Changes to Income Tax Act and wrongful dismissal settlements | Stuart Rudner

By Stuart Rudner

Law360 Canada (October 24, 2023, 2:04 PM EDT) --
Stuart Rudner
Stuart Rudner
On Sept. 8, 2023, a member of the employment law bar had a column published in the Financial Post which suggested that our bar has a “dirty little secret” — that we routinely settle wrongful dismissal cases with an allocation to general damages in order to reduce the tax consequences of the agreement, and that this is “pretty close to a tax fraud, albeit practiced with abandon in the employment bar.”

The column states that “[s]ince more than 95 per cent of the time such a payment is not bona fide, the employer always insists on such an indemnity.” The author went on to assert that “CRA is now wise to this” and that:

As of June 22, if such an indemnity is provided in return for a non-taxable payment as part of a severance agreement, the employer and employee must separately disclose, in a RC312, this settlement to the CRA within 90 days, along with a detailed description of the parties, the facts and the tax consequences.

This article caused serious consternation amongst our bar, both for the unfair allegations and the notion that many settlements would have to be reported to CRA, potentially by our clients and also us as their counsel. Most of us are not intimately familiar with the Income Tax Act (ITA), and this led to many rumours and much debate regarding what would, or would not, trigger such a reporting obligation.

I can say that in my mediation practice, this issue came up repeatedly over the past month or so. In some cases, defence counsel who would previously agree to allocate reasonable amounts to general damages in appropriate circumstances simply refused, citing the uncertainty that existed. This made settlement much more difficult and, frankly, prevented parties from reaching settlements that were entirely reasonable and lawful.

In order to help our bar understand the true implications of the changes to the ITA, I worked with the Ontario Bar Association’s Labour and Employment Section to plan an urgent program, which I moderated last week.

The response: Recent changes to the ITA do not impact the reasonable settlement of wrongful dismissal claims.

Before the session last week, a post co-authored by employment lawyers Erin Kuzz and Jennifer Mathers McHenry appeared on LinkedIn and other platforms. The post, endorsed by dozens of our colleagues, refuted the assertions in the original article. Among other key points, the post confirms that:

  • the only thing that has recently changed is the CRA’s rules about when certain types of agreements must be proactively reported to CRA (a “reportable transaction”);
  • [the change] doesn’t mean every settlement with amounts paid as general damages, with or without an indemnity provision, must be reported to CRA;
  • it certainly doesn’t mean, as the columnist suggests, that when parties to employment litigation enter into settlements which include payment of general damages, they are “pretty close to committing tax fraud.”

At the OBA CPD, I moderated, Bhuvana Rai of Mors & Tribute and Sean Bawden of Kelly Santini offered their comments on the issue. Bhuvana, who has extensive expertise in tax law, was blunt in stating that the change to the ITA was not motivated by employment law considerations, and that a straightforward settlement of a wrongful dismissal action with appropriate and justifiable allocations to damages/taxable income would be unlikely to create a reporting obligation even where there is an allocation to general damages and an indemnity.

Bhuvana also posted her comments on LinkedIn in a very helpful article titled “Tax Reporting Requirements for Employment Lawyers.” As she writes, “[t]o be a reportable transaction, one of the main purposes of the transaction must be to obtain a tax benefit. Provided that the amounts are correctly characterized, there should be no issue with reportable transaction legislation in any event — well before the examination of indemnities.”

Many lawyers formed the view that the inclusion of an indemnity in settlement documents can turn a non-reportable transaction into a reportable one. However, Bhuvana was clear in stating that a clause pursuant to which the former employee indemnifies the employer for penalties which arise out any CRA assessment of the payments does not necessarily have such an effect: “[i]t seems unlikely that the indemnity would turn the settlement into a reportable transaction, because the person indemnified is not obtaining any purported tax benefit, let alone the one at the heart of the transaction.”

Moving forward

The issue that has been discussed and debated following the Financial Post article is not whether CRA can or will review a settlement and reject one that is clearly not justified; the issue is whether the recent changes to the ITA mean that all settlements which include an allocation to general damages must be reported. The answer to that, based upon the words of wisdom from Bhuvana, Kuzz, McHenry and others, is no.

All that said, counsel must be sure that any amount characterized as general damages in the context of a settlement of a wrongful dismissal claim is reasonable and commensurate to the claim. If it is included or inflated simply to avoid tax obligations, then liability is likely to follow.

Hopefully this will allow our bar to get back to work seeking reasonable solutions for our clients without fear that such a settlement will raise concerns with CRA and be akin to tax fraud. I have several mediations coming up, and I hope counsel will not refuse to consider reasonable allocations, where justified, due to the Financial Post article.

Stuart Rudner is a leading Canadian employment lawyer and mediator at Rudner Law. He is the author of You’re Fired! Just Cause for Dismissal in Canada. He can be reached at 905-209-6999 or

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