXXX following the elimination of his position.
2. The employment contract provided for a performance bonus and also offered a stock option plan.
3. The employee instituted proceedings in the Superior Court of the district of XXXXXXXXXX to recover the performance bonus and to be compensated for the loss of benefits under the employer's stock option plan.
4. On XXXXXXXXXX, an out-of-court settlement stipulated that an amount of $XXXXXXXXXX was to be paid, and covered 3 components
- an amount of $XXXXXXXXXX as reimbursement of professional fees;
- an amount of $XXXXXXXXXX as payment of the bonus for the period from XXXXXXXXXX;
- an amount of $XXXXXXXXXX as damages in lieu of lost benefits under the employer's stock option plan;
5. The out-of-court settlement dated XXXXXXXXXX stipulated that the employee tendered his resignation as of XXXXXXXXXX.
YOUR QUESTION
Does the amount of $XXXXXXXXX represent a retiring allowance as defined in subsection 248(1) of the Income Tax Act (the “Act”)?
OUR COMMENTS:
Subsection 248(1) defines the term retiring allowance as “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, by the taxpayer.” The Agency considers that, in general, compensation for damages received as a result of wrongful dismissal is included in income under subparagraph 56(1)(a)(ii) as a retiring allowance if it is not stated that the employee must be reinstated retroactively. That allowance may include loss of salary, wages or other benefits.
As stated in paragraph 15 of Interpretation Bulletin IT-365R2, where a taxpayer receives an amount pursuant to the terms of an employment contract, the amount is to be included in computing the taxpayer's income under subsection 5(1) or section 6, whichever may be applicable, as income from an office or employment, whether or not it is received on termination of the employment. Such an amount would include, for example, salary, wages, accrued vacation pay, and an amount paid in lieu of notice of termination.
In the situation where the performance bonus was payable to the taxpayer under his employment contract even though he had terminated his employment, we are of the view that the amount of the performance bonus would be included in computing the taxpayer's income under subsection 5(1) or section 6. However, if the employment contract provided that the right to the bonus was forfeited in the event of termination of employment, we are of the view that the amount would be included in the taxpayer's income under subparagraph 56(1)(a)(ii).
Pursuant to paragraph 7(1)(b), an employee who has transferred or otherwise disposed of rights in respect of a stock option to a person with whom the employee was dealing at arm’s length, is deemed to have received a benefit because of the employee’s employment if the amount received exceeds the amount paid by the employee for those rights. The fact that the amount is received before or after the termination of employment does not prevent the application of this paragraph.
It is a question of fact whether an amount was received as consideration for the disposition of rights in respect of a stock option of the taxpayer or as damages for the loss of an office or employment. However, if under the terms of the stock option agreement, the taxpayer's right to the option terminated upon termination of employment, it is our view that the amount received for the loss of benefits under such a plan would be received as a retiring allowance.
As indicated in paragraph 27 of Interpretation Bulletin IT-99R5 and paragraph 10 of Interpretation Bulletin IT-337R3, amounts received as an award or reimbursement of legal expenses paid by a taxpayer to collect or establish a right to a retiring allowance are required to be included in the taxpayer's income under paragraph 56(1)(l.1).
However, given the limits set out in paragraph 60(o.1), the taxpayer may deduct judicial and extrajudicial costs incurred to recover or establish a right to a retiring allowance. In this regard, please refer to paragraphs 25 and 26 of Interpretation Bulletin IT-99R5.
According to paragraph 22 of IT-99R5, paragraph 8(1)(b) permits a deduction in computing income from an office or employment, for legal expenses paid by a taxpayer in the year to collect or to establish a right to salary or wages owed by an employer or former employer. Paragraph 6(1)(j) requires a taxpayer to include in income any award or reimbursement received in respect of amounts for which a deduction under paragraph 8(1)(b) is available. These amounts must be included in income to the extent that they are not otherwise so included or taken into account in computing the amount deducted under subsection 8(1). Legal fees relating to the recovery of an amount taxable under section 7 would also be subject to paragraphs 8(1)(b) and 6(1)(j).
ACCESS TO INFORMATION
For your information, a copy of this memorandum will be severed using the Access to Information Act and will be available in the Legislative Access Database (LAD) located on the mainframe of the Canada Customs and Revenue Agency. 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 Legislative Access Bank 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 that has been severed in accordance with the Privacy Act will be sent to you for delivery to the client.
Acting Manager
Financing and Plans Section
Financial Industries Division
Income Tax Rulings Directorate
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