"Retiring allowances" are not novel in taxation and employment law. Defined in the Income Tax Act (Canada)1 and explained in CRA publications2, "retiring allowances" are routinely treated as a tax effective approach to severance obligations on termination of employment or "loss of office". Yet, with the ability to also grant a retiring allowance in recognition of "long service", they are becoming more prevalent when transitioning an executive out of an organization either at the time of termination or retirement.
As part of an executive exit strategy, retiring allowances can offer an employer greater flexibility than many other more conventional arrangements. Although the most common application of a retiring allowance is the payment of an additional sum to an employee upon the termination of their employment relationship (e.g., severance), it is also possible for an employer to pay a retiring allowance solely in recognition of long service on departure. This can be done either as an established contractual obligation or simply as an ad hoc payment at the time of an executive's departure.
The treatment of a retiring allowance as a contractual obligation between an employer and an executive is not widely utilized. However, if employed, retiring allowance obligations may be evidenced through specific contractual terms or an internal policy that clearly establish when a payment will apply: retirement, specific circumstances of termination, termination due to change of control, etc.
In recognition of long service, the case law is far from conclusive in establishing guidelines for what actually constitutes "long service". Although the CRA position is that long service is "usually considered"3 to reference the employment term with a particular employer or affiliate, it is suggested that an employer could take into consideration the cumulative industry employment of an executive in determining an appropriate payment. As the quantum of the retiring allowance must be reasonable, it is necessary to define, within the parameters of the contract or internal policy, what service conditions an executive must satisfy in order to be entitled to payment. In the simplest terms, the contract or policy must specify when payment of the retiring allowance becomes a right accrued to the executive through, for example, the completion of a specified period of service.
While the promise of a retiring allowance as a contractual or policy obligation creates certainty for the parties, both in amount and payment method, there is no requirement that it must be a formal arrangement. From the perspective of the employer, a retiring allowance may also be a gratuitous payment offered to a departing long service executive as a means of, for example, increasing retirement income outside of a registered or supplemental pension arrangement.
The benefit of utilizing a retiring allowance as an additional form of compensation is that it can be highly beneficial from a tax perspective. For instance, retiring allowances are one of the few payments, in the employment context, that are permitted to be paid over several years.
This also allows the employer to spread out the cost of the payment obligation. However, it is a question of fact considered by the CRA whether incremental payments are truly a retiring allowance. As such, if challenged, the executive must be able to establish that all other ties indicative of an employment relationship have been extinguished.
Historically, retiring allowances have generally been paid to employees in conjunction with the termination of employment or "loss of office". However, the definition of "retiring allowance" contemplates payments in the mutually exclusive circumstances of both a "loss of office" and "long service" recognition thereby broadening the applicability of such a payment. While it is not advocated that payment of a retiring allowance become a matter of course, it is suggested that if an organization is considering transitioning an executive out of office, either by way of termination or retirement, offering the option of a retiring allowance may provide a flexible form of compensation not previously employed in this context.
Footnotes
1 See Section 248(1).
2 Canada Revenue Agency, Interpretation Bulletin 337R4: Retiring Allowances, February 1, 2006 ("IT-337R4").
3 Ibid. at para. 3.
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