AN EMPLOYMENT LAWYER'S GUIDE TO INCOME TAX IMPLICATIONS IN WRONGFUL DISMISSAL CASES

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1 AN EMPLOYMENT LAWYER'S GUIDE TO INCOME TAX IMPLICATIONS IN WRONGFUL DISMISSAL CASES These materials were prepared by Susan Barber of McDougall Gauley law firm Regina, Saskatchewan for the Saskatchewan Legal Education Society Inc. seminar, Current Issues in Employment Law; September 2002.

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3 2 I. INTRODUCTION The intention of this paper is to provide a brief overview of some of the income tax considerations which frequently arise in negotiating and concluding severance packages for dismissed employees. Although the case law and tax rulings relative to the treatment and characterization of various aspects of damage awards are numerous, this paper will focus on those which arise on a day-to-day basis for employment practitioners. In most cases the more complicated issues that arise should be reviewed by an accountant or a tax lawyer. II. TAX TREATMENT OF PAYMENTS RECEIVED BY A DISMISSED EMPLOYEE In most cases, an amount received by a former employee which arises out ofor in consequence of termination of employment will either be considered to be a retiring allowance as defined in section 248(1 of the Income Tax Act, R.S.C. 1985, c.l, as amended (the "Act" or income from employment under subsection 5(1 or 6(1 ofthe Act. The significance ofthe distinction is that a retiring allowance can be transferred to a registered pension plan or a registered retirement savings plan and thus be deducted under paragraph 60 G.l of the Act whereas income from employment cannot be similarly transferred. (a Income from an Office or Employment The relevant sections ofthe Actin this regard are sections 5(1 and 6(1 ofthe Act which provide as follows: 5(1...a taxpayer's income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year. 6(1 There shall be included in computing the income ofa tax payer for a taxation year as income from an office or employment... (a the value of board, lodging and other benefits of any kind whatever received or.enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of an office or employment, except.., I j

4 3 Canada Customs and Revenue Agency ("CeRA", according to Interpretation Bulletin 337R3 1, considers the following items to be included as income for a taxation year from an office or employment: i a payment received upon or after retirement or in respect of a loss of employment pursuant to the terms of an employment contract with a former employer (unless the payment can reasonably be regarded as being in recognition of long service or as compensation for loss of office, in which case it will be a retiring allowance. ii Receipt of a low salary or no salary before retirement in return for a so-called retiring allowance upon or after retirement from an office or employment. Such an amount is more likely to be regarded as deferred compensation, taxable as income from an office or employment when received. iii Salary and wages for accrued vacation pay. iv Payments in lieu ofearnings for the period ofa reasonable notice oftermination by virtue of the terms of the taxpayer's employment (explicit or implied. This is because payment in lieu of earnings for a period of a reasonable notice of termination is considered to be included in the terms ofthe taxpayer's employment contract. v Amounts received out of or under an employee benefit plan or a salary deferral arrangement; vi Special damages, such as those received for lost (unearned wages or employee benefits, ifthe employee retains his or her employment oris reinstated. vii A payment in respect of a non-competition covenant (generally included under paragraph 6(3(c of the Act. It should be noted that amounts paid for counselling services in respect of the re-employment or retirement ofthe taxpayer are excluded from the definition ofincome by subsection 6(l(a(iv of the Act. 1 CCRA Interpretation Bulletin IT-337R3 - Retiring Allowance, January 30, 1998

5 4 (b The Retiring Allowance "Retiring Allowance" is defined by section 248(1 ofthe Act as follows: "retiring allowance" means an amount (other than a superannuation or pension benefit, an amount received as a consequence of the death of an employee or a benefit described in subparagraph 6(l(a(iv received (a on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer's long service, or (b 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 or, after the taxpayer's death, by a dependent or a relation of the taxpayer or by the legal representative ofthe taxpayer. A retiring allowance includes termination or severance pay that is either awarded by a court or paid by private settlement. Retiring allowances are taxable pursuant to subsection 56(1(a(ii2 and are subject to source withholding pursuant to subsection 153(l(b.3 The component parts of the definition of a 'retiring allowance' have been considered by the Tax Court ofcanada as follows: 1. "Retirement" from an Office or Employment or "Loss" ofan Office or Employment The first portion of the definition of a retiring allowance applies to an amount paid on retirement in recognition of long service. / 256(1 Amounts to be included in income for year - Without restricting the generality of section 3, there shall be included in computing the income ofa taxpayer for a taxation year, (a any amount received by the taxpayer in the year as, on account or in lieu of payment of, or in satisfaction of, (ii a retiring allowance, otherthan an amountreceived out ofor under an employee benefit plan, a retirement compensation arrangement or a salary deferral arrangement (1 Withholding - Every person paying at any time in a taxation year (b.a retiring allowance shall deduct or withhold from the payment the amount determined in accordance with prescribed rules and shall, at the prescribed time, remit that amount to the Receiver General on account of the payee's tax for the year under this Part or Part XI.3, as the case may be, and, where atthatprescribed time the person is a prescribed person, the remittance shall be made to the account ofthe Receiver General at a designated financial institution.

6 5 Whether an individual has retired is a question of fact to be considered based on all ofthe circumstances. CCRA takes the position that continued participation in a former employer's health plan for a restricted period of time would not, in itself, mean that employment has not terminated, particularly if the employer's plan specifically permits former employees to be covered. If, however, pension benefits continue to accrue to that same individual, the employment relationship is assumed to continue since such benefits only accrue to employees. 4 The fact that the employer does not require an individual to report to work is not, by itself, determinative of whether the individual has retired. An individual who has- been given a leave of absence for educational purposes, for example, is still an employee. fu determining "long service" reference is had to the total number of years in an employee's career with a particular employer or with affiliated employers. Generally speaking, a payment for a loss of office or employment refers to the elimination or expiration of a particular office or employment such as the abolition of a job or shutting down of a business. A loss ofoffice oremployment might also refer to an early retirement program which is designed to eliminate a number of positions. CCRA has determined, however, that retirement orloss ofan office oremploymentdoes notinclude the followings: transfer from one office or position to another with the same employer (or an affiliate, in a different capacity (including one with diminished responsibilities; termination of employment with an employer followed by re-employment with the employer on a full or part-time basis or employment with an affiliate of the employer, either of which is made pursuant to an arrangement prior to the termination ofemployment; or termination of employment where salary and benefits continue to accrue until a later date (in which case, retirement or loss of employment will be considered to take place at the later date. 4 IT 337R3, supra, note 1, paragraph 4

7 6 In R. v. Fostey, [1999] 99 DTC 1004 (Tax CC, Mr. Fostey was terminated from his position as ChiefExecutive Officer when his employer, Company A, sold the business goodwill to Company B. However, the sale agreement provided that Company B would hire Mr. Fostey for a 40 month personal employment contract and that he would receive a retiring allowance of $30, on the cessation of his employment. The Court held that the original employment had ceased and, as such, the payment was a proper retiring allowance. The Court considered the fact that after the sale, Mr. Fostey's corporation surrendered its customs brokeragelicense and became inactive. After the sale, Mr. Fostey had no contact with clients or with importers and no financial responsibility. Nor did he perform any external representation or research roles and, most importantly, he was not the control behind the customs brokerage business. It was clear that Mr. Fostey's new role was mainly clerical and thus sufficiently distinguished from his original position as CEO. The original employment or office had thus been 'lost' and the retiring allowance was properly characterized as such within the meaning of subsection 248(1 of the Act. The Court concluded that Mr. Fostey retired from his position as Chief Executive Officer and, when he ceased his employment, he received a retiring allowance in respect of his many long years of service. 2. "Office or employment" The definition of "office or employment" in the context of elected or volunteer positions was considered in R. v. Gordon, [1999] 1 CTC 2327 (Tax CC. Mr. Gordon, a former alderman for the City of Burnaby, received a complimentary golf pass in recognition of his service. The Court confirmed that he did not hold an 'office or employment' as an independent elected representative of the citizens and, as such, the value of the pass should not be included as income. The Court stated: I find that the Appellant's volunteer services do not meet the definitions of "office.or employment." He was not a servant or employee. He generously donated his time to benefit his community. There was no evidence that he was an individual holding a position in the service ofsome other person... 5 Ibid, paragraph 3

8 7 3. Received "in respect or' the Loss ofan Office oremployment This phrase has been widely considered in the context of settlement or damage awards for terminated employees. The touchstone Supreme Court case, R. v. Norwegijick, [1983] 83 DTC 5041 (SCC, directed a very broad approach and stated as follows: The words "in respect of' are, in my opinion, words of the widest possible scope. They import such meanings as "in relation to", "with reference to" or "in connection with". The phrase "in respect of' is probably the widest of any expression intended to convey some connection between two ~elated subject matters. In R. v. Saardi, [1999] 99 DTC 767 (Tax CC, the taxpayer sued his American employer for both unpaid wages and moving expenses. The parties were able to reach a settlement for $50, approximately 3 years after the commencement of legal proceedings. The taxpayer did not include that settlement amount in his taxable income. In a subsequent assessment, CCRA treated the $50, as a taxable retiring allowance and assessed a penalty. The taxpayer appealed on the grounds that the settlement proceeds were reimbursement of costs and expenses incurred during or priorto employment in the United States. The Court found that there was an "insufficient connection" between the settlement payment and the loss of employment. In particular, the court suggested that the payment arose primarily from the lawsuit and was thus "extraneous" to the loss of employment apd could not be characterized as the payment ofa retiring allowance. The Court also refused to accept the argument of the Minister that the $50, payment represented remuneration caught by subsection 5(1 of the Act. The amount that was initially claimed for unpaid wages represented 90% of the total claim and the balance of 10% was claimed as damages. The taxpayer accepted $50, out of a claim of $366,000.00, being approximately 10% of the total claim. The Court found that the parties to the out-of-court settlement were at liberty to settle their litigation by mutual agreement and to characterize the transaction in such a way as to minimize the tax payable. The Court found that 10% of the

9 8 amount claimed in the lawsuit was in respect of damages and that the taxpayer agreed to accept compensation for that portion only. The Court accepted that the amount of $50, was paid to compensate the personal loss suffered by the taxpayer in agreeing to move to the United States and was not a payment ofunpaid wages. In R. v. Fournier, [1999] 4 CTC 2247 (Tax CC, a female employee resigned and accepted a settlement payment following sexual and physical harassment by co-workers. The payment was intended to serve the purposes of reimbursing, retraining, re-educating and re-establishing the taxpayer in return for her agreeing to apply for long-term disability -and to withdraw all grievances and complaints. As a consequence, her employment was terminated and recorded as a resignation. In computing her income for the tax year in question, the taxpayer included income from the employer in the amount ofapproximately $55,000.00, a retirement allowance from heremployer in the amount of approximately $5, and employment benefits from a wage loss plan in the amount of approximately $15, She also claimed an amount of $42, as a deduction in computing her taxable income. The Minister refused the deduction on the basis that the amount was a retiring allowance to be included in income. The Court found that the amounts received by the taxpayer from her employer were not received "in respect of a loss of...employment...on account of or in lieu of payment of, damages." The employer did not make any payment, nor did the taxpayer receive any payment in respect of a loss ofemployment. The payments were made due to the fact that co-workers were harassing the taxpayer and that the taxpayer had a valid claim for damages against the employer due to the actions of its employees. The Court found, similarly, that her agreement to resign was simply a way for the employer to get rid of an employee. She did not receive any payment in consideration of, or on account of, her agreeing to leave the employment of the employer and did not receive these amounts as damages for any stress, medical or other injuries she sustained as a result of the termination of her employment.

10 9 The case of louvet v. Canada, [2000] TCJ No. 48 (Tax Ct of Canada presents an opposite approach to Fournier. In that case the taxpayer was terminated without cause and her grievance for the employer's verbal abuse was settled for a cash sum of$10, She signed a Release discharging the employer from future claims connected with the termination. The Employer issued a T4A slip indicating that the $10, payment was for "damages settlement". No income tax was withheld at source and the taxpayer did not include that amount in her income tax return. The Minister ofnational Revenue assessed the taxpayer and added the amount of $10, to her income for the tax year in question on the basis it was income from a retiring allowance. The taxpayer appealed, arguing that the settlement was never intended to form a severance or retiring allowance, that the sole purpose was to prevent her further legal action, and that the amount was significantly more than the one month severance pay she would have ordinarily received. The Court found that the release signed by the taxpayer was clear in indicating that the $10, amount was received in respect of the loss of employment. The Court found a sufficient nexis between the money and the employment and determined that, had there been no loss of employment, there would have been no grievance, no settlement, no award and, therefore, no payment. Even though both parties intended to characterized the payment as damages. it did not change the fact that the taxpayer received that amount as a consequence of the loss of her employment. The Court also rejected the suggestion by the taxpayer that the settlement amount was received as damages in compensation for a human rights violation. The Release specifically provided that there was no admission ofliability on the part of the employer and, accordingly, the Court found it impossible to attribute a reasonable amount in respect of general damages caused by a human rights violation.

11 10 (c Characterization of Damages and Human Rights Awards CCRA takes the position that amounts paid by way of general damages - i.e. damages for loss of self-respect, humiliation, mental anguish, hurt feelings, etc., or pursuant to an order or judgment of a competent tribunal may be a retiring allowance if the payment arises from a loss of office or employment ofa taxpayer. However, ifa human rights tribunal awards a taxpayer an amount for general damages, the amount is normally not required to be included in income. When a loss of employment involves a human rights violation and is settled out of court, a reasonable amount in respect of general damages can be excluded from income. The determination of what is reasonable is influenced by the maximum amount that can be awarded- under the applicable human rights legislation and the evidence presented in the case. In Young v. MNR 86 DTC 1567 (TCC, the taxpayer was dismissed from employment and sued his employer for wrongful dismissal. In addition to the damages for wrongful dismissal the Court awarded damages for mental distress and exemplary damages. The Minister treated the entire damage award as a retiring allowance. The taxpayer appealed. The Tax Court of Canada dismissed the appeal on the basis that the amounts paid by way of exemplary damages and for mental distress were not shown to be outside of the parameters of subsection 248(1 of the Act. It is interesting to note, however, that the Court was careful to point out that if there had been some direct evidence or testimony as to the origin of the amounts in issue, the decision might have been otherwise. The Court suggested that the position of the Minister in assessing the taxpayer could have been more clearly demonstrated and that the case "raised some questions" regarding matters ofevidence before the Court. In 1990, the Tax Court of Canada again considered the issue of taxation on damage awards in Louis - Philippe Bedard v. MNR 91 DTC 573. In that case the taxpayer was dismissed from his employment and the reasons for his dismissal made their way to radio and television news headlines. A settlement was reached between the employer and the taxpayer in which the taxpayer received 6 months salary together with a $32, payment which was stated to be "by way of compensation for damage suffered". The Minister included that amount in the

12 11 taxpayer's income for the taxation year in which it was received as a retiring allowance. The taxpayer appealed. The Tax Court of Canada determined that the law makers did not, in adopting the definition of "retiring allowance", intend it to include damages for defamation that might be suffered by the occasional victim of a dismissal. The Court held that while an amount granted to an employee after his dismissal may include damages for defamation, it is clear that any such part of the compensation granted belongs to an entirely different order of compensation that is manifestly not covered by the definition of "retiring allowance". The Court agreed, based on testimonyofthe taxpayer, that the compensatory amount was granted partly to make up for the defamation of which he was the victim and partly to compensate for the financial damage suffered by him and his family after he lost his job. The court somewhat arbitrarily considered the extent of the blow to his reputation and found that only one-half of the $32, should be included in income. The other half, as found by the court, constituted damages for defamation, not classed as income from a retiring allowance. The Court, in passing, opined that the judge in the Young case did not rule out the possibility that amounts granted as compensation for mental distress might not be regarded as a retiring allowance. The Court simply found that the evidence was insufficient to show how the amount received had been granted as compensation for a type of damage other than that resulting from the loss of employment. In Niles v. MNR 91 DTC 806 (TCC, decided in 1991, the taxpayer settled a complaint filed with the Ontario Human Rights Commission by receiving $5, from his employer. The Minister included the amount in the taxpayer's income in the year in which it was received. The taxpayer appealed. The Court found that the payment in question was not compensation ordered for breach of the Human Rights Code but, rather, payment of a settlement reached between the employer and the

13 12 employee. The Courtcharacterizedthe payment, not as an award ordamages but as settlement of a complaint. Although the method of calculating the settlement was based on the taxpayer's hourly rate of pay and the number of weeks between his lay-off and the time of commencing his re-training, that, in itself, was not necessarily the sole method of determining the nature of the payment. The Court held that all of the factors taken together pointed to the payment being one made as a result of loss of employment. In dismissing the appeal, the Court concluded as follows: There is no doubt but that the settlement payment was made because of the employee's loss of employment. It makes no matter why he was laid off whether for breach of contract or because of an alleged discrimination. He received the amount to settle his claim against the employer for loss of employment. There was no finding of discrimination, nor was there an award which might have altered the character of the payment. The settlement was based on lost wages and determined in that fashion. In Stolte v. Canada [1996] T.C.J. No. 215, the Court considered the matter of compensation for mental distress and whether a payment by way ofcompensation for such distress was taxable. A claim by the taxpayer against her former employer was settled by the taxpayer receiving five weeks severance plus two months salary as a compensation for pain and suffering. The position of the taxpayer was that the sum of approximately $6, (two months salary was not received "in respect of a loss of an office or employment" but was paid and received to compensate her for the physical and mental damages which she suffered from the ill-treatment to which she was subjected at the hands of managers and supervisors of her employer during approximately 1 Yz year prior to her ceasing to be employed by the company. The Court reviewed the facts and found that the amount in dispute was for damages and not for the loss of employment. The damages were for the mental and physical injuries that the taxpayer sustained by reason of the "insensitive, arrogant and wholly unacceptable treatment" that she suffered at the hands of her employer prior to the termination of her employment.

14 13 III. INCOME INCLUSION AND TRANSFERS TO A REGISTERED RETIREMENT SAVINGS PLAN OR REGISTERED PENSION PLAN As noted at the outset of this paper, retiring allowances are taxable and included in computing the income of a taxpayer under subparagraph 56(l(a(ii of the Act. However, section of the Act allows a deduction for all or part of a retiring allowance which is included in computing the taxpayer's income under subparagraph 56(l(a(ii and transferred to a registered pension plan or a registered retirement saving plan under which the taxpayer is the annuitant, provided that the transfer is made in the year or within 60 days after the end of the year. The deduction, generally speaking, is limited to the aggregate of: (a $2, times the number of years before 1996 during which the employee was employed by the employer or a related employer; and (b $1, times the number of years prior to 1989 in respect of which employer contributions to a pensionplan or a deferred profit sharing plan ofthe employer or a person related to the employer had vested in the employee. According to a CCRA advanced tax ruling 6, a year will qualify for inclusion in the calculation even if the employee worked for the employer for as little as one day in that year. The Act does not stipulate that the employment must be continuous. Nor does the Act exclude part-time employment and, accordingly, such periods may be included in the formula. IV. OTHER RELEVANT CONSIDERATIONS a Deductions atsource The employer who pays a retiring allowance is required to report the amount paid on form T4A Supplementary and, pursuant to subsection 153(l(c7 of the Act is required to withhold tax in such amount as is prescribed by the regulations. 6 CCRA ATR48 Transfer of Retiring Allowance to an RRSP, April 6, (1 Every person paying at any time in a taxation year (c a retiring allowance, shall deduct or withhold therefrom such amount as is determined in accordance with prescribed rules...

15 14 According to the regulations and, specifically, regulation 103(4, the withholding rates for retiring allowances are as follows 8 : Ifthe payment does not exceed $5,000.00, 10%; Ifthe payment exceeds $5, but does not exceed $15,000.00,20%; and Ifthe payment exceeds $15,000.00, 30%. It used to be the case that if the retiring allowance or any part of it was paid directly to a registered pension plan or a registered retirement savings plan, the employee had to obtain a waiver of withholding tax in respect of amounts that would qualify for deduction by completing Form TD2, Tax Deduction Waiver for a Direct Transfer of an Eligible Retiring Allowance. According to CCRA Income Tax Technical News Bulletin #19 9, Form TD2 is no longer required for a direct transfer. For the purposes of the Employment Insurance Act, a retiring allowance does not constitute insurable earnings and no withholdings are required in respect of a retiring allowance. 10 There may, however, be an issue as to repayment if E.I. benefits are received by an employee after the date of termination but before payment of the retiring allowance. For purposes of CPP, section 12 of the Canada Pension Plan Act defines "contributory salary and wages of a person for a year" as his or her "income for the year from pensionable employment computed in accordance with the Income Tax Act". Because a retiring allowance is included under section 56 of the Act and not as employment income under section 5, a retiring allowance is not within section 12 ofthe CPP Act and no withholdings for CPP are required. 8 The federal rates are 7%, 13% and 20% respectively but, when combined with the provincial rates, bump up to the level set out. 9 CCRA Income Tax - Technical News No. 19, June 16,2000.

16 15 b Taxation of Pre-Judgment and Post-Judgment Interest The position of CCRA is that post-judgment interest on an award of damages for wrongful dismissal, calculated from the date of the settlement or judgment, is required to be included in income under paragraph 12(1(c of the Income Tax Act. However, source deductions are not required to be withheld from such amounts. I I Conversely, pre-judgement or pre-settlement interest received in respect ofan award for damages for personal injury, death or wrongful dismissal may be excluded from income and, accordingly, there are no withholding or reporting requirements imposed on the payer in respect of such amounts. 12 c Deductibility of Legal Fees Underparagraph 60 (0.1 ofthe IncomeTax Act, a deduction is allowed for legal expenses which are paid by a taxpayer in order to collect or establish a right to a pension benefit or a retiring allowance (including a right to damages for wrongful dismissal. Conversely, any reimbursement or award of legal expenses for the same purposes must be included in the taxpayer's income under paragraph 56(1(1.1. The amount that is allowed by way of deduction in the year is limited to the aggregate of the amount of the retiring allowance included in income in the year or a previous year and in respect of which the legal expenses were paid, and the amount of any award or reimbursement of legal expenses included in income pursuant to paragraph 56(1(1.1 for the year or a preceding year, less any portion of the retiring allowance that has been transferred to a registered pension plan or a registered retirement saving plan pursuant to paragraph Moreau v. Canada (Minister ofnational Revenue - M.N.R., [2000] T.C.J. No Round Table, November 13, 1998 reference: Window on Canadian Tax, CCH Canadian, paragraph CCRA Interpretation Bulletin IT-99R5 Legal and Accounting Fees, December 11, 1998, paragraph 26.

17 16 Eligible legal fees that are not deductible because they exceed the income as calculated above can be carried forward and deducted in the next seven years, but only to the extent that further related income arises and to the extent that the amounts in question were not previously deductible. The best way to understand the deductibility of legal fees is by way of example, two of which are set out in IT99R5 and IT337R3: 1. In 1995 and again in 1996, Mr. X incurred legal fees of $3, and $6, respectively to establish a right to a retiring allowance. 2. In 1996, Mr. X received from his employer a retiring allowance of$15, and a payment towards legal fees of $7, Mr. X transferred the $15, to his RRSP. 3. In 1997 and 1998, Mr. X received a further retiring allowance from the same employer of $10, and $5, respectively. He transferred the first $10, to his RRSP in 1997 and an additional $2, to his RRSP in1998. According to Canada Customs and Revenue Agency, the legal fees incurred in 1995 cannot be deducted because Mr. X did not receive either a retiring allowance or a reimbursement of fees in that year. In 1996, Mr. X has to include the $7, reimbursement in his income. While he has incurred legal fees of $9, ($3, in 1995 and $6, in 1996 his deduction is limited to $7, which remains after taking the aggregate of the retiring allowance and reimbursement of fees ($15, and $7, less the amount transferred to the RRSP ($15, The remaining legal fees that were not deducted in 1996 ($2, can be carried forward for up to seven years as long as Mr. X receives a further retiring allowance or reimbursement of legal fees which relates to the legal fees incurred in 1995 and No deduction would be allowed in

18 because the entire amount was transferred to an RRSP. In 1998, however, the remaining $2, in fees could be deducted because only $2, of the $5, received in that year was transferred to an RRSP. Accordingly, the amount transferred by an employee to a RRSP or a RPP can affect the deductibility oflegal fees and the employee will want to try, to the extent possible, to have sufficient "room" to allow the deduction. In many cases, however, the disadvantage associated with non-deductibility of fees will be more than offset by the benefit received from the transfer. According to CCRA Tech Interp , there is no statutory requirement for an employer to withhold tax in respect of legal fees reimbursed to an employee, nor to report such amount on an information slip. The Department position is that reimbursement of legal fees as contemplated by the Act is not a payment described in subsection 153(1 of the Act, nor is it an amount included in the definition of "remuneration" as found in subsection 1OO(1 ofthe Regulations. By virtue of subsection 8(1(b. of the Act, an employee is allowed a deduction in computing income from an office or employment for legal expenses paid in the year to collect or to establish a right to salary or wages (as distinct from a retiring allowance or pension benefit owed by an employee or former employer. Subsection 6(1(j requires a taxpayer to include in income any such amounts received by way of an award or reimbursement for which a corresponding deduction is available. 15 Note that the deduction is allowed only in respect of an amount "owed" by an employer or former employer. Ifthe taxpayer is unsuccessful in court or otherwise fails to establish that some amount it owed, no deduction for legal expenses is allowed. However, failure to collect an amount established as owed does not preclude a deduction From Carswell Tax Partner Main 2002 Thomson Canada Limited 2002, Release 4, Tech Interp Reimbursement of Legal Fees, February 19, IS IT-99R5, supra, note 13, paragraphs 22 and Ibid, paragraph 23.

19 18 Unlike the position respecting legal fees described in subsection 56( 1(11.1 of the Act, CCRA takes the position that amounts included in income under paragraph 6(10 are payments described in subsection 53(1 of the Act. As such, the employer would technically be required to make the appropriate withholdings and prepare the appropriate information slip in respect of any such payments. However, to the extent the fees are otherwise deductible under subsection (8(1(j of the Act and the reimbursement of those fees has not been taken into account in determining the amount of deduction under that subsection, the Department is generally prepared to waive the withholding requirement. The appropriate information slip must still be prepared. I? d Periodic Payment It may be in the best interests of an employee to consider deferring the receipt of a retiring allowance until the next taxation year or splitting the allowance between taxation years in order to avoid having all of the income received at once and triggering a higher marginal tax rate. From the employer's perspective, deductibility is governed by subsection 78(4 of the Act which provides that if the expense (Le. the retiring allowance, salary, wages or other remuneration is not paid within 180 days of the end of the taxation year in which it was incurred, the amount owing is deemed not have been an expense incurred in the year and is not deductible. However, if the amount owing is actually paid after that time, it is deductible in the taxation year it is paid as the amount is deemed to be an expense incurred in that year. Interestingly enough, under these circumstances, it is possible that the employer might get the deduction in.one year and the employee might defer the payment receipt until the next year. v. CONCLUSION This paper is not a treatise on tax treatment of wrongful dismissal awards and should not be relied on as such. It is intended to provide a practical, straightforward and basic overview of some of the issues that can arise more frequently in settlement and structuring of wrongful 17 Tech Interp , Supra, Note 14.

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21 19 dismissal awards. accountant. Any unusual "twists" or concerns should be raised with a tax lawyer or an

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