19 October 1999 External T.I. 9925615 - WRONGFUL DISMISSAL-OUT OF POCKET EXP.

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether special damages for out-of pocket expenses (not legal fees) such as the cost of having a resumé typed, in a wrongful dismissal suit would be taxable and subject to withholding tax.

Position TAKEN: Based on information provided, it appears that these "special damages" awarded of $XXXXXXXXXX are not a reimbursement of costs which are essential to and directly related to a conduct of action in a wrongful dismissal/breach of conduct (loss of employment) case. Therefore, the special damages in this situation would appear to form part of a retiring allowance and would be subject to withholding tax.

Reasons FOR POSITION TAKEN: See E56848, 56399, 9813585, 58444, E5C5745, E51943, 9824890

XXXXXXXXXX 5-992561
G. Moore
October 19, 1999

Dear XXXXXXXXXX:

Re: Withholding tax on special damages relating to
out-of-pocket expenses in a wrongful dismissal suit

This is in response to your letter of September 20, 1999, regarding whether income tax is required to be withheld from special damages awarded to your client in respect of out-of-pocket expenses for a wrongful dismissal suit.

As we understand it, your client, XXXXXXXXXX, sued the XXXXXXXXXX for wrongful dismissal and this matter has been settled on the basis of a number of payments, including payment in lieu of notice. From such amounts, certain amounts have been withheld pursuant to the provisions of the Income Tax Act (the "Act"). It is the view of XXXXXXXXXX that there should be withholding tax with respect to payment of special damages of $XXXXXXXXXX for repayment to XXXXXXXXXX for his out-of-pocket expenses. You do not believe that special damages should be subject to withholding tax as this amount represents a reimbursement to XXXXXXXXXX for his out-of-pocket expenses, which he paid for with after-tax dollars. Further to the telephone conversation (Moore/XXXXXXXXXX) of September 30, 1999, it is our understanding that the special damages of $XXXXXXXXXX is entitled to receive represents his out-of-pocket expenses such as the cost of a placement agency and the cost of having his resumé typed but does not include any costs for legal fees.

Our Comments

As stated in paragraph 9 of Interpretation Bulletin IT-337R3, Retiring Allowances, (copy enclosed) an amount received as damages for loss of employment is taxable as a retiring allowance. Thus, a retiring allowance includes any amount paid to an employee, to a former employee, or to a third party on behalf of the employee or former employee, if the amount is paid in respect of a loss of office or employment. This statement applies to punitive damages, amounts received for hurt feelings surrounding the loss of employment, and amounts received for specific and special damages as a result of the loss of employment.

In our view, although all reimbursements would not be excluded from the definition of retiring allowance in subsection 248(1) of the Act, amounts provided to a taxpayer or paid on behalf of a taxpayer to the taxpayer's solicitors as a reimbursement for costs which were essential to and directly relate to the conduct of an action in wrongful dismissal/breach of contract (loss of employment) are, to the extent that such costs were actually incurred by the taxpayer and are not otherwise deductible, not considered to form part of a retiring allowance. In other words, the Department takes the position that reimbursements for necessary legal expenses in wrongful dismissal cases will not be included in a taxpayer's income as part of a retiring allowance, to the extent that they were actually incurred by the taxpayer. Therefore withholding tax will not be required on the payment of such reimbursements. However, amounts received as special damages in respect of a taxpayer's out-of-pocket expenses (excluding legal fees) are generally treated differently. It is the Department's position that special, general, and other damages received in respect of a loss of an office or employment form part of a retiring allowance and therefore would be included in the taxpayer's income in the taxation year in which the taxpayer receives them pursuant to subparagraph 56(1)(a)(ii) of the Act.

Based on the information provided, it appears that the special damages XXXXXXXXXX is entitled to receive in respect of his out-of-pocket expenses (ex., cost of hiring a placement agency and cost of having his resumé typed) would form part of a retiring allowance because these expenses were not essential to nor directly relate to the conduct of an action in wrongful dismissal/breach of contract (loss of employment). With respect to an employer's obligation to withhold source deductions, paragraph 153(1)(c) of the Act requires an employer to withhold income tax from the amount of any retiring allowance paid to an employee or former employee, in accordance with the rules set out in the Income Tax Regulations. The withholding requirements apply equally to payments made directly to an individual and to payments made to a third party on behalf of that individual.

We trust that these comments will be of assistance.

Yours truly,

Jim Wilson
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch