Under the tax rules, any money you get from an employer (or ex-employer) as a so-called "retiring allowance" (that's tax talk for severance or other types of payments made on leaving a job) will be taxable as income to you. In a previous article I looked at a few strategies to reduce the taxman's take. But over the years, the government and the courts have made the whole issue of what constitutes a "retiring allowance" – and what in fact might be a tax-free payment – a rather complicated mess. Some payments are taxable, others are tax-free. Here's my attempt to set the record straight.
What's a "retiring allowance"?
The tax rules define a "retiring allowance" as the following:
- An amount received on or after "retirement" of a taxpayer from an office or employment in recognition of the taxpayer's long service; or
- An amount received for loss of office or employment, including amounts received for, in lieu of, damages. This specifically excludes superannuation and pension benefits, amounts received as a consequence of the death of an employee, and benefits received from counselling services paid for by an employer.
There is no requirement that a retirement allowance must be paid in cash. For example, the Canada Revenue Agency (CRA) has stated that the fair market value of a car transferred to an employee as part of a severance package was considered part of the retiring allowance, and taxed as such. So if you've received what you believe is a parting gift from your employer, think about whether this nice gesture will land you with some extra tax liability.
However, the CRA opinion is that retirement (or loss of a job) does not include a transfer from one office or position to another with the same employer, or termination of employment (other than mandatory retirement) with an employer followed shortly by employment with an affiliate of the former employer, or termination as a result of death. So you can't really keep it "all in the family" and still call it a "retiring allowance."
More than "severance"
In the past, the term "retiring allowance" has often been synonymous with job severance payments. However, CRA pronouncements and some court cases in the area have complicated the situation. In fact, when all of the CRA technical interpretations are put together, the result can be pretty confusing.
In a 1993 Round Table, the CRA expressed the view that "termination pay" under the Ontario Employment Standards Act does not qualify as a retiring allowance. This is because the legislation imposes a minimum number of weeks of notice prior to termination, dependent on the years of employment.
During the notice period, the employee is entitled to receive regular wages. Because of this, CRA's position is that if the employee is terminated without written notice, the employee is entitled to termination pay equal to regular wages payable over the same number of weeks for which notice was required. What does this mean? Essentially, the termination pay is treated as a continuation of regular salary payments, in spite of the termination of employment. (Presumably, there would be similar problems in other provinces.)
Yet a different interpretation was given to "severance pay," under which an Ontario employee may be entitled to payments by virtue of large employers' discontinuing businesses, where 50 or more employees have been laid off within a six-month period. This does qualify as a retiring allowance.
The CRA's says that an amount paid by court order for damages related to emotional distress may be a retiring allowance if the payment arises from a loss of office or employment. If you're hoping that the word "may" opens the door for you to argue that such damages are not a retiring allowance, but may in fact be tax-free payments, think again. The CRA stated in a ruling that damages received as compensation for mental distress as a result of the loss of employment "would be taxed as a retiring allowance" (unless the damages relate to human rights violations).
Interest on payments delayed by court cases
Sometimes, employer/employee disputes end up in court, with severance payments on hold, and collecting interest, while the court deliberates. The CRA has stated that pre-judgment interest on either a retiring allowance or a tax-free award is considered to be tax-free. But in yet another ruling, it expressed the view that interest paid on an award for wrongful dismissal for the period after the date of settlement is in fact taxable as interest, and on top of that, it does not form part of a retiring allowance and therefore cannot be rolled into an RRSP.
So, pre-judgment interest appears to get the best possible treatment – it can be completely tax-free (if related to a retiring allowance or a damage payment which is not income from employment). Post-judgment interest gets the worst treatment – it's fully taxable and can't even be rolled into an RRSP.
Besides CRA pronouncements, there have been a couple of interesting court cases in the area, which have held that not all damage payments received by a terminated employee fall within the definition of retiring allowance. A case in point is Bedard v. M.N.R, where it was held that an amount paid to compensate an employee for defamation fell outside the retiring allowance definition. Some practitioners have also argued that exemplary damages and damages for mental distress awarded in a wrongful dismissal action are, arguably at least, non-taxable.
A number of other Canada Revenue Agency rulings have dealt with other typical scenarios. For instance, compensation for termination due to a work-related injury was held to be a retiring allowance under the particular situation. A payment received as a result of a layoff under the terms of a labor agreement will usually qualify as a retiring allowance. And unused sick leave credits paid on termination qualify as a retiring allowance, but accumulated vacation pay does not.
If you're in doubt about what constitutes a "retiring allowance," and what the tax treatment might be in your case, consult with a qualified tax practitioner to ensure you don't get a surprise bill with your next Notice of Assessment from the CRA.
Previously published in The Fund Library Thursday, January 21, 2015.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.