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I Just Got Fired – Why Am I Getting a Retiring Allowance?

As discussed in previous posts and in my recent Canadian HR Law article, it is sometimes possible to allocate portions of a severance payment in a more tax-effective manner than simply paying a regular salary with all associated withholdings and deductions.

Where amounts are paid as a lump sum, they are often paid as a “retiring allowance” in accordance with the provisions of the Federal Income Tax Act. This is to the advantage of the recipient, as it means there will be no deductions for employment insurance, the Canada Pension Plan (CPP), or anything else, and the tax withholding will be applied a lower percentage than on the usual payroll.

However, people are often completely surprised, and sometimes upset, to see any mention of a “retiring allowance” when they are relatively young, have unexpectedly lost their job, and have no intention of retiring.

Those of us who practise in the area of employment law won’t blink an eye when the topic of retiring allowances comes up, even when it is for a 25 year old. However, it is worthwhile to take a step back in order to understand what they are intended to be used for, and what restrictions exist on their use.

Recently, an external interpretation from the Canada Revenue Agency (CRA) was publicized. The introductory portions are as follows:

“Principal issues:

Will  the  amount  paid  to  a  taxpayer  on  retirement  be  a  retiring  allowance?  Can the amount be transferred under paragraph 60(j.1) to the taxpayer’s RRSP?

Position: Question of fact. Depends on whether the amount received by the taxpayer is a retiring allowance.

Reasons: Whether an amount paid to a taxpayer on retirement is a retiring allowance is a question of fact and will  depend,  amongst  other  things,  on  whether  the  amount  was  received  due  to  the  taxpayer’s employment. We do not have sufficient information and/or documentation to make this determination. Accordingly, general comments are provided.”

With respect to whether a payment qualifies as a retiring allowance, it wrote as follows:

“The  Canada  Revenue  Agency’s  general  views  regarding  retiring  allowances  are  contained  in Interpretation  Bulletin  IT­337R4,  “Retiring  Allowances.” The  term  “retiring  allowance”  is  defined  in subsection 248(1) of the act, in general, as an amount  received on or after  retirement of a taxpayer from  an  office  or  employment  in  recognition  of  the  taxpayer’s  long  service  or  in  respect  of  the taxpayer’s loss of an office or employment. Accordingly, to qualify as a retiring allowance, the amount received must be received in respect of the taxpayer’s employment or position as an officer. The term “office”  is  defined  in  subsection  248(1)  of the act to mean the  position  of  an  individual  entitling the individual  to  a  fixed  or  ascertainable  stipend  and  includes,  inter  alia,  the  position  of  a  corporate director. It is a question of fact and a matter of law whether an employee/employer relationship exists or whether a taxpayer holds the position of an officer in a particular situation. In order to determine whether an employee/employer relationship exists or whether a taxpayer is an officer of a corporation a  review  of  all  of  the  relevant  facts  and  supporting  documentation,  e.g.,  employment  contracts, agreements, etc., would be required. If an employee or officer, who is also a shareholder, receives an amount as a retiring allowance on or after  retirement or after a loss of employment and the amount is not  received in  recognition of long service  as  an  employee  or  in  respect  of  the  loss  of  employment,  the  amount  received  will  not by definition  be  a  retiring  allowance. In these circumstances,  in  our  view,  the  amount  received  by  the shareholder may be a shareholder benefit and included in income pursuant to subsection 15(1). This determination would be a question of fact.”

If an employee or officer, who is also a shareholder, receives an amount as a retiring allowance on or after  retirement or after a loss of employment and the amount is not  received in  recognition of long service  as  an  employee  or  in  respect  of  the  loss  of  employment,  the  amount  received  will  not by definition  be  a  retiring  allowance. In these circumstances,  in  our  view,  the  amount  received  by  the shareholder may be a shareholder benefit and included in income pursuant to subsection 15(1). This determination would be a question of fact.”

So, to begin with, a retiring allowance is only applicable to the loss of an “office” or employment. It cannot be used where the relationship will be continuing, such as for a bonus payment. Therefore, retiring allowances are appropriate where the individual has been dismissed from her job and, despite the name, are not only for situations where the individual has retired. In fact, they are often used to provide payment to individuals who have unexpectedly been dismissed.

That said, as the excerpt above makes clear, a lump sum payment will not be a retiring allowance if it does not relate to a loss of employment or in recognition of long service as an employee.

As we often advise clients, lump sum payments in relation to “severance” (defined, in this context, to relate to statutory and common law or contractual entitlements arising out of the termination of employment) can be quite advantageous. To begin with, a lump sum will not be subject to any mitigation obligation or “clawback” in the event that the individual finds new work.

Furthermore, the tax withholding on a retiring allowance is typically less than those applied to regular payroll. Specifically, the withholding rates are:

  • 10 per cent (five per cent for Quebec) on amounts up to and including $5,000
  • 20 per cent (10 per cent for Quebec) on amounts over $5,000 up to and including $15,000
  • 30 per cent (15 per cent for Quebec) on amounts over $15,000.

The use of lump sum payments can often facilitate resolution of a matter. However, it is important that employment counsel ensure that payments are only treated as retiring allowances where appropriate. And they may have to explain to the people involved that a retiring allowance does not imply that the person is actually ending his career, or as I have had to explain on occasion, that the company thinks he is old enough to retire.

For more information, employers and employees are welcome to contact us.

By Stuart Rudner


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