Tax and Legal Claims Related to Employment

It’s a well-known fact that anything categorized as “employment income” when paid out to an employee, is taxable. So naturally, litigants in a wrongful dismissal matter typically worry about the settlement monies (such as severance pay) being paid out in a lump sum.

There are certain types of claims, aside from severance, which is not taxable if the damages are awarded at a trial or if the issues are resolved prior to a trial.

General Damages

One such category of claim is one for human rights violations. A litigant who is awarded human rights damages for their employers violations of human rights legislation (i.e for a termination on the basis of disability) will not be taxed on the damages awarded for those violations in accordance with Canada Revenue Agency Interpretation-Internal 2006-0204971I7:

“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….”

This interpretation was provided in November 2006 as a clarification to Section 5(1) of the Income Tax Act, R.S.O. 1990, c.1.2 which defines taxable income.

The issue of whether general damages are taxable was more recently explored by the Federal Court of Appeal in the decision of Canadian Imperial Bank of Commerce v. the Queen, 2013 FCA 122. The question was whether CIBC acted in a manner contradictory to the Income Tax Act when it deducted monies paid to Enron through private settlement. The claims which were settled contained allegations that CIBC had engaged in “egregious and repulsive” conduct when it mischaracterized transactions and misrepresented financial reports for Enron and related affiliates in order to personally benefit from the same. The alleged conduct and the settlement for the same was not related to any business expense or activity, and so the Court found that no deductions should have been made from the monies. In effect, the Federal Court of Appeal indicated its approval of general damages for egregious conduct on the part of the party being paid in a non-taxable manner.

The principle is logical given that an individual who has already faced discrimination and hardship at the hands of their employer should not be penalized for a successful claim against that employer for those reasons.

Punitive Damages

The same principle is applied to punitive damages given the nature of the award.

In Bellingham v. Canada, [1996] 1 FCR 613, 1995 CanLII 3544 (FCA), the Appellant had had her land expropriated by the town of Grand Centre, Alberta and was paid for same, along with additional interest on the compensation for the land. In this case, the issue was whether the amounts paid out for the expropriation were taxable was explored. The Federal Court of Appeal agreed that all sums, with the exception of “additional interest” on the compensation, were taxable; the logic behind not taxing the “additional interest” was that the court deemed it similar to punitive damages in that it was paid to compensate the Appellant for something above and beyond the gain or loss for the disposition of the property.

Retirement Allowances

Settlement monies paid out as a “retirement allowance”, while not completely non-taxable, are subjected to a lower tax rate than regular earnings (10% for $5,000.00 or less; 20% for an amount between $5,000.00 and $10,000.00, and 30% for anything higher than $15,000.00).

The Canada Revenue Agency approves of sums being paid in this manner in the instance of retirement but also in the instance of dismissal. This is in accordance with Canada Revenue Agency Income Tax Interpretation Bulletin IT-337R4.

Other Cases

The courts have refused to make taxable damages which, although associated with employment, are linked to an inactive period of employment or service to that employer. In the Federal Court of Appeal decision of Schwartz v. Canada [1996] 1 SCR 254, the issue of whether settlement monies paid as a retirement allowance were taxable was brought to court. The Appellant, whom had been offered a job only to be told three months later that it was no longer available, sued the potential employer and resolved the matter out of court, agreeing to have the settlement monies paid as damages. However, when the amount was taxed, he brought the matter to the courts. While he was unsuccessful at trial, he was successful on appeal, as the court agreed with his reasoning that, as he was never in the “service of the company” that the settlement monies from the issues arising out of the potential employment relationship could not be categorized as a “retiring allowance” or employment income and declared the entire $360,000.00 settlement non-taxable.

Knowing your legal entitlements and negotiating a better severance package can be difficult, which is why it is best to consult with a professional. Taxation plays a big role in the value within a settlement and it is very important to seek advice to get the most out of your money.

If you have questions regarding an employment law issue and believe that you may have a legal claim, contact Monkhouse Law today for a free consultation.

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