If, for one of the following reasons, your employer has ceased your employment:
- you have been unreasonably dismissed. Please note the “dismiss” here means “fire” or “terminate” but not “lay off”
- you are injured at work hence you cannot continue to take a job
You therefore bring an action against your employer. As the result
- the court decided that your employer shall pay you 1 million dollars as the dismissal fees, or
- you and your employer settled before the court, and it’s agreed that your employer shall compensate you 1 million dollars.
So now the question is if these 1 million dollars would be regarded as your income. If so, it’s taxable.
To better answer this question, we’ll have to analyze the specific categories that this 1 million consists of.
Because, for example, you’ve signed a no-win-no-fee agreement with your lawyer with a 17.7% success fee, and when your lawyer has helped you to get 1 million dollars from your employer, there would be a $177,000 success fee. And since we are in Ontario with a 13% HST rate, the final legal fee you pay your lawyer would be $200,000.
This $200,000 can be counted as your “expense”, which needs to be deducted from the 1 million. In short, the $200,000 legal fee is not taxable to you (the lawyer will need to pay CRA his income tax but that’s a different story).
Now it’s $800,000 left.
Example 1: You were sexually harassed by your boss, you resisted, you were fired, and you are now between jobs at home. From the day you’ve lost your job till the day you get a new one (assuming you are doing the same level of work), the wage/salary that you’ve missed consists of this category of compensation.
Example 2: You are a mannequin (a hand model); due to the employer’s negligence you were injured at work (a minor paper cut), so your hand is no longer perfect and you can no longer be a hand model. You have to therefore go find another job. From the date of your injury till the date of your new job, the money you’re supposed to earn as a hand model will be this part of compensation.
In order to get this part of the compensation as wage/salary, it is required to satisfy the court that:
- You have been actively and diligently looking for a job during the unemployed time
- If you are injured, a doctor’s note is needed
Assuming that the amount of compensation for this “wage” part is $300,000, the tax burden is pretty heavy. It requires an accountant’s closer look at how the CPP and EI are withheld and deducted depending on the length of time getting paid.
The name of this category is very misleading as it has not much relation to the actual retirement.
So how to define this type of compensation? A 1997 authority provided the answers. The court will need to run two tests:
- The traditional “but-for” test: the court asks if the equivalent of compensation should have been earned but for the unemployment.
- The objective “purpose” test: the court asks if the purpose of the payment directly compensates for the economic loss caused by unemployment.
As long as the results of both tests are “yes”, the compensation will be recognized as a retirement allowance. Overin v The Queen [1997]
Assuming it’s $400,000 of the 1 million falls in this category, the money is taxable. The personal income tax rate of Canada will make you pay almost half of the $400,000 to CRA, unfortunately.
Your lawyer is good. In addition to the wage compensation and retirement allowance mentioned above, both of which belong to the category of specific damage), the lawyer also helped you win $100,000 for psychiatric harm which belongs to the category of general damage.
Why are there “specific” vs “general” terms? That’s because wages and retiring allowances can be calculated by simple multiplication in math. It’s specific and clear.
On the other hand, the physical and/or mental harm is hard to quantify and hard to monetize. We can only vaguely say a total amount, which is “general” damage.
This general damage is generally not taxable. But how we can categorize the settlement payment to general damage, that’s something tricky. The court provides four authorities to guide us.
- Unreasonable cancellation of future employment
In May 1988, a private company took a project from the Ontario government. As there are tasks in the project that require a lawyer’s work, the company made an offer to a lawyer promising him a $250,000 annual salary until the project is completed.
But just before the lawyer could start his work, the company informed him: the Ontario government had cancelled the project, so here is $75,000, you can take the cash without doing anything, and you must be very happy about that.
The lawyer said he was unhappy, and he went to court to claim more money. He won, and the court ordered the company to pay him $400,000.
A few years later, CRA showed up with the statement: The $400,000 is considered your retiring allowance income; therefore it’s taxable, and you will need to pay us around $200,000.
The lawyer was unhappy again so he brought this to the court again. In court, the lawyer had the following classic statement:
Among all types of wrongful dismissal settlement, all those that are related to the employment (the actual daily work) such as salary compensation and retiring allowance, are taxable; all those that are not related to the employment, such as legal fees or the compensation to mental harm, are not taxable. Thus, according to the definition of retiring allowance in ITA s.248(1), my work was not yet started, so it has nothing to do with “employment” itself. Since it is irrelevant, I am not subject to pay tax under ITA s.3(a).
The judge was stunned, and then realized that they had to agree to the lawyer. Schwartz v. Canada, [1996]
- Violation to the employee’s human rights
Since 1989, Karen Fournier has been working for the Ministry of Transportation in the Ontario government. She worked as a labourer on the province’s highways and then as a sign painter. She testified she was one of the first women to be so employed and she was subject to sexual and physical harassment.
Beginning in 1993, Karen began to defend her rights against the provincial government.
In 1995, the Ontario government expressed its willingness to pay her $50,000 as compensation and let her take a half-year paid sick leave. But this half-year was just a “transitional period”, after which Karen would turn into a long-term disability leave covered by the insurance company, which means she was no longer an employee of the Ontario government.
CRA showed up for 2 years with the opinion that the money Karen received is considered as retiring allowance; she is therefore obligated to pay tax for her income.
Karen did not agree so she brought an action to the court. Eventually, the court held that the compensation did not satisfy the definition of retiring allowance pursuant to ITA s.248(1), hence Karen was not required to pay tax on that. Fournier v The Queen [1999]
- Impairment of the employee’s capability due to the employer’s negligence
From 1967 until 1987, Dr. Ahmad was employed by AECL. His research focused on heat transfer in nuclear reactors and he was held in high esteem by his peers in this field.
AECL’s main partner is Ontario Hydro.
In 1984, Dr Ahmed refused to sign off on a technical report, which hindered a joint project between AECL and Ontario Hydro.
As a result, Ontario Hydro induced AECL to remove Dr Ahmad as head of the branch in 1984. He was given a desk to sit at in a corner, though he continued to draw his salary and received raises until 1986.
In other words, since 1984 the scientist has been unable to engage in the nuclear research he loves.
In August 1986, Dr Ahmed took Ontario Hydro to court.
In October 1987, Dr Ahmed brought a claim to AECL and got fired by AECL 15 days later with a settled compensation of $100,000.
A few years later, the CRA came into the game again with the statement: the $100,000 is considered as retiring allowance, hence it is taxable.
Dr Ahmed brought the matter to court. In the end, the court held that the essence of the settlement is the compensation for the wrongful deprivation of the scientist of his nuclear research capabilities for 3 years, rather than a wage payment for firing him after the 3 years. Consequently, the money Dr Ahmed received is not a retiring allowance, and the scientist is therefore not required to pay tax to the CRA. Ahmed v The Queen [2002]
- Physical and/or psychological harm by the employer
Jacques Abenaim was an entrepreneur, he had 2 roles in Minolta Montreal, an executive level job with an average annual salary of $260,000, and a shareholder.
In the 1990s, the relationship between Mr Abenaim and Minolta was not good. In 1990 he was fired by the company and in 1994 the relationship was reconciled and he was hired back.
But since the merger of Minolta and Konica in 2003, Mr Abenaim’s relationship with the company has deteriorated.
In 2006, Mr Abenaim was terminated by the company with undisclosed compensation.
Two years later, CRA showed up with a claim that the compensation Mr Abenaim received should be categorized as retiring allowance; hence it’s 100% taxable.
Mr Abenaim objected to CRA’s decision and brought the matter to the court. The undisclosed amount of the compensation was then revealed to the public, it was 1.5 million.
Mr Abenaim argues that he always understood that half of the amount constituted a retiring allowance, which could be taxable; while the other half constituted psychiatric harm, which was not taxable.
While CRA challenges the legality of his “moral damage” claim, he stated that he was dismissed not once, but twice from the same company, and each time, his life’s work was taken away from him. this was the collapse of his life and a form of harassment and humiliation.
In the end, Mr Abenaim’s lawyer knocked down CRA with the following statement:
If it is not mortal damage but purely based on missing salary calculation, there is no need to make an undisclosed agreement. It must have the component of psychiatric harm in the compensation and that is exactly why the settlement amount was undisclosed.
The court held for Mr Abenaim. Abenaim v The Queen [2017]
Well, as a smart person, you would have figured out that, for the same amount of 1 million dollars compensation, if the proportional allocation of different categories is adjusted, the amount of tax that the recipient needs to pay will be very different. At a certain time, if it has been determined that the employer would make some payment, it’ll be a good idea to ask your lawyer to discuss the “allocation” with the employer. On the basis of mutual agreement, the change o the proportion can get the claimant more money while the total amount the employer has to pay can be reduced. It’s a win-win situation.
