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:
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.
By Stuart Rudner