Principal Issues: The tax treatment of a lump-sum amount paid pursuant to an order.
Position: Question of fact.
Reasons: Generally, the tax treatment of a settlement amount should be the same as the amount it is intended to replace.
XXXXXXXXXX 2018-074873 T. Baltkois March 19, 2019
Dear XXXXXXXXXX:
Re: Taxation of damages
We are writing in response to your correspondence of March 19, 2018, concerning the income tax treatment and withholding requirements of a lump-sum amount (“Order Amount”) paid by the XXXXXXXXXX (“Employer”) to each full-time XXXXXXXXXX (“Employee”) pursuant to an order issued by the XXXXXXXXXX (“Labour Board”).
In the situation you describe, the Labour Board determined that the Employer had committed an unfair labour practice and ordered the Employer (among other things) to pay an Order Amount to each Employee. The Order Amount was to be paid pursuant to XXXXXXXXXX of the Labour Relations Act of XXXXXXXXXX (“LRA”), and provided to each Employee in the bargaining unit when the unfair labour practice was committed.
Our Comments
This technical interpretation provides general comments about the provisions of the Income Tax Act (“Act”) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R8, Advance Income Tax Rulings and Technical Interpretations.
In determining the tax consequences of a particular payment, the essential question is to ascertain what the payment was intended to replace. In this regard, the Canadian courts rely on the common law concept referred to as the “surrogatum principle”. Therefore, depending on the particular facts and circumstances, a payment may be a retiring allowance, employment income, non-taxable damages, or some combination thereof.
Retiring allowance
If a settlement payment is a retiring allowance, the amount is included in income under subparagraph 56(1)(a)(ii) of the Act. As discussed in ¶2.3 of Income Tax Folio S2-F1-C2, Retiring Allowances:
“A retiring allowance is defined in subsection 248(1) of the Act as an amount received by an individual:
- on or after retirement of the individual from employment in recognition of the individual’s long service; or
- in respect of loss of employment of the individual, whether or not received as, on account of or in lieu of payment of, damages or pursuant to an order or judgement of a competent tribunal. ”
Since the Order Amount is being paid to each Employee who was in the bargaining unit when the unfair labour practice was committed, it is unlikely that the Order Amount would be a retiring allowance. That is, the amount likely is not paid in recognition of the Employees’ long service or in respect of the loss of employment.
Income from an office or employment
If a payment is not a retiring allowance but is received “in respect of, in the course of, or by virtue of an office or employment,” it may be taxable as employment income under paragraph 6(1)(a) of the Act. It is well established that there need only be a small connection between a benefit and the employment, in order to trigger the operation of paragraph 6(1)(a) of the Act.
In the situation you describe, the Labour Board ordered the Employer to pay an Order Amount to each Employee pursuant to XXXXXXXXXX of the LRA, which provides for the payment of an amount in situations where an unfair labour practice has interfered with the rights of any person under the LRA.
Notwithstanding that a payment made pursuant to XXXXXXXXXX of the LRA is provided in the context of employment, such payments are limited to situations where an employee has not otherwise suffered a loss of income, benefits, etc. as a result of the unfair labour practice. By contrast, payments made pursuant to XXXXXXXXXX of the LRA are specifically intended to compensate for financial losses (i.e., income, benefits, etc.) that arise as a result of an unfair labour practice.
It is therefore unlikely that an Order Payment provided pursuant to XXXXXXXXXX of the LRA would be made for the purpose of replacing an amount that would generally be required to be included in employment income.
However, to the extent that an Order Payment is required to be included in employment income under subsection 5(1) or paragraph 6(1)(a) of the Act, the amount would be subject to withholdings in accordance with subsection 153(1) of the Act. Please refer to Guide T4001, Employers’ Guide - Payroll Deductions and Remittances, for more information.
Non-taxable damages
As noted in ¶2 of Interpretation Bulletin IT-365R2, Damages, settlements and similar receipts, a settlement payment, or a portion thereof, may represent damages in respect of personal injury (including general damages for pain and suffering). Damages of this nature are excluded from income, even if the amount of damages are determined with reference to the loss of earnings.
Therefore, to the extent that the Order Amount was provided as a remedy for the violation of the employees’ rights under the LRA, the amount will be considered non-taxable damages and excluded from income. There are no reporting or withholding requirements for non-taxable damages.
Summary
The income tax treatment of a payment is generally based on the nature and purpose of the payment, which is a question of fact. In most cases, the parties involved are in the best position to make this determination. After reviewing the limited information provided, it appears that the Order Amount was likely provided to compensate each Employee for interference with his or her rights under the LRA, and would constitute non-taxable damages that are excluded from income.
We trust these comments will be of assistance to you.
Yours truly,
Jason R. Ward, CPA, CA
Acting Manager
Business and Employment Income Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch