7 June 2024 External T.I. 2024-1006831E5 - Employment settlements and reporting requirements

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Does a settlement agreement containing an indemnification clause and that was signed in the context of an employment termination meet the definition of contractual protection under s.237.3(1)(a)(i)(A)?

Position: Generally, no.

Reasons: A reportable transaction is an avoidance transaction entered into by or for the benefit of a person and that meets one of three legislated hallmarks. In turn, an avoidance transaction exists if it may reasonably by considered that one of the main purposes of a transaction (or a series of which the transaction is a part of) is to obtain a tax benefit. Where principled settlements are negotiated in good faith without consideration to the tax implications and the damages are properly allocated, then generally “one of the main purposes” of the settlement will not be to obtain a tax benefit. To the same extent, the contractual protection hallmark is unlikely to be triggered in light of the indemnity clause in the case at hand.

XXXXXXXXXX								2024-100683
									Pierre Girard

June 7, 2024

Dear XXXXXXXXXX,

Re: Reporting Requirements and Employment Settlements

Unless stated otherwise, all statutory references in this document are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.) (the “Act”), as amended to the date hereof.

We are writing in reply to your inquiry of December 6, 2023 in which you asked for our views as to whether a settlement agreement signed in the context of an employment termination is a “reportable transaction” due to the indemnity clause contained herein (the “Settlement”).

Our comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of a particular transaction proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

The determination whether a transaction is a “reportable transaction” is dependant upon an analysis of all the facts and circumstances of each case. Although we cannot confirm whether your Settlement is a reportable transaction, we can provide you with the following comments to assist you in making that determination.

The mandatory disclosure rules require the disclosure of certain transactions to the Canada Revenue Agency. Section 237.3 contains the rules in respect of reportable transactions.

A “reportable transaction” means an “avoidance transaction” that is entered into by or for the benefit of a person, and each transaction that is part of a series of transactions that includes the avoidance transaction if at least one of three generic hallmarks is present: contingent fee arrangements, confidential protection or contractual protection. Our understanding is that the scope of your request is limited to the latter, which we will refer to herein as the “contractual protection hallmark”.

The definition of “contractual protection” indicates, in clause 237.3(1)(a)(i)(A), that there is contractual protection in respect of a transaction or series where any form of insurance or protection, either immediately or in the future and either absolutely or contingently, protects a person against a failure of the transaction or series to achieve any tax benefit from the transaction or series.

It is common for employment settlements to include a clause according to which the employee will agree to indemnify the employer against tax-related claims resulting from the settlement. In your situation, you indicated that the indemnity clause in the Settlement protects the employer against any claim in respect of the failure to withhold income tax under the Act as well as any other applicable amount pursuant to the Canada Pension Plan and the Employment Insurance Act, including any regulations made thereunder.

Generally, the person having contractual protection is the person that would be entitled to compensation in the event of a failure of the transaction to achieve a tax benefit. In an employment context, where the employer is protected by an indemnity clause like that in the Settlement, we are of the view that the contractual protection hallmark is unlikely to be triggered in most instances.

In addition to the above, to be a “reportable transaction”, a transaction has to be an “avoidance transaction”. A transaction will only qualify as an “avoidance transaction” if it may reasonably be considered that one of the main purposes of the transaction (or series) is to obtain a “tax benefit”. Pursuant to subsection 245(1), there is a tax benefit where, for example, there is a reduction, avoidance or deferral of tax payable under the Act and where there is an increase in a refund of tax or other amount under the Act.

Employment settlements usually include the payment of damages to the employee. Damages vary in nature and their characterization will usually inform the parties regarding their taxability and deductibility, as the case may be.

While the existence of a tax benefit is a fact driven determination, to qualify as an “avoidance transaction” it is still required that obtaining such tax benefit be reasonably considered as one of the main purposes of the settlement. Presumably, the main purpose of an employment settlement is to resolve a dispute between an employer and employee. In our view, the fact that damages are paid as a result of a settlement should not systematically lead to the conclusion that “one of the main purposes” of the settlement is to obtain a tax benefit. In situations where the parties negotiated in good faith and reached a principled settlement that provides for a proper characterization of the damages, it is unlikely that such settlement would qualify as an “avoidance transaction”.

However, there are situations where a settlement would be reportable pursuant to the rules under section 237.3. For example, the absence of legal or factual basis to the payment of non-taxable damages could lead to a determination that the settlement is an “avoidance transaction”. In this situation, the presence of at least one of the three hallmarks would make the settlement a “reportable transaction” and reporting would be required in this respect.

We trust these comments will be of assistance.

Yours truly,

Gillian Godson
Manager, Administrative Law Section I
Specialty Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch